LORD COPPER: Who can live with low prices for oil, iron ore and nickel?

The longer I spend looking at commodity markets, the more I wonder how many people actually understand what makes them behave as they do (and for the avoidance of doubt, I include myself in that non-comprehending majority).

The longer I spend looking at commodity markets, the more I wonder how many people actually understand what makes them behave as they do (and for the avoidance of doubt, I include myself in that non-comprehending majority).

Look at some of the issues that have arisen in recent times. Earlier this year, with high energy prices threatening UK household budgets, the leader of Her Majesty’s Opposition announced his masterplan – if ever elected, he would freeze the price energy suppliers could charge their customers.

If we sidestep the philosophical discussion of whether or not it ever makes sense for governments to try and fix prices in a free market economy, and taking the crude oil price as a reasonable proxy for the direction of energy prices, then we can see that this was a seriously bad idea. Oil has slipped a long way since then, so had prices been frozen, consumers would have ended up paying substantially more than the prevailing market price.

Or look at iron ore.

The Chinese steel industry is a bottomless pit that can absorb however much product the big miners decide to throw onto the market. You can keep ramping up iron ore production because the buyers will always be there.

Except it hasn’t quite worked out like that. The Chinese buyers are not there to take everything, and in the face of continuing iron ore output the price has dropped – sharply, down something in the area of 30% this year.

Nickel is another case in point.

In the wake of the Indonesian ore export ban announced earlier this year, rafts of commentators jumped on the bandwagon and assured us that the nickel price would be heading much, much higher. It clearly had to go up, didn’t it, because of the ban’s effect on supply to China? Well, there was a rally – but it was pretty short-lived, and then the nickel price started coming off again. A number of people are now – at this significantly lower level – again tipping it to rally sharply. Hmmm.

A common thread?
So, apart from yet again pointing out how difficult it is to predict prices, is there a common thread of some sort here?

Well, in two cases I think there is, and in the third I think there may be a possible link. Could it be that there is something deliberate going on, rather than a misjudgment of economic circumstances?

In the case of both oil and iron ore – which in the past have been markets characterised by fairly solid producer discipline – it would appear to be the low-cost producers who are not following the expected course of reducing production in the face of slowing demand. The Saudis don’t seem interested in adjusting their flow to help support the oil price, and the big boys in iron ore (mainly Rio and BHP Billiton) seem equally reluctant to slow down their output.

Now, going back to my opening, that could be the result of a failure to understand the market, but I doubt it. What we’re seeing is much more to do with the low-cost producers using their position on the cost curve to enforce their dominance.

Shale oil in the USA – while a boon for consumers – threatens conventional producers while the oil price stays high enough to make it economic; so why wouldn’t a major conventional driller – with far lower costs of extraction – attempt to disrupt shale oil’s growing importance?

Likewise, the Pilbara producers are blessed with a cheaper route to get their product to consumers in China than their competitors – so again, why not use that muscle to emphasise their power? In other words, if you’ve got the ability to squeeze the competition out, surely the best time to use it is when markets are difficult?

All of that is, I think, pretty conventional wisdom these days; but what about the third market I’ve mentioned?

With all the talk of Indonesian and Philippine ore and NPI (which is indeed a fine product for stainless mills), perhaps we should also remember that there is a dominant producer in the nickel business, and one that is blessed with an extremely rich polymetallic ore that, despite difficult mining conditions, puts them right down at the favoured end of the cost curve. In the boom times of the previous decade, you could make money any which way; now, where you sit on the cost curve is crucial again, and it would be naive not to expect the producers sitting near the bottom of the cost curve to use their advantage.

So actually, I don’t necessarily share the view that nickel is due for a big rally any time soon; it may be that the long view reflects an acceptance of lower prices for the moment. If you’re the low-cost producer, you can always play the long game. And despite what I opened with, there are actually some players who understand commodity markets extremely well…

Lord Copper 

See also:
Iron ore prices to ‘fall into the $50s’ next year, Citi says
Rio Tinto’s iron ore shipments up 15% in Q3
COMMENT: The miseducation of the nickel market

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