OUTLOOK FOR METALS AND MINERALS. Full Year Results February Rio Tinto Economics & Markets

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1 Highlights OUTLOOK FOR METALS AND MINERALS Full Year Results 20 February 2014 Rio Tinto Economics & Markets Prices for most commodities finished 20 below levels at the start of the year, but volatility was much reduced compared to previous years. The likelihood of further macroeconomic crises has been diminishing over the year, confidence is starting to return in the OECD and there is a sense that developed economies are finally on the path of a more stable and robust recovery. However, the tightening of global monetary conditions have seen concerns in emerging markets materialised through currency falls and declining foreign exchange reserves. Meanwhile, the Chinese economy is embarking on a gradual reform process, resulting in slower growth albeit from a higher base. China s government managed to stabilise the economy to reach its 20 target after concerns that growth was losing momentum during the first half of the year. Iron ore prices were less volatile in 20 than each of the previous six years. During 20 prices averaged $5/dmt CFR China, $5/dmt higher than the previous year as Chinese steel production growth matched GDP growth. The copper price fell in the first half of 20 from $3.70/lb to $3.20/lb as mine supply growth accelerated but then stabilised through the rest of the year. Aluminium prices remained below the marginal cost of production during 20 and averaged $1850/t. At this level, around 25 per cent of ex-china production was cash negative. Low LME prices have been partly offset by high regional premiums. Thermal coal prices continued the declining trend of the past two years, as the market remained well-supplied, recording a year-on-year fall of per cent and finishing the year on $86/t. A strong recovery in Australian exports kept metallurgical coal under pressure with average prices just below $150/t, a decrease of nearly 30 per cent on the 20 price. As we enter 2014, the consensus for global growth at 3.7 per cent has an increasingly optimistic tone, although underlying structural fragilities remain. Imbalances within the Eurozone are not resolved and although the financing of sovereign debt is less of a shortterm concern, overall debt levels are still high. Developed financial markets have responded well so far to the tapering of Quantitative Easing in the US and the US Federal Reserve is signaling a very gradual normalisation process, but the unwinding of unconventional monetary policies remains a potential source of renewed markets volatility. The recovery in developed markets should be supportive of global commodity demand in 2014, although short-term cycles in China, and in particular credit flows into the commodity intensive Chinese property sector, remain key factors to watch. For some commodities healthy demand trends will be required to balance the addition of new capacity as the recovery in supply growth observed last year is expected to continue into Although the industry has actively been reducing capital expenditures during 20, this is the lagged response to previous years of high investment rates. Looking further out, we maintain a favourable perspective for long-term commodity demand while the complexity of future mining projects continues to increase. As noted earlier, China s growth is slower but from a much stronger base and prosperity in other developing economies remain on an upward path. We still estimate that China s crude steel consumption will peak at around 1 billion tonnes towards of 6

2 Daily commodity spot prices Index (1 20 = 0) Copper Gold Oil (Brent) Aluminium Thermal Coal Spot iron ore (62% Fe, FOB) c/lb $9/bbl $1/t $90/oz $1664/t $77/t 50 Prices as at th Feb Source: Bloomberg, Platts Macroeconomic overview Macroeconomic themes The global economy remained muted in 20, managing just to match the previous year s moderate growth performance of 3 per cent. Growth remained uneven across regions but in general there is a sense that the macroeconomic environment became increasingly stable through the year, with growing optimism, particularly in the United States, that the recovery is underway. Despite concerns during the first half of the year, China s economic growth in 20 managed to remain on par with 20 growth thanks to the effects of a substantial liquidity injection on the property market. Reform remains firmly on the agenda, carrying some short term risks, but there is good reason to believe that the Chinese government will maintain an achievable growth target around 7.5 per cent for Improving economic growth prospects in the US and Europe and rising expectations of Quantitative Easing (QE) unwinding throughout the year have resulted in a sharp reversal in global capital flows, with funds flowing out of emerging markets and precious metals. While growth in key developed economies was below expectations in the first half of 20, growth accelerated in the second half with indications that the momentum will be carried through into The risk of an emerging market crisis related to QE unwinding has been increasing. Currencies have been influenced by the reversal in capital flows, with the Australian currency depreciating by around 14 per cent against the US dollar over the course of the year. Effects of the US recovery and QE tapering on the US dollar are expected to remain an important dynamic of currency markets in coming months. GDP growth China s economic growth was short of initial expectations in the first half of 20 as the government focused energy on reform, reigning in government spending, hot money inflows and introducing new property tightening measures. A credit scare in June, along with 2 of 6

