Commodities cycle is alive and well – and turned very, very bearish

By Clyde Russell

ComoditiesLAUNCESTON, Australia, Nov 27 (Reuters) – Anybody who still has lingering doubts that the commodity cycle has turned bearish need only delve into two reports released this week on Australia’s resources sector.

The half-yearly report from the Bureau of Resources and Energy Economics (BREE), the government’s forecaster, showed only three projects, worth a total A$597 million ($507 million), reached a positive final investment decision (FID) in the six months to October.

This is not only the lowest number, but the lowest value for more than a decade, and is conclusive proof that investment in projects is waning under the burden of low prices and more muted demand forecasts as growth in top buyer China slows.

The other report released this week came from consultants PwC, with their annual review of mid-tier Australian miners showing companies are now trying to maximise productivity by boosting output while cutting costs.

The problem is so far these efforts aren’t bearing fruit, as prices fall faster than the companies can make improvements.

“In fact, the worst may be yet to come, at least for iron ore and coal miners,” PwC said in the Nov. 25 release.

What both reports confirm is that the decline in commodity prices has put the brake on new projects, while also forcing companies to cut costs in a bid to try and survive for longer than competitors.

This has both short- and long-term consequences for the resources sector, not just in Australia, which is the top exporter of iron ore, coal and will be in liquefied natural gas (LNG) once the seven projects being built are completed.

The reports may be focused on Australia, but they will resonate in other resource-rich countries such as Indonesia,South Africa, Brazil and Canada, where companies are all exposed to much the same pressures and dilemmas.

The short-term impact of cost-cutting and trying to lower the unit cost of production by boosting volumes and productivity is likely to be lower prices for a number of commodities.

This has already been seen in coal, where miners responded to a more than 50 percent drop in prices at Australia’s Newcastle port since early 2011, the post-2008 recession peak, by increasing output and cutting costs.

This has led to higher coal supply in the seaborne market, thus driving the price even lower.

But it has also allowed some miners to move far enough down the cost curve to justify continuing operations. It can also limit the size of losses for those that aren’t profitable by enough for it to make more sense to keep mining rather than face the expense of mothballing pits.

The same dynamic is now likely in iron ore, Australia’s most valuable export, as smaller miners will do everything to keep going even as the major producers such as BHP Billiton, Rio Tinto and Fortescue Metals Group increase capacity by way more than the market can possibly absorb.


A similar story is likely to play out in LNG, where Australia will overtake Qatar as the world’s top exporter by 2019, when the last of the seven projects under construction, worth a combined $200 billion, comes on line.

The extra LNG will come on stream in a flood in the next few years, pushing what had been a deficit market into a surplus, and therefore pushing prices lower.

This can already be seen in spot Asian LNG prices <LNG-AS>, where prices haven’t enjoyed much of a rally ahead of the northern winter, in stark contrast to the previous two years.

While natural gas storages are at comfortable levels in Asia and a milder-than-normal winter is currently forecast, it’s unusual that spot prices should be dropping as much as they are.

After rallying from the summer low of $10.50 per million British thermal units (mmBtu) to $15 in late September, the price has subsequently slumped to $10.10 in the week to Nov. 23, a near four-year low.

This is perhaps a sign of things to come in LNG, where producers will keep pumping out the super-chilled fuel even as profits evaporate, while they try desperately to cut costs.

All this cost-cutting shows up in the form of cancellations or delays in new projects or expansions, as well as the curtailment of exploration spending.

BREE figures show exploration spending in Australia on mineral and petroleum dropped 12 percent in the 2013-14 fiscal year from the prior year, a trend likely to accelerate.

The number of projects at the feasibility stage dropped by eight to 138 in the six months to October, while those at the committed stage fell by four to 44, BREE said.

This means by the time the current excess supply in several commodities is worked through, the possibility that new supply will be available is decreasing as companies backtrack from expansion plans.

The overall message is that the old cycle of boom to bust to boom in commodities is still alive and kicking, despite the belief among resource companies, analysts and consultants that they have improved at forecasting supply and demand.


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