EY: More Pain Ahead for Metals and Mining before Recovery in Price, Productivity

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Written by Richard Finlayson, Senior International Editor for Industrial Info Resources (Sugar Land, Texas)--Falling commodity prices, recalcitrant capital markets, and a greater-than-expected softening in Chinese demand growth made 2014 a year to reacquaint most mining and metals companies with their cyclical industry, according to Mike Elliott, global mining and metal leader of EY (Ernst & Young) (London, England) global mining and metals leader.

"We have probably already seen the bottom for a number of commodities, including base metals such as zinc, lead, copper, metallurgical coal, uranium and aluminum," he said. "For other parts of the sector, it may take more time for the imbalances in supply to work through, and there will be continuing price volatility and more casualties among high- to mid-cost producers.

"The outlook is different for each commodity. It would be much easier, for example, to raise capital for a zinc or metallurgical coal project than it would be to raise money for a thermal coal or iron ore project.

"By 2017, most commodities should have recovered and prices are likely to be at a level that encourages new supply."

Price and currency volatility, productivity, and capital allocation and access to capital are the biggest issues weighing on mining executives going into 2015.

"This cyclical price trough is acute because the peak of the super-cycle was also acute. The speed with which prices have fallen in the past six months and the likely ongoing price volatility make it incredibly difficult to have a stable business model," he said.

"During the past 12 months, most miners moved from outright cost-cutting into productivity mode, but this is a two-to-three-year transformation. The need for sustainable, enduring productivity improvements, which inevitably also deliver cost savings, remains the key business issue for miners going into 2015."

With tighter margins, miners have responded with cuts estimated at $20 billion to $25 billion in the past 12 to18 months.

Capital allocation and access to capital remain key issues going into the new year, with shareholders continuing to demand buybacks and keep a tight grip on investment purse strings.

"The risk aversion of the capital markets to the sector was not expected to last as long as it has. The lack of investment in exploration and development will come back to bite and may exacerbate the peak of the next upswing," Elliott said.

In 2014, the public attention given to the anti-coal lobby surprised many people in the coal sector, and the broader mining sector did not anticipate the new momentum on carbon reduction initiatives by the U.N. Intergovernmental Panel on Climate Change's 2014 assessment report and, more recently, the U.S.-China cooperation agreement on climate change and clean energy.

"This potentially changes the economics of energy-intensive projects for mining and metals companies," Elliott said. "At the beginning of the year, carbon constraint was probably seen as a medium-term issue, but it has now moved to a short-term issue with potential business model impacts."

A significant trend in 2014 was the "blurring" of the gap between producers and traders, with Trafigura (Lucerne, Switzerland), Glencore (LSE:GLEN.L) (Baar, Switzerland) and Vitol (Rotterdam, Netherlands) making upstream acquisitions. At the same time, the larger producers have been expanding their sales and marketing operations to include the classic functions of trading companies.

For related information, see August 19, 2014, article - EY Report: Productivity is Top Risk Facing Mining and Minerals.

Industrial Info Resources (IIR), with global headquarters in Sugar Land, Texas, three offices in North America and 10 international offices, is the leading provider of global market intelligence specializing in the industrial process, heavy manufacturing and energy markets. Industrial Info's quality-assurance philosophy, the Living Forward Reporting Principle™, provides up-to-the-minute intelligence on what's happening now, while constantly keeping track of future opportunities.