Overview
A global perspective for metals and minerals
Competitive environment
Rio Tinto is a major producer in most of the metals and minerals markets in which it operates. It is generally among the top five global producers by volume in each such market. Rio Tinto’s activities are spread across the globe. Most of Rio Tinto’s competitors are private sector companies which are publicly quoted. Several are, like Rio Tinto, diversified in terms of commodity exposure, but others are focused on particular commodities.
High quality, long life mineral resources, on the basis of attractive financial returns, are relatively scarce. Nevertheless, Rio Tinto holds interests in some of the world’s largest deposits. Rio Tinto expects world production volumes to grow in line with global economic growth. In addition, higher demand from China and potentially India, as a result of high rates of economic growth and urbanisation trends in those countries, could contribute further to increases in world production volumes in the long term.
Global economy
The introduction of large fiscal and monetary stimuli by governments around the world started to take effect towards the middle of 2009. Global trade started to recover during the second half of the year, led by activity in Asia. Major developed economies gradually stabilised with most experiencing renewed GDP growth by the third quarter of 2009.
Economic imbalances may lead to volatility
Countries debt to GDP ratio (%)
- Sources: IMF
The recovery continued into 2010, although with marked differences in the pace and sustainability of growth between OECD and emerging Asian countries. The emergence of a two-speed economy reflects the fact that financial excesses leading to the global crisis had developed primarily in advanced economies, which now face a significant adjustment process. However, it is also a reminder that many of the global imbalances that had accumulated over the past decade remain, and in some cases, have become more acute.
The recovery in the OECD has so far been dependent on government stimulus and an initial phase of inventory rebuilding, with the growth momentum built since the middle of 2009 fading slightly in the latter part of 2010. Sovereign debts in advanced economies have increased significantly as a result of the financial crisis and governments in several countries are now faced with tough decisions to address fiscal imbalances by reducing spending and raising taxes, with likely negative consequences for short term growth. Financial systems remain fragile implying scope for volatile outcomes ahead.
Although the short term prospects for emerging economies are much brighter, Asian countries continue to rely strongly on demand from advanced economies. The reform process required to boost domestic consumption is likely to be lengthy. In the meantime, growth in China has become even more dependent on investment than before the global financial crisis, with fixed capital formation now accounting for over 40 per cent of China’s GDP. Such imbalances are likely to remain key challenges for the global economy in coming years. However, the key underlying trends of urbanisation and industrialisation in populous parts of the world will continue to provide a strong platform for growth.
China
The sharp rebound in China’s economic growth since the first quarter of 2009 resulted from the Chinese Government’s rapid response to the collapse of global trade as well as a reversal of tightening policy introduced during 2008 to combat an overheating property market. The RMB4 trillion stimulus package introduced in late 2008 and the accompanying surge in bank lending spurred the development of infrastructure projects and a quick turnaround in housing construction activity. Having fallen to an annualised pace of nearly six per cent in early 2009, China’s GDP growth exceeded ten per cent in 2010.
With the growth momentum firmly back on track, the Chinese Government renewed its attempts to quell rising house prices through a series of policy interventions. The key challenge is for the Government to successfully contain inflation and asset bubbles in an environment of excess liquidity. The Government is also pushing for more incremental structural reforms to boost household consumption.
As the Chinese economy transitions towards its 12th five year plan, it is likely to focus increasingly on development strategies and institutional reforms aimed at reducing some of the growing domestic imbalances. This should translate into a stronger focus on technology and services as well as policies targeting the development of inland and rural areas. Although such reforms could ultimately lead into a phase of economic growth that is less commodity intensive than over the past ten years, investment and the development of infrastructure projects should remain an important aspect of the Chinese economy in the medium term. China consumed 400kg of steel per capita in 2009, about half the levels seen in Japan at its peak, with significant scope for further increases in coming years.
Commodity price indices
Daily spot price index (1 January 2009 = 100)
- Sources: LME, Reuters Ecowin, globalCOAL, Platt’s
Commodity markets
The start of a stabilisation in the global economy from the second quarter of 2009, and more importantly the rapid turnaround of the Chinese economy, triggered a sharp rebound in commodity prices. Chinese imports of metals and minerals soared to new highs during 2009 as a result of recovering underlying demand, restocking, scrap shortages, closure of high cost domestic capacity and some speculative activity facilitated by rising liquidity. As a result China’s share of global demand in 2009 increased to between 35 and 50 per cent for several commodities and up to two thirds for traded iron ore.
Chinese demand as a share of global consumption
- Sources: WBMS, BP, IISI, CRU
- Global 2010 coal demand data was unavailable at the time of publication
China’s strong appetite for commodities continued into 2010 in combination with resurgent demand from OECD economies. Although minerals and metals consumption in advanced economies remained below pre-crisis levels, the demand trends contributed to a further tightening in some markets and a return to prices seen in mid 2008 for commodities such as copper and iron ore. In a significant shift in energy markets in 2009, China became a net importer of thermal coal. This continued into 2010, absorbing supply from traded Asian seaborne coal and keeping upward pressure on prices. Meanwhile, the aluminium market has moved closer to balance during 2010 benefiting from strong demand from the recovering automotive sector. However, overall stock positions remain high compared to historical levels.
For bulk commodities, a key development during 2010 has been a further step away from previous benchmark price settlement mechanisms and towards more market oriented and shorter term pricing arrangements. These movements reflect changing market dynamics, with China being the main catalyst through rapid demand growth and greater fragmentation of the demand and supply sides. Pricing periods for coking coal and iron ore have moved towards quarterly cycles and, in the case of iron ore, references to published price indices started to appear in term contracts. Although still relatively underdeveloped, these new pricing arrangements are attracting the attention of financial institutions with the establishment of financial tools such as futures contracts for iron ore.
The growing influence of financial investors is also being felt in the already well developed base metals markets, with discussions during 2010 focused on plans to introduce physically backed Exchange Traded Funds for aluminium and copper. Low interest rates are already facilitating the financing of stock positions in the aluminium market where a large proportion of on and off LME inventories are currently understood to be tied into financing deals. Such activities are likely to continue in a context of further quantitative easing, the major effects of which are to reduce real interest rates, weaken the US dollar, raise inflation expectations and increase asset prices, especially for assets leveraged to growth in developing countries such as commodities.
Despite the greater participation of an increasing web of financial players in the commodity markets, physical fundamentals remain key in driving price dynamics. In a context of renewed strong demand, cost inflation is starting to creep up again across the mining industry with potential supply side challenges as a consequence.
Outlook for 2011
Forecasters have become more cautious about the strength in OECD economies in 2011 but the IMF is still predicting global growth above four per cent and Chinese GDP is expected to grow above nine per cent. Historically global growth at these levels has provided a strong basis for commodity demand allowing Rio Tinto to run its operations at full capacity.
Some risks to the near term outlook include an inevitable reduction in the level of fiscal and monetary stimulus, much of which is commodity intensive. Another key risk is linked to sovereign debt crises, especially in Europe, and the potential impact that these could have on the stability of global financial markets as well as implications for investor and consumer confidence.
2009 urbanisation rate
Looking to the longer term, increasing prosperity in developing countries including China and India, with associated industrialisation and urbanisation, will continue to drive underlying growth in demand for commodities. At the same time, it is apparent that global imbalances might take many years to resolve. This points to a high average growth setting for our markets but also one characterised by potential strong volatility. Rio Tinto, and the mining industry in general, are responding to the rapid demand recovery and stronger prices with reinvigorated capital expenditure expansion plans. This is in turn putting renewed pressure on skills, equipment and key raw material availability with implications for cost escalation and project schedules.
