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COVER STORY • COMMODITIES metals companies into defense mode.

Tey are now scrambling to boost effi- ciency by cutting staff, delaying planned capacity expansions and shutting down some higher-cost operations. But those measures will not likely

be enough to prevent declines in prof- its. Following a year of record profits for the mining sector in 2011, Britain’s Rio Tinto and Switzerland-based Xstrata have reported more than 30% declines in first-half earnings, while BHP reported a 35% drop in profits for the fiscal year ending June 30. Profits are likely to fall more sharply

in roughly one year, when long-term fixed-price contracts begin to expire, said one analyst, who spoke on condition of anonymity since he is not authorized to speak to the media. “Most of the miners can still be profitable but less profitable than they’ve been previously,” he said. Other analysts predict earnings per share for the sector in 2013 to show double- digit declines. Metals companies will also find it

more difficult to secure financing, adding to pressure to shut down less profitable operations. Lenders are wary of financing any miners when even majors like BHP Billiton are delaying giant projects like Olympic Dam, said Mike Elliott, head of global metals and mining at accountancy Ernst & Young.

90,000 80,000 70,000 60,000 50,000 40,000 30,000 20,000 10,000 0

Chile Source: CEIC 36 China Economic Review • November 2012 Brazil Australia Indonesia Source: London Metals Exchange, CRU

With metals accounting for 6% of global trade in 2010, a decline in the market will weigh on already-flagging trade levels

Financing pressure is likely to be more

severe within China, which is experienc- ing an oversupply of coal, iron ore and aluminum. According to Craig Charney, research director at consulting firm CBB International, in the third quarter “inter- est rates for the [mining] firms that were fortunate enough to get loans shot up like rockets. And this was true whether they were state or private.” Chinese firms that turn to the domestic shadow banking system to keep projects afloat may find that the usurious lending rates only com- pound their troubles. Indeed, Chinese miners are likely

to be among the first pushed out of the market as prices fall. With a few excep- tions, Chinese miners generally operate at higher costs, since the country is rela- tively resource poor and those resources it does have are more costly to access. Domestic iron ore mining is already

Chinese imports by country (US$mn), 2001-2011

Copper Index (US$/metric ton) $12,000.00

$10,000.00 $8,000.00 $6,000.00 $4,000.00 $2,000.00 $0.00

2004 – After years of steady growth, Chinese imports of metals jump. Copper imports roughly double, and iron imports triple year-over-year

being scaled back, and Chinese output may fall from 330 million tons in 2011 to about 250 million tons this year due to price declines, according to data from investment bank CLSA. “It’s for sure that many [Chinese]

companies will eventually be forced to exit,” said Guo of CASS. “In a market economy, as the industrialization pro- cess continues and market regulations are further improved, the competition will intensify.” Many Chinese miners, as well as

metals processors and some provincial governments, are likely to suffer because they have bought into metals during the boom years, a practice that Michael Pet- tis, a Peking University finance professor, terms “pro-cyclical investment.” Compa- nies have a short-term incentive to stock- pile hard commodities in a bull market because, as metals prices rise, the value of stockpiles on balance sheets increases, which can then be reported as profit, Pet- tis argues. But this same principle will hit many Chinese firms with outsized losses when price declines drag down the value of their stockpiles.

World of woe

With metals accounting for 6% of global trade in 2010 according to research firm Capital Economics, a decline in the mar- ket will weigh on already flagging trade





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