Major Industry Trends
The mining sector covers everything that companies extract by way of geological materials from the earth: from base and precious metals to coal, uranium, diamonds, rock salt, and potash. (Oil and gas extraction is covered in a separate sector profile and will not be considered here.) This profile will focus on the commodities aspect of mining rather than on extraction techniques, while the fortunes of particular companies in the sector will be touched on collectively, through an examination of merger and acquisition deals conducted during 2012–13.
The sector, along with agricultural products such as grain and coffee beans, constitutes the commodities sector, which is notorious for price volatility and boom-and-bust cycles. This has certainly been true in recent years. The price of many metals soared from around mid-2005 until the advent of the global financial crisis in 2008. Prices then plunged, but have been reviving gradually since the end of 2009. The price of commodities is clearly correlated to the global economic cycle, but the growth of emerging economies, particularly China, has also become a key driver in recent years. However, according to an IMF Working Paper published in May 2012, China’s impact on world commodity markets is rising but, perhaps surprisingly, remains smaller than that of the United States.
The paper says that China is a large consumer of a broad range of primary commodities. As a percentage of global production, China’s consumption during 2010 accounted for about 20% of non-renewable energy resources, 23% of major agricultural crops, and 40% of base metals. The paper adds that China’s commodity intensity of demand has been growing particularly fast, and is now unusually high. In terms of broad commodity groups, China has come to play a dominant role in base metals markets, and, to a somewhat lesser extent, agricultural raw material markets. In contrast, China has not yet assumed a large role in global food and energy markets, although its share of world imports is rising gradually.
The price of iron ore has also experienced a rollercoaster ride in recent years, with demand from China being a key driver. By the end of February 2013, the price of iron ore had jumped almost 80% since hitting a low of US$87 per tonne in September 2012, and analysts have been upgrading their profits forecast for the big iron ore miners. In February 2013, for example, UBS calculated earnings at BHP and Rio Tinto in 2013 would jump by 22% and 23%, respectively, while Fortescue’s earnings could jump by 54%, if spot iron ore prices were sustained. The upturn largely reflects hopes that Chinese economic output is picking up, and that the country’s demand for iron ore will also recover strongly. Other factors driving prices up include panic buying due to an expected cyclone in the Pilbara region of Western Australia, which led steel mills to replenish their stock, and political factors that led to many mines shutting down in India.
Rio de Janeiro-based Vale is the world’s largest iron ore producer and exporter. It posted net earnings of US$5.51 billion in 2012, down 75.9% from a record US$22.89 billion the previous year, partly reflecting the slump in iron ore prices in 2012. Vale reported a net loss of US$2.65 billion in Q4 2012, compared to net earnings of US$4.67 billion in Q4 2011. The company saw record sales of iron ore and pellets in 2012 of 303Mt, up 1.4% from the previous record of 299Mt in 2011.
One of the consequences of the adverse macroeconomic scenario seen in 2012 was a general decline in minerals and metals prices. “In this context, our financial performance was adversely affected,” said Vale CEO, Murilo Ferreira. “In 2013, we expect a less volatile market and an increased demand for raw materials, as 2012 was one of the most challenging years for the company.”
Copper prices also came under downward pressure in 2012, a development that also affected earnings at the big copper miners. In February 2013, for example, Kazakhstan’s largest copper producer, Kazakhmys plc, reported lower earnings as a result of a drop in copper prices, and output earnings before interest, taxation, depreciation, and amortization (EBITDA), excluding special items, dropped 30% to US$1.36 billion for the 12 months to December 31, 2012, compared with US$1.96 billion in 2011, missing analysts’ expectations. Revenue dropped 5.9% to US$3.35 billion, from US$3.56 billion in 2011,as the average copper price dropped 10% during the year, missing analysts’ expectations of US$3.41 billion.
Copper prices have continued on their downward trend in 2013. According to the Copper Development Association, 40% of copper demand is derived from the construction industry, as copper electrical wires and pipes are essential to both residential and commercial construction. However, housing demand remains weak in the United States and China. Concerns regarding China’s housing demand also increased after the Chinese government ordered cities to promptly curb housing purchases. China currently accounts for approximately 40% of the world’s copper demand.
Gold has seldom been far from the headlines in recent years. Demand for the precious metal has steadily risen since 2000, with much of it down to developing nations using their new-found wealth to fill their reserves with bullion. The increased popularity of gold jewelry, particularly in India, has also helped. But the asset is regarded as a safe haven that holds its value in times of trouble; demand surged following the global financial crisis, with many investors worried that the extremely loose monetary policies pursued by central banks around the world would reignite inflation. The gold price surged, eventually hitting a high of US$1,895 in 2011. Gold’s last bull market was at the tail-end of the inflation surge of the 1970s. However, by February 2013 the gold price had plunged to US$1,600 per troy ounce.
According to PricewaterhouseCoopers (PwC), the volume of global mining mergers and acquisitions (M&A) deals fell more than 30%, to 940 transactions in the first half of 2012, compared to 1,371 for the same period in 2011. The total value of deals for the first six months of 2012 was US$79 billion, slightly higher than US$71 billion for the same period a year earlier, but this includes Glencore International plc’s US$53.6 billion offer for Xstrata plc. Excluding that deal, the total value of transactions announced drops to US$25 billion, one-third of 2011’s first half-year total, reflecting global market uncertainty. In 2011, more than 2,600 M&A deals worth US$149 billion were announced in the global mining sector. Volumes were close to historic highs, and values were 33% higher than 2010. Buyers were plentiful, bidding wars ensued, and valuations were high. Not at all the kind of behaviors expected in a cyclical downturn, according to PwC.
PwC said that the top 40 mining companies invested US$98 billion in capital projects in 2011, and were planning for a further US$140 billion for 2012 in an effort to increase supply. The market, however, doesn’t seem to be buying the industry’s long-term growth story, which has sent share prices lower; 2011 marks the start of the growing disconnect.
PwC reported that:
2011 was a year of great contrast for the mining industry—record profits for the top 40 companies of US$133 billionn, but market capitalization fell 25%.
The market does not appear to buy the long-term growth story of the emerging world, as the European debt crisis lingers.
Supply will be a focus for future years as the industry has undergone a structural change in the cost base, as cost increased 25% on 2010.
The industry invested a record US$98 billion in capital projects in 2011 and planed for a further US$140 billion in 2012, but shareholders and investors are demanding greater returns of cash.