BHP, Vale lead struggle amid slowdown in China

Patrick Barta, Robert Guy Matthews and Andrew Batson | November 17, 2008

MINE giants that couldn't dig minerals out of the earth fast enough a few months ago are now struggling to climb out of a very deep hole.

On Friday, the world's biggest miner, BHP Billiton, said major Chinese customers were trying to delay purchases of iron ore amid a sharp slowdown in China's building boom.

The scale of the December delays could cut BHP's iron-ore deliveries by at least 5 per cent for the full year.

The mining giants that feed the world's appetite for iron, copper and other industry staples earned piles of money as commodities prices soared the past few years. But those days are over for now.
Metals prices fell 35 per cent in just four weeks last month - the steepest decline ever recorded, according to Barclays Capital.

Prices for palladium, a key ingredient in vehicle catalytic converters, are down 70 per cent since mid year as car buyers make themselves scarce. Half or more of the world's aluminum production is now unprofitable.

Mining companies, a significant barometer of global economic health, are shuttering operations and firing thousands of workers across South Africa, Australia, Canada and Russia.

Rio Tinto cut 10 per cent of its iron-ore production last week, matching a similar move by the world's largest iron-ore producer, Brazil-based Companhia Vale do Rio Doce.

On Thursday, Xstrata announced plans to close two nickel mines in Northern Ontario. Alcoa has so far cut about 15 per cent of its annual capacity.

Big steelmakers worldwide have been cutting production as much as 35 per cent. US Steel Corp, the largest steelmaker in America, last week said it was laying off 2 per cent of its workforce due to the slowing economy.

Nearly every mineral is affected. Molybendum, which gives steel its strength, fell 60 per cent to $US12 a pound in the past year. Copper - recently so expensive that burglars would break into houses to steal the plumbing, and not jewellery - is off more than 50 per cent since April. Tin smelters across Indonesia, where nearly 25 per cent of the world's tin is made, are halting production.

Mining ranked among the fastest-growing sectors of the world economy in recent years. That money flowed to the four corners of the globe. China's voracious appetite for commodities helped spur waves of investment in poor but resource-rich Africa, a rare economic bright spot there.

That's changing now, as Chinese demand slows at the same time that consumers worldwide start penny-pinching. In the past few days, the world's largest producer of steel ingredient ferrochrome, Merafe Resources Lindiwe Montshiwagae, said it would shut down six of its South African furnaces. In Kenya, a $US25 million ($38.9 million) titanium project was also put on hold.

The question is whether these cutbacks, while sizeable, will be enough to stabilise prices and the industry. Markets got a brief boost early last week, when China announced an $855 billion spending spree to perk up its economy by building new roads and railways, among other things.

By Tuesday of last week, however, prices for many commodities had resumed their decline as the reality set in that even China's plan might not be enough to prop up demand in the short term.

The mining business has been through cycles before, and is exceedingly volatile. But analysts say they can't recall a more sudden, sharp decline in prices.

Of course, this slump is still in its early days. Prices could bounce back if China's housing market regains its vigour. After all, China, India and other developing nations still need massive helpings of copper, zinc and other metals as they strive to catch up to rich countries' living standards.

China currently consumes only about one-fourth as much copper per capita as Germany.

Still, at current market prices, it's hard to make money running many mines, which have high costs of labour, equipment and energy. About 30 per cent of nickel mines and more than 15 per cent of zinc mines have turned unprofitable due to falling prices.

Two weeks ago, North American Palladium said it would lay off 350 workers and shut down production at its Lac des Illes mine, near Thunder Bay in Canada, because it couldn't turn a profit once prices fell to about $US180 an ounce, from a high of $US582 as recently as March.

The pain from shutdowns like these is particularly acute in places that rely almost exclusively on mining for their well being. Because of their odd locations - mines are often in hard to reach places where they are the only major employers in town - closures can decimate local economies.
Two weeks ago, Blue Note Mining closed its zinc and lead mine in Bathurst, a Canadian town of 12,000 or so that is perched on the edge of New Brunswick. Younger workers will probably leave town, said Mayor Stephen Brunet. But the closing was particularly tough for older workers, many of whom were laid off a few years ago.

“They have paid for their houses and aren't likely to move,” he said.

Across Africa, many new projects that were to begin this year and next, including for uranium, iron ore and titanium, are being put on hold. This is bad news for the continent, which had been enjoying a rare economic boom. In recent years, mining activity had helped propel growth rates to their highest levels in decades, offering new hope of an end to the continent's cycles of poverty.

But when commodities prices fall, investing in Africa becomes a hard sell again. While countries like Congo are sitting on lucrative mineral deposits, it and other large chunks of Africa lack the roads or ports needed to process and export those minerals. Many regions are also politically unstable or dangerous, further dissuading investors.

The economic spasms aren't limited to poor countries.

