February 2008

MAC Economic Commentary

How long will the boom last?

By P. Stothart

The Canadian and international mining industries are enjoying buoyant times. While the specific figures vary by mineral, overall prices have grown by roughly two-fold to five-fold over the past five years.

In some instances, prices have continued to increase through 2007. Gold, for example, has increased in value by another 35 per cent since 2006 — to around $850 per ounce. Copper is expected to climb another 50 per cent to 450 cents per pound in 2008 according to Bloomsburg projections. Nickel and zinc prices generally levelled off or declined in the latter part of 2007.

At these high price levels, exploration spending, both globally and in Canada, has increased significantly as companies seek to find new mineral reserves. Global exploration spending has grown exponentially from $2.4 billion in 2003 to $10.5 billion in 2007.

Merger and acquisition activity has also exploded in recent years. In Canada, Xstrata bought Falconbridge for $20 billion, CVRD bought Inco for a similar amount, and Rio Tinto bought Alcan for $38 billion. A possible global alignment between Rio Tinto and BHP Billiton would be valued at well over $100 billion. Worldwide, in 2006 there were 1,145 merger and acquisition deals in mining, valued at some $176 billion, as companies in all parts of the world strive to secure mineral reserves and to obtain the skills and technical ability to find and develop new supply.

Buoyant mineral prices have also meant higher executive compensation, higher worker salaries, ambitious capital investment commitments, and generous flows of tax and royalty payments to governments.

The budget surplus situation in Ottawa and the recently announced federal tax cut commitments are affordable in no small part because of healthy revenue flows from natural resources companies.

How long can this boom last? Given the traditionally cyclical nature of the mining industry, and the fact that the boom is already some six years old, it is natural that many observers are raising questions as to how much longer the present level of prosperity can continue.

Certainly there are conditions under which one could envision a marginal or even major decline in mineral prices. A recession in the United States could be possible, given the macro-economic mismanagement of the Bush administration, if the American consumer were to pay heed to their debt-loads and become less bullish. American economic performance will also depend on how the asset-backed commercial paper crisis unfolds. As well, a number of national governments, particularly in Central and South America, are seeking to raise their take from the mining industry and are, in effect, expropriating wealth by revising existing business agreements. On the trade side, countries such as China and Russia are enacting measures aimed at keeping their raw materials out of the global trading system so as to meet their own consumption needs. An escalation of these trade and investment barriers could serve to undermine business confidence and contribute to an economic downturn.

On balance, however, there are two considerations that would seem to overwhelm these potential obstacles; namely, the basic economic concepts of global demand and global supply.

On the demand side, as a consumer of 25 per cent of the world’s base metals, China remains the critical variable. There is no evidence that economic growth in China is slowing — indeed growth in 2007 again appeared to be in the range over 10 to 11 per cent. Despite its staggering expansion of the past 15 years, the country also remains relatively low in its measure of metals intensity in comparison to western countries. For example, the United States features 765 motor vehicles per 1,000 people, while China features 10! While it is unlikely that this 76-fold gap would ever be closed entirely, it will narrow significantly over the coming decades. Similar gaps exist in most other economic measures; for example, there are 20 times more personal computers per capita in Canada than in China. A comparable growth potential story can be told for Russia, Brazil and India among other low metal-intensity, high-population countries.

A comparable story can be told, in an even more compelling manner, on the supply side. An economic analysis from Anglo American plc illustrates the magnitude of the mineral supply challenge that faces the globe. If demand for copper grows at four per cent per year for the next decade, global demand will exceed projected output from current mines and approved projects by 39 per cent. This is equivalent to eight new mines the size of Escondida, the world’s largest copper mine in Chile.

A similar situation is seen in nickel and zinc — average growth for the next decade will mean a 36 to 43 per cent shortfall in 2017, necessitating 14 new world-scale nickel mines and 40 new large zinc mines. While the high exploration spending levels of recent years may well generate new supply of this magnitude, the recent mine-development experience does not lend cause for optimism. Cost escalation, infrastructure bottlenecks, political uncertainty and resistance from environmental and social groups (naturally armed with iPods, cellphones and other metals-intensive tools!) have combined to seriously challenge the ability of companies to turn mineral discoveries into viable mines.

The result of these combined demand and supply pressures means continued above-historical-trend prices, profits, exploration and taxes — for many years to come. Beyond this reality though, it is important that businesses and governments not become complacent — some commodities will still experience mismatches between supply and demand that will have short-term (positive and negative) effects on price. The troughs in prices should not be as low as past business cycles and the highs should be above historical trends. For producers, the key to performance will still depend, as always, on how well capital and operating costs are managed.


Paul Stothart
Paul Stothart is vice-president, economic affairs, at the Mining Association of Canada. He is responsible for advancing the industry’s interests regarding federal tax, trade, investment, transport and energy issues.

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