3 concerns that the annual GDP growth target of 7.5 per cent might not be achieved, resulted in a mid-year relaxation in policy, with the government announcing a new social housing program and loosening credit. Despite policy loosening in mid-20 the political agenda shifted firmly back to reform after the third Party Plenum in November. China s new leadership set the agenda for a gradual reform process at the third Party Plenum meetings in November 20. After several years of expansion dominated by investment, the country s economic growth model is beginning to rebalance towards consumption. While planned reforms should gradually deliver a more sustainable model, the pace of growth is expected to continue to slow gradually. Despite a significant contraction in fiscal spending, US growth looks to have achieved initial expectations in 20 with a strong rebound in construction activity. Growth prospects for 2014 look very encouraging given the sharp fall in the unemployment rate towards the end of the year, even if this was partly due to a reduction in participation rates. Japan s growth considerably exceeded expectations in 20 thanks to investor optimism in the domestic QE policy and improved trade competitiveness assisted by a sharp depreciation in the exchange rate. The effects of monetary easing should continue to work their way through the Japanese economy in Prospects have also improved in the Eurozone with the economy recovering from recession and sovereign yields in peripheral regions continuing to fall throughout the year. Despite the market optimism, banking fragilities and labour competitiveness issues remain a concern. Consensus expectations are of stronger growth in emerging markets such as India and Brazil in 2014 (5.4 per cent and 3.0 per cent respectively), while consumer price inflation in many emerging markets is expected to ease. However, the risk of an emerging market crisis remains as concerns have increased recently with Federal Reserve tapering, a reduction in emerging market confidence, equity and currency declines and the resulting pressure on foreign exchange reserves. Currencies The US dollar and euro have strengthened against both emerging market and commoditybased economies as improving growth prospects and expectations of QE unwinding in the US resulted in capital flows returning to the US and Europe. The Australian dollar weakened as a result of lower than expected economic growth in China and interest rates cuts by the Reserve Bank of Australia. Whilst volatility remains high, it does look like there has been a fundamental downward shift in the Australian dollar s perceived market value this could ease the margin pressure on Australian producers. The Canadian dollar has not depreciated to the same degree as it is not as reliant on Chinese growth or experienced a decline in policy rate expectations. Commodity markets Costs A key feature of the mining industry in 20 has been a renewed focus on managing margin compression through operating cost reductions. Heightened risk aversion and capital constraints are also resulting in capital expenditure rationalisation. For existing operations there is a greater attention on costs and driving productivity improvements. The curtailment in capital expenditure across the industry is being felt by Heavy Mobile Equipment (HME) manufacturers with equipment shipments at the lowest level since 20. Sales forecasts continue to decline with little signs of a short-term recovery. Manufacturers are responding by reducing employment levels, a continued focus on maintenance and maximising the installed machine base. Meanwhile lead times have been relatively stable throughout 20, for example 4-6 months for haul trucks. 3 of 6

4 Aluminium, alumina and bauxite In Q4 20, aluminium prices fell to their lowest level in over four years, averaging $1,815/t due to a combination of factors including overcapacity in China and record high London Metal Exchange (LME) inventory levels. However, low prices have been partly offset by strong increases in premiums. Smelter curtailments and strong demand have moved the market ex-china into a modest deficit with load-out bottlenecks at warehouses and a tight scrap market. Premiums have rallied again at the start of 2014 despite the proposed changes to LME warehousing rules. These aim to cut the length of queues at LME warehouses and reduce the incentive to purchase metal for storage, which is expected to increase metal availability. For the meantime though, the strong contango yield continues to incentivise stock financing with LME stocks rising 5 per cent to 5.5 Mt in 20. Total inventories ex-china are equivalent to more than 16 weeks of demand. Aluminium is expected to exhibit strong consumption growth relative to other commodities over the medium term. This is predominantly driven by growing intensity of use in the transportation, construction and consumer durables sectors. Despite this positive demand setting the aluminium market looks to remain well supplied, as economic incentives drive the addition of further new smelting capacity in north-west China. The Indonesian unprocessed ore export ban has come into full effect as of uary 2014, and, while there is still some uncertainty over amendments, exemptions and enforcement, this represents a key upside risk for bauxite and alumina prices. Approximately 75 per cent of China s bauxite imports are currently shipped from Indonesia, with the balance mostly from Australia. Chinese refineries have built up their inventory positions during 20 in anticipation of trade disruptions. Further positive price support for bauxite could come from the pressure that China s strong alumina production growth is putting on its constrained domestic bauxite resources. Copper The LME copper price fell in the first half of 20 from $3.70/lb to $3.20/lb and fluctuated around this level through the rest of the year, before climbing to $3.35/lb by the year end. Global copper mine supply grew by 6.5 per cent in 20, led by Africa and Latin America which each contributed an incremental 300kt. This compares to growth of 1 per cent per annum during Chile registered strong growth of about 6.4 per cent through to November 20. In addition to the ramp-up from new projects the high production levels were supported by a lower level of mine disruptions (4 per cent) compared to recent years (closer to 6-7 per cent). While the strong growth in mine supply pushed the concentrate market into surplus, several factors combined to maintain a tighter cathode market: global demand growth was healthier than expected, scrap generation was relatively low and some bottlenecks appeared at the smelting stage. As a result of this, copper LME stocks have been declining since y 20. Rising Treatment and Refining Charges (TCRCs) indicate that 2014 is likely to be another year of concentrate surpluses as additional copper projects ramp-up and scrap generation recovers to previous levels in the developed world. Further out we expect the market to return to equilibrium as copper miners continue to face declining grades, stakeholder pressures and project delays. Iron ore Spot iron ore prices were relatively stable in the second half of 20. From a y start of $6/dmt CFR China, the Platts index increased by $15/dmt throughout y before settling into a tight $/dmt trading range around $5/dmt for the remainder of the year. Stability in the iron ore price was brought about by strong steel production in China counterbalancing growing seaborne supply. 4 of 6