Some economists fear the mining slump will help drag Australia into recession.

As one of the world's biggest producers of iron ore and nickel, this country seen its currency weaken more than 30 per cent against the US dollar since July as the mining industry stumbles.

Melbourne-based OZ Minerals recently said it was contemplating some shutdowns, including possibly at its operation in the vicinity of Mount Isa, Australia, now the second-largest open-pit zinc mine in the world. Big cutbacks could leave scores of towns across the dusty, forbidding outback with little or no other reason to exist.

The swift reversal is remarkable in an industry that saw its profits increase 20-fold in five years, climbing to $US80 billion in 2007 from just $US4 billion in 2002. Just a few months ago, miners were struggling to hire enough workers to keep up with unprecedented global demand.

Some companies were so desperate for equipment that they were forced to dig up old, discarded tyres from garbage dumps to outfit their giant trucks because new tyres were in such short supply.

In South Africa, power companies were no longer able to provide enough electricity to keep the country's burgeoning mines running.

In the last major commodities downturn, in the late 1990s and early part of this decade, mining companies got clobbered. Prices for copper fell some 50 per cent in the wake of the 1997 Asian financial crisis, followed by the US recession in 2001.

In 1998 and 1999, BHP (a predecessor of today's BHP Billiton) posted cumulative losses of nearly $US3 billion and required a major restructuring before it could be revived. It mothballed major mines in Arizona and Nevada, while Rio Tinto laid off staff at its copper operations in Utah. Other companies went out of business.

The mining business didn't perk up again until demand in China began to take off around 2002 and 2003.

This time around, the biggest mining companies - including BHP Billiton, Companhia Vale do Rio Doce, Anglo-American and Barrick Gold - are likely to use this downturn to try to grab market share from smaller rivals, known as “junior” minors, that sprang up like mushrooms in recent years when it was easier to raise capital.

While junior miners often carry heavy debt, the giant firms have built up formidable war chests over the past few years. Many are keeping an eye peeled to buy struggling smaller companies on the cheap.

The current pricing volatility has been intensified by the global financial crisis. Many hedge funds, pension funds and other investors desperate to raise cash as their stock- and bond-related holdings tumbled, rapidly sold their commodities holdings in recent months. That pushed down prices of copper, zinc and nickel more rapidly than in previous downturns.

Five years ago, nickel was selling for about $US9000 a ton. A year ago, that price had swollen to more than $US40,000, in part because of demand, but also because so many hedge funds and other investors were piling in.

In recent months, demand for nickel has declined somewhat - but cash-strapped investors like these have rapidly bailed out of their holdings. As a result, the price declines have far outstripped the rate of decline in actual demand for the metal. Nickel is now selling for about $US11,600 a ton.
Ultimately though, the industry's problems are rooted in weakening demand, particularly in China, rather than the financial crisis.

China's soaring economy gobbled up unprecedented amounts of raw materials in recent years, as the country built skyscrapers and roads, cellphones and vehicles at an historic pace. With the urban migration of tens of millions of people spurring an epic construction spree, many analysts still believe the China metals boom could have a decade or more to run.

Now, however, China is suffering a one-two economic punch. The world is buying fewer of the goods cranked out by its factories, and China's own spooked consumers are retreating from the housing market.

As a result, China's economic growth is slowing sharply, to 9 per cent in the third quarter from nearly 12 per cent last year. Some analysts worry it could easily drop below 8 per cent next year.

That’s weak by China’s recent standards, and many consumers are worried about the future. On a recent weekend in Beijing, hundreds of young families piled onto buses to tour new housing developments on the city’s edge. But many have no plans to put money down just yet.

“I prefer to wait for a bit, until the end of this year, or early next year, in case the housing prices in Beijing continue to fall,” said Xiao Yalin, a kindergarten teacher.

With so many people taking the same wait-and-see attitude, housing sales in China have collapsed: the volume of transactions has been dropping 40-60 per cent nationwide in recent months, according to Macquarie Securities. In September, the volume of China's of new construction fell 13 per cent, its sharpest decline in a decade.

That decline hits mining companies right where it counts. A large chunk of China’s metals demand is directly tied to construction, from the steel rebar that supports buildings to the aluminum that goes into new appliances.

China’s steel output plunged 17 per cent in October alone. That has led to an equally rapid reversal in the demand for iron ore. As of last month, the country had nearly three months worth of imports, or 89 million tons of ore, sitting unused at its ports, according to the China Iron & Steel Association.

Getting that ore off the docks depends in large part on getting China’s reluctant homebuyers back into a buying mood. But people on the front lines, like Nie Xin, a director at Beijing real estate agents E-House China, aren’t particularly optimistic.

“We feel that the rebound won’t come until 2010,” he says. This market “is very cold right now”.

With Sue Feng in Beijing