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2015-08-21 08:40:04
A decade of bingeing on raw materials may leave an even longer hangover
Aug 22nd 2015
IT WAS only a decade or so ago that Scotland was hit by the Great Drain
Robbery , the disappearance of 50 manhole covers in Fife. It gave an inkling of
the emergence of a new era in commodity markets, spurred by insatiable demand
from China. Scrap-metal prices and so scrap-metal thefts soared. Africa was
over-run by Chinese engineers; Australia elected a Mandarin-speaking prime
minister; and emerging markets from Argentina to Zambia relished the rising
values of their farmland and mines. The boom was fanned by a weak American
dollar, the currency in which most stuff that comes out of the ground is
priced.
The gears have now gone into reverse. A resurgent dollar has hammered commodity
prices: many have recently fallen below their levels of a decade ago. That is a
fate not shared by other tradeable assets: not since the late 1990s have
commodity prices been so weak compared with shares (see chart 1). The American
economy is strengthening, but by no means enough to encourage thieves to filch
bronze bells from Chinese temples to send as scrap to the United States. The
impact of its recovery is dwarfed by slowing demand in China, which still
consumes about half the world s metals such as iron, aluminium, and zinc.
The real curse for producers is over-supply in almost all raw materials. Yet
they continue to act as if they are blithely unaware of it. Capital is still
pouring into holes in the ground, creating a hangover that may last at least a
decade. Jeff Currie of Goldman Sachs, a bank, says past cycles suggest it can
take up to 15 years to work through the over-investment. The world has just
flip-flopped, he says.
Analysts point out that not all commodities act the same way. Coal prices
started falling in 2011; crude oil hung on until mid-2014; agricultural prices
hinge on the weather. But a generalised whiff of fear about China s economic
prospects has re-emerged in recent weeks, partly caused by sliding stockmarkets
and by the unexpected devaluation of the yuan this month. So far this year,
almost all major commodities energy, industrial metals and agriculture have
fallen in a 10-20% range, a fairly homogenous performance. What s more, the
supply glut is being fed by three common factors. Cost-cutting has led
producers to think they can bear the pain of falling prices for longer. Heavy
hitters, whether OPEC princes or global miners, still yearn to increase market
share. And funding is still available.
The cost cuts are part of a self-reinforcing downward spiral. Outside America,
cheap currencies vis- -vis the dollar have made domestic inputs, such as
manpower, appear less pricey. Ironically, cheaper energy and steel help, too.
In Australia, for example, Gina Rinehart, a mining tycoon, uses low costs to
justify opening a $13 billion mine in the outback that is expected to produce
55m tonnes of iron ore a year as much as America s annual output.
In the oil world, cost cuts have come from producers once thought likely to be
wiped out by falling oil prices: shale producers. Frackers have slashed a
third off their cost bases, and continue to pump enough black stuff to depress
prices. Lower costs may give them a false sense of security about where prices
will go: when crude prices temporarily ticked higher in America this spring,
the number of drilling rigs rose for the first time since December. Shortly
afterward prices fell again.
Among drilling titans, efforts to recoup market share from fracking upstarts
can appear counterproductive. Led by Saudi Arabia, OPEC is pumping well above
its 30m barrel-a-day quota, helping push crude prices to below $47 a barrel on
August 19th, just about the lowest level since March 2009. But if it intended
to strangle American shale producers, its plan has backfired, instead pushing
frackers to become more efficient. Meanwhile global miners such as BHP Billiton
and Rio Tinto have continued to increase iron-ore production, despite plunging
prices. Analysts say they are trying to drive higher-cost competitors in China
and elsewhere out of business.
Funding avenues have not closed down, however. Tom s Guti rrez of Kallanish
Commodities, an industry watcher, notes that in China steel output has only
recently peaked. Yet rather than facing bankruptcy, many inefficient steel
producers are limping along thanks to local-government support. Their surpluses
are exported, adding to the pressure on global steel prices (see chart 2).
In the oil industry Goldman s Mr Currie says that, unusually, high-cost output,
such as Canada s tar sands, is owned by oil majors with strong balance-sheets.
Though they have cut spending, it may take longer to shut down entire projects.
Eventually stresses will manifest themselves more violently. Small shale
producers may find themselves in a pickle unless prices stop falling. Deutsche
Bank notes that energy companies account for about one in six of America s
high-yield borrowers. It believes American crude prices below $55 a barrel may
push them into financial distress. OPEC has its own invalids, such as
Venezuela, Nigeria and Libya.
But the latest leg down in crude prices may not yet have run its course. Saudi
Arabia, the all-important swing producer of the cartel, is deaf to talk of a
cutback. Earlier this month it raised $5 billion to offset flagging oil income.
America s summer driving season is ending. If an Iran nuclear deal is ratified
by America s Congress next month, once-embargoed oil will start flowing.
Glencore, an Anglo-Swiss miner and commodities trader, reported whopping losses
on August 19th. Its boss, Ivan Glasenberg, has railed against rivals unwilling
to throttle back production and decried prices that are still not making any
sense .
If these are daunting headwinds, they are not unusual. When prices fall far
enough for long enough, output does eventually decline, as it started to do
with nickel last year. In the meantime, big mining and oil firms will take over
smaller ones and shut down their weakest assets. Then another decades-long
cycle can start.