Natural Resources
14 March 2022
Comment
Something’s Got to Give
Buyer’s remorse is that nagging sense of regret after purchasing something, usually expensive, that it turns out you didn’t really need in the first place. No doubt a familiar feeling for many in the mining industry a decade ago having expended a lot of capital to bring on new capacity just as a Chinese slowdown caused demand to peak and prices collapse.
Although the industry is in much better shape than back then, right now the opposite seems to be the case. Seller’s remorse is going round as commodity prices move ever higher.
This week a seasoned portfolio manager of a global resources fund expressed their feelings of frustration and some embarrassment despite being amid a commodity bull market. Having spent the last few years extolling the virtues to mining companies of capital discipline and the need to get rid of “non-core” or unfashionable assets rather than pursuing risky M&A or growth projects, they are now seriously questioning the wisdom of their advice. There are probably a few mining executives thinking what might have been.
Asset divestment, capital discipline, deleveraging balance sheets and, more recently, increasing dividend pay-outs (According to the FT the mining sector was responsible for a remarkable 25% of all UK dividend payments in 2021), have been the hallmark of the industry in recent years. The focus has been on cash returns rather than investing in new projects.
The buyer’s remorse experienced in the last commodity cycle has cast a long shadow.
Hindsight isn’t as useful as foresight.
The energy transition was already significantly upping the pace prior to Covid, and now Putin’s Russia has thrown a very large spanner into the global supply chain and supercharged the whole commodity environment, including fossil fuels. Supply shortages in copper, met coal, nickel, lithium and rare earths – to name a few – have been widely predicted for the end of the decade.
The already precipitously low project pipeline (see our Copper Project M&A update from Dec 2021) is complicated further as geopolitical bifurcation of supply chains looks to add another level of uncertainty.
Somewhat ironically the current inflation surge, partly caused by the rapid changes in commodity pricing, is putting more constraints on the natural resources industry to deliver the very supply that could alleviate those pressures. Operating margins are already being impacted by higher oil and freight costs and increasing pay demands.
The costs of decarbonisation of the industry itself, which we note are largely conspicuous by their absence from company statements, will only complicate capital allocation decisions.
Last year Wood Mackenzie estimated that to deliver the metals required for a 2C pathway the mining industry needs to invest $1.7 trillion dollars over the next 15 years, an average of $113bn pa.
The chart below shows historic and planned mining capex broken down by commodity. The world has changed since S&P Global compiled the data just prior to the start of the global pandemic and individual company expectations have begun to change, nevertheless it is surely cause for concern, particularly the decline in development capex.
If Wood Mackenzie’s projections are anywhere near right it looks a long way short of the required run rate if the mining industry is going to deliver the metals needed for the energy transition and whatever the new Western world supply chains are in a post Ukrainian war economy.
Mining Industry Capex – Historic and Forecast. Source S&P Global Market Intelligence (2020)
Whether Seller’s or Buyer’s remorse gets the upper hand will likely determine whether we see a significant shift in capex and ultimately capacity expansion or if dampened enthusiasm for exploration and M&A prevails, and a near-empty pipeline leads to constrained and incremental additions at a time when the world needs more commodities than ever to decarbonise.
Charlie Cryer
Head RFC Ambrian London
+44 (0)20 3440 6834
charlie.cryer@rfcambrian.com
*RFC Ambrian acts as Financial Adviser to this company and holds a significant interest.
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