5 Strong iron ore prices were brought about by an 8 per cent expansion in China s crude steel production in 20 which was driven by sustained growth in property and infrastructure spending. Providing further support to China s iron ore demand was a steady rebuild in iron ore inventories held at steel mills and ports in the second half of 20. China experienced a rapid increase in housing sales and prices throughout the year owing to a substantial increase in credit in late 20 and early 20. This in turn supported a revival in land sales, housing starts and floor space under construction across China which has flowed into higher end use demand for steel. Infrastructure spending was also a strong contributor to steel demand growth in 20 with fixed asset investment in infrastructure growing at over 20 per cent. Investment in railway infrastructure was the main contributor to growth in the first half of the year with investment in utility and transport infrastructure supporting growth in the second half of 20. Growth in fixed asset investment in infrastructure slowed gradually over the second half of 20. Accompanying strong demand growth from China has been equally robust seaborne supply expansions from traditional suppliers, particularly in the second half of 20. Australia contributed to most of this supply growth with exports increasing by 17 per cent year on year. Brazilian exports were largely flat year-on-year although a strong second half, with exports increasing 25 per cent half-on-half, was a major contributor to the overall growth in seaborne supply in the second half of 20. The outlook for 2014 points to continued growth in China steel demand while the main iron ore seaborne producers continue to steadily ramp up supply. Short term changes in China s inventory cycles and supply variations are likely to result in continued iron ore price volatility. Thermal coal Prices globally continued the trend of the past two years with the Newcastle Index recording a year-on-year fall of per cent, finishing the year on $86/t. The price decline culminated between June and ober with prices spending time below $80/t for the first time since Q4 20 before stabilising in second half of 20. As with 20 the price declines were not so much a result of weak demand but robust supply, principally out of Australia and Indonesia in the first half of 20, with Indonesia exports notably exceeding 400Mt for the first time. A strengthening US dollar and concerted effort to compress costs allowed traditional supply hubs to remain largely cash positive, albeit with thinner margins than previous years. The sluggish supply response in the face of falling prices was in part due to take-or-pay infrastructure obligations factored into closure decisions. Looking to 2014, prices will depend on the extent to which swing supply from the US and Indonesia soak up incremental demand. Recent commentary on a stricter Chinese coal policy clearly has air pollution as the key driver. This will not necessarily impact on China s national total demand for coal: we continue to see total coal demand in China growing through this decade. Metallurgical coal Premium hard coking coal prices remained under pressure in the second half of 20 as the market continued to be characterised by excess supply. After hitting a year low in June of around $0/t, prices for prime hard coking coal showed some strength on the back of a restocking activity in China. Nevertheless, prices have since fallen again with spot prices at the end of December returning to levels not seen since 20. Excess supply continues to impact the coking coal market with nearly all major exporting countries increasing supply in 20. Australian producers led the supply growth with exports increasing by 18 per cent year on year as production was supported by a renewed focus on productivity across the supply chain, low rainfall and minimal disruptions. North American and Russian supply was also robust with increasing exports from Canada and Russia more than offsetting a moderate fall in US exports. In China, domestic production of washed 5 of 6

6 coking coal is estimated to have grown at nearly 5 per cent in 20 led by continued supply expansion in Shanxi. Looking forward, seaborne supply growth is expected to moderate in 2014 with slowing growth from Australia and Canada expected to be met with further reductions in US supply. Other commodities The uranium market in 20 continued its downward slide that begun following the Fukushima nuclear disaster in March 20 and saw the spot price fall below $35/lb in y for the first time since From there it traded in a narrow band to finish the year at $34.50/lb and record a year-on-year decline of 20%. Uranium upside is limited in the near term due to strong utility inventories and a persisting weak demand environment. Further out a price recovery will be prompted by falling supply growth, the return of Japanese nuclear fleet to operation and increasing momentum in the Chinese nuclear build. The market for titanium dioxide and zircon has softened further over the course of the year as the industry continues to deal with high levels of stocks. Pigment producers are believed to have absorbed a large portion of pigment inventories in 20 but a stock overhang remains on the feedstock side despite some curtailments in production volumes last year. The normalisation of pigment stocks should support a gradual drawdown in feedstock inventories as underlying demand recovers. Polished diamond prices were relatively stable throughout 20 whilst slightly greater variance was experienced in rough diamonds. In the medium to long run, strong demand growth is expected, especially from India and China, as disposal incomes rise and increase consumer luxury demand. 6 of 6