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China Slowdown Cools Commodities

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Pacific Money

China Slowdown Cools Commodities

Weakening demand in China is having significant ramifications for the resources sector, particularly in Australia.

China Slowdown Cools Commodities
Credit: Australian coal via

China’s economic chill has sent shivers down the spine of the global resources industry. With prices of coal, iron ore and other commodities tumbling and mines shutting down, Beijing’s move to curb lower-quality imports has not helped sentiment, although many miners remain upbeat.

On Tuesday, coal miners in Australia’s resource-rich state of Queensland awoke to yet another mine closure, with Japan’s Sumitomo Corporation confirming it was placing the Isaac Plains mine near Moranbah on “care and maintenance” with plans to cease operations by January.

Owned jointly by Sumitomo and Brazil’s Vale, the mine employs nearly 300 workers and is the latest to suffer the effects of coal’s decline. Its closure closely followed an announcement by the BHP Billiton Mitsubishi Alliance (BMA) that it would cut 700 jobs from its central Queensland mines, adding to an estimated 12,500 job losses from the Australian coal sector over the past two years.

The cutbacks reflect tumbling coal prices, with the benchmark spot price for metallurgical (coking) coal from Queensland trading at $112.75 a metric ton Monday, compared to the $300 it reached in 2011.

Meanwhile, the iron ore price crashed to a five-year low the same day of $77.70 a ton, with Goldman Sachs forecasting an expanded global surplus as major miners ramp up production despite reduced demand from China, the world’s biggest steelmaker and consumer of iron ore.

In its latest quarterly forecasts, Australia’s Bureau of Resources and Energy Economics (BREE) said prices of the nation’s key exports of coal and iron ore would not recover for at least two years, largely due to excess supply.

“Global supply has grown significantly over recent years with the prospect of further increases in supply over the next few years. This has placed pressure on commodity prices in the medium term,” said BREE’s deputy executive director, Wayne Calder.

According to BREE, the price for the key steelmaking ingredient of metallurgical coal averaged $128 a ton from January to August, down 21 percent on the corresponding period last year.

“Metallurgical coal prices have declined in response to oversupply and reduced import demand from China stemming from the cyclical downturn in the real estate sector,” BREE said, noting that “many metallurgical coal operations are unprofitable at prevailing prices.”

With further weakness in China’s housing market expected to persist in 2015, BREE said prices would decline another 2.6 percent to average $123 a ton next year, rising modestly to $130 by 2019.

For thermal coal, which is used in power generation, BREE said prices averaged $73 a ton in the first eight months of 2014, down 16 percent year-on-year due to “abundant supply and reduced import demand.”

“Coal prices are forecast to remain subdued throughout the remainder of 2014 in response to weaker import demand from China and a continued abundance of supply. At lower spot prices many producers are unprofitable, which is expected to support further cost-cutting measures and signals the risk of more mine closures or production curtailments over the remainder of the year,” BREE said.

However, the researcher said large volumes of new coal-fired electricity generation were being developed, particularly in India and China, resulting in a forecast upturn in prices to $86 a ton by 2019.

For iron ore, BREE said prices would average $94 a ton in 2014, down from its December forecast of $119 a ton, with prices expected to average between $90 and $95 over the next five years.

“Iron ore prices are expected to rebound from the current low levels, but remain well below the high prices seen in previous years due to the supply overhang that is prevailing. As in previous price cycles, a number of higher cost producers, both in China and around the world, will be forced out of the market over time to reduce the oversupply,” BREE said.

BREE painted a mixed picture for other commodities, forecasting declining prices for copper, gas and gold but an upturn for aluminum, nickel, uranium and zinc.

China Pollution Drive

China’s decision to ban “dirty” coal imports to fight pollution has added to the pressure on miners. According to China’s National Development and Reform Commission (NDRC), coal with ash content exceeding 40 percent and sulfur of more than 3 percent will be prohibited from sale and import from January 1.

The regulations are even tougher in major cities such as Beijing and Shanghai, where the restrictions comprise 16 percent ash and 1 percent sulfur.

The move by the world’s largest coal consumer could see imports drop by as much as 15 percent to below 300 million tons this year, analyst Winston Han said.

Consultant Wood Mackenzie said the move could affect more than half of Australia’s thermal coal exports to China, which total 49 million tons a year, as well as Indonesian exports.

However, the Minerals Council of Australia said the nation’s A$2.7 billion ($2.37 billion) annual thermal coal trade with China would not be affected.

“There is nothing in the information which suggests that Australian coal exporters will be disadvantaged and we are confident that we can meet the proposed specifications. Australia is fortunate to have reserves of high quality black coal, which will continue to be in strong demand from established and emerging markets, including China,” it said in a statement.

Citi Research commodity analyst Ivan Szpakowski even suggested that the move would be more damaging to Chinese producers than importers, restricting domestic supply and forcing up prices.

Michael Ryan, director at Balance Advisory, told The Diplomat that the impact would be mixed, with the potential for other Australian coal to displace affected imports. Non-complying mines could also potentially wash their coal at an additional cost to meet the regulations.

“I don’t see it as anywhere near the biggest issue affecting Australia’s international competitiveness…the demand side remains strong with record exports, but Australia still has a high dollar and high cost base with an oversupply in the market in general at this point in time,” he said.

“There won’t be a significant upswing in the next 12 months until the oversupply eases, but after that there is some positive news in terms of Asian demand, such as new coal-fired power stations being built in [South] Korea.”

Brice Mutton, director at Australia’s Cuesta Coal, said China’s move highlighted the opportunity from so-called “eco coal,” with growing demand from power plant operators for higher quality coal.

He cited a study by analyst Lindsay Juniper, which said the substitution of Chinese domestic coal with Australian supply, such as from the emerging Galilee Basin, could result in lower emissions as well as increasing efficiency.

“There’s a disconnect between the buyers and power station operators, and that gap needs to close. The buyers are trying to get coal very cheaply and not caring about the quality very much, and that disconnect has to be fixed,” he said.

Quentin Hill, managing director of Australia’s Carpentaria Exploration, said China’s move to improve efficiencies would also improve demand for higher quality iron ore.

“China’s focus on reducing pollution is being treated seriously by its steel mills, with stringent standards expected to be introduced next year. The mills will be looking to improve efficiency and reduce emissions and this will lead to increased demand for high grade, low impurity products,” he said.

“There is no doubt there is a short term oversupply of iron ore, but the medium and long term fundamentals are good, especially for higher grade products such as the one we’re targeting at our Hawsons project.”

A recent industry survey showed that Australian miners remain upbeat, with 72 percent of respondents expecting an increase in commodity prices in the year ahead. According to Grant Thorton’s 2014 JUMEX Survey of 100 junior mining and exploration companies, 41 percent also reported improved investor interest, despite challenging market conditions.

With the China boom fading, miners are eagerly awaiting an upturn in other emerging markets such as India, which is forecast to double thermal coal imports by 2020.

“The downturn will not continue forever,” Mitsui Australia’s chairman and chief executive Yasushi Takahashi told The Australian, predicting a rebound in prices by 2018.

According to Takahashi, cycles in mining are long and investors need to roll with the punches – even if China’s performance weakens further.