Q: What do we need to know to understand the mining and metals industries?
In so many ways, the story of mining and metals, today, is the story of China. Globally, the mining and metals sector has a $1.5 trillion annual value. For many years, it grew more or less in step with global GDP. Starting with the turn of the millennium, the sector and demand for commodities started to grow significantly faster than global GDP. The main reason for that was the takeoff of the Chinese economy, particularly infrastructure and manufacturing.
At this point, between 40% and 60% of every mineral that gets dug up anywhere in the world ends up in China. So the slowdown in China’s economic growth now has caused softening of the sector worldwide.
Q: How does the sector break out?
On a value basis, 40% is thermal coal. That is the roughly 6.5 billion metric tons consumed in coal-fired utilities for electricity generation. Iron ore, used in the production of steel, is another 20%. Coking coal, which is also used for steel production, is about 15%. And it goes down from there: copper, gold, bauxite, nickel, zinc, etc.
China accounts for about 50% of the world supply and demand of coal. But they have traditionally been a big coal producer and more or less self-sufficient.
China has gone from being roughly 15% of global steel production and consumption at the turn of the millennium to close to 50% today. That’s particularly important because, unlike coal, when it comes to raw materials, China lacks the necessary quality and size of iron ore reserves. The reserves are in Australia, Brazil, and, to a lesser extent, India and South Africa.
With the surge in demand came a significant escalation in prices. From 2000 to 2012, prices for iron ore increased by about 1,000%. Coking coal prices increased by 300%.
Q: Were there issues beyond Chinese demand that led to the price spikes?
Prices escalated so rapidly and so significantly because the supply of many minerals and ores was constrained, and that was because there had not been a lot of investment in capacity during the prior decades. Demand was only growing at GDP. Prices were relatively stable. There was little economic incentive to expand mining capacity.
To put that in context, going back to the 1970s and 1980s, large parts of both the mineral and the steel sectors were in one form or another state owned. Since then, there has been significant privatization and consolidation. Companies used capital to acquire other miners and to build scale in individual commodities. That means in some cases there’s an oligopolistic industry structure. Three companies account for 65% to 70% of the globally traded iron ore, as an example.
Consolidation continues, but the surge in demand and prices has also spurred significant capital investment to identify and develop mineral resources around the world. The activities of identifying and developing new mineral resources is carried out by both the incumbent producers and newcomers who saw opportunities or had access to mineral rights. This very much includes the Chinese. It’s well known and well documented that the Chinese have been extremely aggressive in overseas investments to acquire and develop minerals and energy.
Further, much of the Chinese steel industry is under government control. The central government controls about 20% of steel industry capacity; another 40% to 50% is in the hands of regional or provincial governments. Those producing entities are getting either direct or indirect government subsidies and that introduces a set of very political issues around trade. This gets into global supply and demand and commodity pricing.
Globally, the sector has gone from rapid growth to retrenchment, in large part because, having built out the infrastructure and manufacturing capacity, the Chinese government is reshaping its economic growth model to get more services and more consumer spending. Those activities are significantly less steel intensive. Whereas the global demand and production of steel had been growing by 10%, now, with the Chinese GDP in the 7% to 8% range, steel growth is in the 2% to 3% range, which means there’s significant excess capacity in China. That acts as an overhang to the world’s supply and demand, affecting steel prices.
For most of the world, excess capacity is being addressed through industry consolidation and capacity rationalization. There’s a wall preventing foreign entities from participating in that process within China. The minerals and mining sector is closed to majority control by foreign entities. Government ownership of much of the sector exacerbates the excess capacity issues. This is having major impacts on the pricing and profitability of metals and mining companies all around the world.
Q: How is this economic shift playing out inside China?
What drives Chinese decision making is the leadership’s views about what is required to maintain stability—and stability is a code word for social order. Their goal is keeping people from being so upset about pollution and environmental issues that they challenge the government.
