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Demand vs Supply Resources Steve Hamblyn Wednesday 16 August 2006. Resources: Global Themes. Chinese demand growth: The world’s biggest raw materials consumer (China) is also the world’s fastest growing. We believe that this situation could continue for many years.
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Demand vs SupplyResources Steve Hamblyn Wednesday 16 August 2006
Resources: Global Themes • Chinese demand growth: • The world’s biggest raw materials consumer (China) is also the world’s fastest growing. • We believe that this situation could continue for many years. • In the longer term, this will be supplemented by Brazil, India, Russia ( the Goldman Sachs “BRIC” idea). • Bumps in the road will occur, but in the longer term, it’s the trend rate of growth that matters. • Supply constraints: • Reduced exploration and development spending over the past eight years. • Too few greenfield projects available, and reduced discovery rates. • Long lead-times from discovery to commercial production. • Infrastructure bottlenecks (oil; bulk commodities). • Skills shortages, and long lead-times for equipment orders. • Currency: • Weak US dollar environment. • Investment Flows: • Dominance of “long-only” investment style (Index Funds). • Hedge funds and CTAs. • Global demand growth: • We envisage moderate (trend) growth in OECD raw materials offtake. We believe this environment will sustain strong commodities prices and improved growth opportunities. Resources company valuations should continue to rise. We recommend an overweight resources position.
Chinese Industrialisation has Some Way to Run;whilst India has Barely Started
Supply is Struggling to Keep Pace “In this market the risk to production is on the downside and the risk to costs is on the upside”Chris Lynch, Group President BHP Carbon Steel Materials, June 2006. • Geological constraints: Enough orebodies? And of what quality (copper, nickel, zinc)? • Infrastructure bottlenecks: Rail and port capacity (bulk commodities). • Skills shortages: Geology and Mining Engineering have become unfashionable disciplines. • Equipment lead-times: Extended lead-times contribute to project delays. • Cost-push: Capital and operating costs have risen and are continuing to rise. ** Positive for incumbent producers as raises barriers to entry for the industry **
Commodities Preference: Positive for BHP and RIO Price risk is relative to GSJBW forecasts Source: GSJBW Research estimates
Project Inventory Issues: Copper Example • The world is not running out of copper, but: • Discoveries are lagging demand growth. • Head grades are falling. • Key projects for near-term development are smaller than those available a decade ago. • Therefore more are needed… • …exacerbating the skills shortage. • There are no more “free” SXEW options. • There is a tendency to more remote locations. • With infrastructure implications. • With different country risk issues.
Costs are Rising: Capex (1)Some Australian Examples Source: Company data, GSJBW Research estimate
Costs are Rising: Capex (2) • According to data from BHP Billiton, the cost of construction in Western Australia has risen by 50% over the last 4yrs. • Combined with the strengthening A$ over the same period (which increased 46%), capital costs for projects in WA have more than doubled.
Costs are Rising: Operating Costs • Operating costs are also on a rising trend. Contributing to this are: • General inflation. • Exchange rates (weak US$). • Energy costs. • Consumables. • Labour (at all levels). • Falling ore grades (some commodities). • Rising royalties. • Some elements of the cost increase will be at least partly reversible (e.g. our long-term oil price assumption is US$40/bbl, not today’s cash price!). • Other parts of the cost increase, we regard as essentially structural.
