Mining & Metals 2019: China and trade tensions top industry fear list
Monday, 21 January, 2019
In brief: A worsening of the ongoing economic slowdown in China, consumer of about half the world’s commodities, is the single biggest challenge mining and metals companies face this year, a new survey of senior executives shows.
The global mining & metals sector spent 2018 in the thrall of macro uncertainty and geopolitical tensions. The impact was a challenging year for commodities, especially those susceptible to speculative money flows rather than underlying fundamentals. While most accepted gauges for base metals, such as LME stockpiles and end-user demand, signalled bullish signs, metals across the board from copper to aluminium suffered significant price declines last year. Even gold remained relatively flat in 2018, but corporate activity not seen elsewhere has given that sector a shot in the arm that should play out this year, and analysts expect prices to move up as investors may start to turn to 'safe' assets.
Uncertainty dented appetite among investors for mining & metals stocks, and despite reporting substantial profits, often at multi-year highs, in addition to further record distributions to shareholders, most equities ended the year in the red, following two years of outperformance. Therefore, the sector faces a large degree of uncertainty heading into 2019. To get an idea of what to expect, White & Case has conducted its third-annual straw poll of industry participants, with 51 senior decision-makers providing us with their thoughts for 2019.
Responses from our survey indicate that an economic slowdown in China, consumer of about half the world's commodities, is the single biggest fear for the mining & metals sector this year, with one-third of our respondents highlighting that as the key headwind. It was closely followed by trade tensions, which have ramped up in recent months with US President Donald Trump's increasingly aggressive trade policies with China. About 20 per cent of respondents see this as the key risk to the sector for 2019.
China; the biggest challenge for the mining and metals sector
Markets seem to have absorbed the impact of the current raft of trade barriers — US import duties on steel and aluminium, and defensive safeguards from the EU and elsewhere in the world — and there is cause for optimism. But White & Case’s survey results indicate that the main impact of trade tensions this year will be on speculative pressure on commodity prices, rather than any erosion of underlying demand for the hard commodities.
Companies, they say, will likely place mergers and acquisition on the back burner and focus instead on getting the most out their current assets, while increasing returns to investors. Shareholder returns will be the mining sector’s number one priority, according to 31% of the executives interviewed, closely followed by productivity gains, according to 29% of them, the report shows.
“That’s a similar picture to what our respondents expected last year, when a similar percentage expected shareholder returns to be the main goal for management,” White & Case’s partners Rebecca Campbell and John Tivey write. “However, looking back to our 2017 survey, it was debt reduction that was seen as the keen focus, showing how successful the sector has been in moving from balance sheet recovery to rewarding investors.
Another key issue the industry will have to address this year is the use of balance sheets to fund expansions. Given the wary approach to growth and lack of major deals, major producers have plentiful cash on hand to fund much of the limited growth they are pursuing, the experts say.
A case in point is Anglo American’s new Peruvian copper mine, Quellaveco. Its development will be funded through cash flow, while many of the additional brownfield expansions planned by the majors will be paid for from earnings.
While the survey’s respondents expect to see a combination of financing this year, balance sheet funding is deemed as the most likely route, while raising equity is seen as the least likely, as investors are still reluctant to pay for new capacity.
The one area in which mining executives expect to see real growth is the use of streaming and royalty funding, with two-thirds expecting an increase this year.
Clean skies to hurt coal
Thermal coal was one of the standout commodities in 2018, with prices sitting above US$100 per tonne for most of the year, the highest since 2011. The fuel is largely immune to speculative money given that most contracts are settled directly between producers, traders and customers without the same level of securitization or open trading platforms that exist in base metals or oil, but it has also been supported by increasingly dislocated supply-and-demand fundamentals.
China dominates both factors, mining and burning more coal than any other country, and it has increasingly looked to import higher-quality and less-polluting coal as part of its Clean Skies directive. That's put a squeeze on the seaborne market at the same time that many of the biggest producers start to turn their back on the fuel.
More than half of the respondents to our survey expect coal to be the most impacted commodity from China's continued polices to reduce pollution from its air. Rio Tinto has sold all its coal mines, while BHP and Anglo American have said the fuel will struggle to compete for capital against commodities such as copper. New entrants to the market are also constrained as banks and investors become warier of funding coal production. Lenders to the industry cut funding to US$14.9 billion in 2017 from US$22.5 billion in 2015, according to BankTrack, while at least 15 of the biggest banks have policies that prevent investing in coal projects.
This is a significant break from traditional commodity cycles, where sustained high prices often induce new supply. Yet, as the International Energy Agency confirmed in its annual report on coal in December, risks associated with climate policies and local opposition continue to prevent significant new investment.
That's made it a very profitable space for those still mining thermal coal. Glencore is the only major miner that is increasing its coal footprint, having bought mines, along with Yancoal, from Rio. That's set to see its coal profits jump to US$6.2 billion in 2019, eclipsing its copper earnings this year for the first time since listing in 2011, according to the company. Anglo, which still operates major coal mines, is also forecast by analysts to get more than 40 per cent of its 2018 profits from coal, despite the company’s core assets being platinum, diamonds and copper.
Resource nationalism is a near constant theme in mining, and 2018 proved to be no different. A new mining code in the DRC became a political flashpoint as an alliance of miners, including Randgold, Ivanhoe and Glencore, sought to change the government's stance on raising taxes and royalties, while scrapping a ten-year standstill agreement. Tanzania and Zambia were also more aggressive with some of their resident mining companies, using outstanding tax bills as a source of leverage. Indeed, one respondent expected government revenue collection pressures to be the most prevalent theme of 2019.
Our survey showed that while only about 8 per cent saw resource nationalism as the biggest risk for the sector, 61 per cent expected Africa to be the most risky jurisdiction. Ongoing elections in the DRC, where President Joseph Kabila's 18-year rule is set to end, will probably prove to be the main focus for investors.
Elections are also set to be held in South Africa in the first half of the year. Given the country's work on a new mining charter, and importance to the industry, this will be a very closely watched vote.
Technological innovation gathers pace
While the mining industry has not traditionally been considered to be at the forefront of innovation, the sector continues to take steps that will ultimately revolutionise the impact it has on not only the environment, but also employment and productivity. 2018 was a big year in terms of automation, as the big Australian iron ore miners continued to drive forward in this space. Rio Tinto completed its first fully autonomous train delivery across Western Australia, moving 28,000 tonnes of ore 280 kilometres, all controlled from a tech hub in Perth. Resolute Mining is currently commissioning the first fully autonomous underground gold mine in Mali, while Anglo American unveiled its new FutureSmart Mining programme that has goals such as reducing water use by 20 per cent by 2020. More than 40 per cent of our respondents expect cost pressures to be the biggest driver of continued innovation in the sector. This is likely to gather pace as miners see rivals using automation, live data analytics and integrated supply chains to gain advantages, forcing them to follow suit if they want to hold positions on the cost curve.
Yet the industry is also making use of more fast-moving technologies such as blockchain. So far, the technology has been most developed in sectors where consumer confidence is key. De Beers, trying to combat concerns around supply chain traceability and the long shadow of conflict diamonds, is trialling a blockchain-based tracking programme that has gained support from some of the biggest retailers. There are also moves from the big technology companies and carmakers to use such innovations to assuage concerns about the cobalt supply chain. Still, it might be too early for this technology to be a game-changer for the wider commodity market. Just 3 per cent of our respondents expected a widespread rollout across the industry this year, while 20 per cent saw it gaining little immediate traction. Still, as more industry participants understand its potential benefits and as consumers and manufacturers become increasing aware of the need for supply chain transparency, it's likely to gain momentum.