You open up any newspaper on any given day and you can see articles about the horrendous air or water pollution in China. Having lived in Beijing, I can tell you it is worse than it seems. It is unbelievable. They’re literally killing their people with the pollution. At the same time, increasing literacy and access to the internet is making what was an environmental issue into a political issue.
There are a lot of factors that contribute to the air pollution in China, but overwhelmingly, the biggest factor is that 70% to 75% of electricity production is from coal-fired furnaces, often old coal-fired furnaces. By ratcheting down electricity consumption and trying to shift the sources of energy, they’re trying to improve their environmental conditions, particularly air pollution, quickly.
They are very deliberately trying to reduce their dependence on coal. This links to the long-term outlook for global coal pricing. Coal, used for power generation, tracks the pricing for other energy commodities. It is a direct substitute for other forms of energy—not that they’re substitutable in large scale in the short run but, over time, they are.
On a value basis, coal is 40% of all the minerals and ores extracted globally. It’s not just China’s shift weighing on global pricing for thermal coal. There is the global economic slowdown as well as the prospect of sustained low pricing for shale gas in North America. Those add to China’s efforts to both reduce the energy intensity of its GDP growth as well as its dependence on coal.
Q: How do climate and carbon issues impact mining and metals?
CO2 is an issue for mining but it becomes more of a concern as you move further downstream into steelmaking, aluminum production, and copper smelting. Again, this is an area where the Chinese steel industry has a disproportionate impact. Globally, the steel industry produces about 1.8 metric tons of CO2 for every metric ton of steel. In China it’s significantly more. Much of that is how bad the coal-fired utilities are with respect to technologies for pollution control.
This goes into trade and sustainability issues. The U.S. and Europe have, at times, contemplated more aggressive CO2 restrictions and taxes. I think CO2 controls are absolutely essential. However, there was a real potential for perverse outcomes if regional restrictions on CO2 had forced the closure of steelmaking in Europe or North America, which was certainly a potential outcome. Substituting the relatively carbon-efficient production in mature economies with imports from China would’ve measurably worsened global CO2 production.
Q: Do sustainability issues get attention in the sector?
Going back upstream to the mining stage, sustainable business practices are absolutely on every CEO’s top-of-mind agenda. There are social and environmental sustainability issues associated with this scramble for resources going on all over the world. At the mining stage, sustainability is fundamentally about environmental protection, sovereign rights, indigenous rights, and developing a workforce.
I’m not going to say that the performance of the miners in their traditional mining locations was pristine. There are lots of horror stories about adverse environmental and human health impacts associated with mining activities around the world. But when demand for mineral ores was growing slowly, exploration and new development was done in a measured way and in parts of the world where the sectors were mature.
With the rapid rise in prices, it became economic to seek out and then develop other sources of supply. But because the good locations were already being developed, getting the next increment of supply typically requires going into new regions and accepting lower quality in the underlying reserve. Shipping material out of these remote areas requires putting in rail lanes or pipelines. Those increase cost and environmental exposure. All of it requires larger and larger amounts of capital investment.
As miners ask to open up new locations that are often more remote and further into indigenous-population areas, there has been growing awareness on the part of many governments about impacts of mining. Governments are much more sophisticated and much more appropriately aggressive about commanding behavior.
Countries which in the past might’ve been willing to simply export a raw material have increasingly been insisting on either higher taxes or more value being added to the raw materials in-country in order to create wealth, create jobs, and promote development. We see this all over the world. Brazil, Indonesia, South Africa, and India have all made strong efforts to either keep or utilize raw materials in-country to drive economic growth.
Often governments are requiring mining companies to make massive social infrastructure investments to support the workforce—schools, hospitals, and so on. The company has to develop a workforce, train people, and create a viable, sustainable community in these remote locations.
In a world when everybody is trying to get their hands on resources, how does your company position itself to get the preferred resources at the right price? That has to do with your capabilities in exploration along with everything else you’re willing to do from the sustainability and social-development standpoint. All told, if your goal is to mine and develop commodities, how you manage all the stakeholder groups is of critical importance.
Interview conducted and edited by Ted O'Callahan.