Mining’s improving fortunes weighed down by debt

TORONTO (miningweekly.com) – The mining sector was expected to climb out of the downturn’s trough by year-end 2016, Paradigm Capital partner and senior analyst David Davidson told an audience at a recent meeting of the Canadian Institute of Mining’s Management and Economics Society.

However, debt levels were a notable concern that needed to be tackled before the decade’s end. “The sector took on too much cheap money it can’t afford because commodity prices aren’t sufficient to cover interest and principal repayments,” he warned.

BORROWERS AND LENDERS
The industry’s performance across 2015 was reflected in equity levels that declined far below the corresponding slides in metals prices. “And that’s to be expected because it’s not all about the metal,” he said.

The damage done was reflected in the combined market capitalisation of TSX-listed base metals producers. The level was more than C$100-billion in 2011, falling to around C$15-billion by 2015.

Heavy leveraging started in the wake of the global financial crisis of 2008/09 when money became cheap and easily available. “But it’s now reached levels that threaten to cripple the industry,” warned Davidson. “The only major company not being hammered by this issue is Rio Tinto. The rest are in deep do-do.”

“The risk is not getting those debt loads down and we’re talking about significant repayments,” he told Mining Weekly Online.

Debt for most of the seniors matured in a three-year window starting from 2020. Competition for rollover was expected to grow as that timeframe nears, with concern that some of the banks would seek a high price in return for refinancing.

Interest rate rises by the US Federal Reserve might add to the burden, although the moves higher – expected to come in tranches of 0.25% – would be serviceable because the borrowing rate was low to begin with.

The year would also mark a turning point in terms of the industry restructuring and overhauling business models, either by choice or because of market pressure.

THE EAGLE AND THE DRAGON
The US’s ongoing economic recovery would help the global economy and, through that, mining. It was expected to achieve growth of about 2.5% in gross domestic product (GDP) this year, with two accompanying boosts in the interest rate.

An increase in December was unlikely because of the US election. “And I take all things off the table if Donald Trump gets elected,” Davidson quipped.

China’s GDP growth was expected to range between 6% and 7% for 2016, although many analysts take Chinese numbers with a pinch of salt.

The country continued its shift towards greater retail consumerism, which meant more household appliances sold or upgraded. “It’s not as metals-intensive as building airports or railways, but it’s still metal consumption,” Davidson noted.

China’s demand for copper strengthened across 2015 as tightening of future supply was noted. However, some of the recent upside was tied to pre-Chinese New Year buying, when most of the country comes to a halt and smelters seek to build up their stocks in preparation.

A major fillip for copper prices could come on the need to cover a spate of commodities shorts from last year. The positions were taken after the Chinese government decided to restrict shorting of the stock markets in August 2015.

“Billions of dollars were raised on this, with a lot of short positions taken on copper,” said Davidson. “There could be a massive short-covering rally whenever that changes.”

DR COPPER
Davidson estimated copper prices would stand at $2.35/lb for 2016; $2.75/lb for 2017; and $3.50/lb for 2018. Most copper producers needed prices to reach at least $3/lb to 3.10/lb for returns of 10% to 11%.

“Copper will be volatile in H1, biased towards the upside. We then see some improving fundamentals in H2, or at least people will be paying attention to fundamentals,” he said.

Output might be lower than many analysts expect in 2016 as several senior producers retrench, tweak output or face hurdles with their operations.

For example, MMG’s Las Bambas copper mine, in Peru, was expected by many to produce 300 000 t for 2016. It had already shipped its first 10 000 t of concentrate.

“But the big problem here is the absence of a port large enough to ship the volumes [desired] until mid-year,” Davidson said. “So output will be somewhat delayed in reaching the marketplace”.

He also mulled the negotiations between Freeport-McMoRan and the Indonesian government, which wanted to halt the export of concentrates and boost in-country treatment and refining.

Further, First Quantum’s Sentinel copper project, in Zambia, might have energy issues. Its power provider, Zezco, had struggled with low water levels affecting the Kariba dam, which supplies 65% of the electricity into the nation’s Copperbelt.

“Kariba is running at 25% capacity, with water levels at their lowest since 1995 and not getting any better,” he said.

A LITTLE NICKEL
Nickel had a tough year in 2015 as it continued to face oversupply. In large part this stemmed from new operations brought on stream between 2003 and 2008 that had proven unsuccessful.

The issue was complicated by China’s use of nickel pig iron to produce lower-quality stainless steel. That weighed on nickel’s potential uptake in the Chinese market.

“However, the availability of that material is now dropping off,” said Davidson. “The industry had been operating at about 480 000 t and there’s speculation that this is now down to around 400 000 t. I’ve also seen numbers predicting a drop to 300 000 t or below.”

The nickel pig iron decline could change China’s nickel market and start transforming the metal’s outlook. “China is going to rely on imported nickel as opposed to nickel pig iron for the foreseeable future and that should tighten things up,” said Davidson.

Supply would tighten further as nonviable operations were forced to shutter. Prices were expected to move from a current level of $3/lb to $3.85/lb to an estimated $4.50/lb for 2016, $6.50/lb for 2017 and $9/lb for 2018.

Davidson also noted that a normalised market price was between $8/lb and $9/lb, although it would probably take a couple of years to reach that point.