Although 2014 was, to quote the Queen of England, an ‘annus horribilis’ for mining in general and African mining in particular, there is no reason for the mood of gloom that seems to have descended on traders. Prices have been low and it has been very difficult for miners to make ends meet but China, the world’s largest consumer of commodities, may make a rebound this year and the next on the back of low oil prices, and the current lack of investment could easily lead to shortages which will drive prices back up. In fact, argues MJ Morgan, low commodity prices could be more of a good thing in the medium term than bad.
Reading the Chinese tea leaves
It is unlikely that the great 20th century philosopher, Ludwig Wittgenstein, had African mining in mind when he wrote in his Tractatus “The world is everything – that is the case” but, nevertheless, the great man’s words would serve as a useful tonic to the doom and gloom of some of the sector’s commentators at present.
After all, following a year in which iron ore halved in value, gold, platinum, copper, coal and, of course, oil all fell in price, pessimism might seem to be the order of the day. One cannot help but wonder if, after more than 15 years of an upward trend in prices, whether this is the end to the fabled ‘supercycle’ or, contrarily, merely an anomaly before the upward trend continues?
As avid readers of African Business well know, the biggest driver of commodity prices is Chinese demand. The Middle Kingdom imports two thirds of the world’s seaborne iron ore (which it uses to produce half of the world’s steel), 40% of its copper and – in addition to a chunk of all other major metals – is the second largest importer of gold.
So to seek to understand both the decline in commodities prices in 2014 and the outlook for the sector in 2015 requires close examination of the Chinese tea leaves. Will the country’s remarkable growth continue? Will it overheat? Will it come grinding to a halt?
There are concerns about an overheated property sector and a debt to GDP ratio that, according to Standard Chartered, has risen from 150% in 2008 to 250% today. While this is a rapid increase, it is still slightly lower than the US and UK, for instance – and much less than Japan’s 415%.
But China also has significantly more tools at its disposal with which to direct its economy than its larger rivals. Its ability to direct consumer spending, public spending and drive exports by using its currency peg to increase its competitiveness are all powerful levers.
Whether commodities prices are high on optimism or crushed by pessimism, it remains the case that developing countries such as China consume proportionally more commodities per unit of growth than developed countries. On current UN forecasts, the Chinese population of 1.3bn is set to rise to around 1.5bn by 2030, by which time the proportion of the population living in cities will also have risen from 40% to 60%.
What does this mean for commodity-exporting nations in Africa? It means China is going to need all the commodities necessary to provide houses, infrastructure and goods for 200m new people –which is the population of Nigeria, but with average incomes in excess of that in South Africa.
One of the reasons mineral prices tend to lurch up and down is the simple elasticity of supply. A mine typically has a 25-30-year life, requires vast amounts of capital expenditure to commission at the start of its life and, depending on the random progression of prices over that long period, may be burning piles of cash to the point where it has to be mothballed; or, on the other hand, earning it so fast that host nations clamour for windfall taxes or even nationalisation.
This is why the paradox arises – the best cure for low prices is low prices and vice versa. In iron ore, the big players, and many juniors too, have piled in to capitalise on prices that have risen relentlessly (see cover story) and now prices have halved, they continue to do so in the belief that they can keep costs low enough to survive and that they will benefit from the crushed competition (those same poor juniors) they leave in their wake.
Low prices mean high-cost production ceases and exploration is not economically viable. This inevitably leads to insufficient investment over the medium term and a sharp rebound in prices as a supply bottleneck forms when demand recovers.
Furthermore, it remains the case that only the Arctic has been prospected in detail less than sub-Saharan Africa. According to economists like Paul Collier, the amount of minerals, so far un-prospected, under the African soil, is vast and at least five times greater than current estimates.
Lower commodity prices also provide a unique opportunity to expand African production up the value chain to create more wealth and more jobs. It is an opportunity to tackle the continent’s challenging operating environment and address its lack of cost competitiveness. Capital is hard to come by, so this imposes discipline and drives creativity and entrepreneurship. It is a chance to further the African Mining Vision agenda. To build infrastructure, develop skills, and introduce effective mining codes that equitably share the risks and rewards of mining between operator and host nation.
Along with water, power is another major problem for the continent’s miners. Therefore the current low oil prices also provide a boost to those dependent on generators or power produced using imported oil. It also provides a boost to all those economies that import oil, African or otherwise, that is worth an estimated additional 0.5% to the global growth rate – i.e. something like $400bn.
The benefit of lower oil prices is also going to be keenly felt by the largest oil importer of all, China. China’s demand has risen from 2.5m barrels per day (mbpd) in 2005 to 5.86mbpd in 2012 and an estimated 9.2mbpd in 2020. This will save the country billions of dollars this year if prices remain at current levels, freeing up money to spend on other commodities and resume its spectacular growth pattern.
However, it is true that October saw the publication of the worst Chinese manufacturing data since 2008, when there was a credit stimulus in place. Quarter 3, year on year, saw growth at 7.3%, its lowest level in five years. Goldman Sachs forecasts growth to remain at 7.3% for the final quarter of the year.
But China’s economy has been growing at breakneck speed for years. It grew (in 2013 dollar terms) from $168.367bn in 1981 to $8.227 trillion 30 years later. It is natural that maturity should bring slower growth rates. Chinese growth above 7% presents little risk to commodity markets, just as it brings little froth. Neither of these outcomes is as terrible as some would have one believe.
China imports around 80m tonnes of iron ore a month, more than two thirds of which comes from Australia and Brazil. At present, China sources some 8% of its iron ore from Africa. Africa is currently the source of just 4-5% of the world’s iron ore production but possesses reserves substantially in excess of that proportion.
By 2020, Africa could be producing 400m tonnes or more of iron ore a year.
The current situation is far from desperate, the outlook for prices is probably flat but we may find there has been overselling. This is a chance for producers to cut costs, utilise technology better, plan more strategically to manage political and price risks improve access to energy and water and resolve conflicts with governments and communities; in a nutshell improve their competitiveness and be ready to make hay when global growth proves to be more resilient than flighty traders fear.