Miners Even Worse Off Than Oil Producers?

February 1st, 2016 by

At this point, everyone is aware of the stubborn declines that have gripped the oil market over the last 18 months or so. Benchmark crude oil prices have fallen from over $100 per barrel in the summer of 2014 to just barely above $30/bbl today.

However, the situation has been even worse for mining companies due to the longer amount of time it will take for non-profitable mines to be shaken out from the industry.

Bleeding Cash

mining2There are several reasons that the outlook for mining firms suggest more of a struggle than for their counterparts in oil production. In large measure, environmental regulations within the law have made it less attractive for many miners to update (or rehabilitate) their facilities and layoff excess workers. They are delaying these necessary measures because of the regulatory penalties they face for doing so.

As a result, analysts at Goldman Sachs report that many “[mine] owners will operate the facilities until they run out of cash and are obliged to suspend operations.” This means that such mines have gone from being assets to liabilities. Yet the alternative of restructuring their operations is too costly for all but the most financially well-off mining companies, which are few and far between thanks to the deeply downward trend in the industry.

Differences in Storage

oil stockpilesAlthough both dry commodities and energy resources have each seen their prices tumble the last two years, it is taking longer for supply-demand dynamics to fall back in line with mining compared to the energy sector. This can partly be seen in the lower volatility of gold and metals prices relative to crude oil, natural gas, etc. Oil prices have swung back and forth in a highly volatile fashion in recent weeks especially.

Why is this the case? Storage is a much different issue for energy firms. Metals are relatively easy and space-effective to store, so you can pile them high without a huge opportunity cost. This is hardly the case, however, with something like raw energy resources.

NYfed-vault-Fed-Reserve-Photo“To illustrate the point, Goldman [Sachs] calculates that $1 billion worth of gold would, at current spot prices, fit into a generously sized bedroom closet, while $1 billion worth of oil would take up 17 very large crude carriers, each with a capacity of more than a quarter of a million deadweight metric tons.”

This means that it is easier for excess supply to influence prices in the more sensitive energy markets. Conversely, precious metals can be stored indefinitely without nearly as big of an immediate effect on where prices are going.

Lost Investment

Another factor that has particularly affected miners is the collapsing value of their equipment. These are usually large capital expenditures that firms count on being able to sell back if they must recoup their money. Yet, the dwindling demand for commodities and mining in general has erased much of the value of major mining equipment. According to leading audit firm Ernst & Young (EY), equipment prices in the mining industry have plummeted 64% over just the last two years.

open-pit-mining-195082_640Research by EY showed that auctions for the industrial equipment used by miners had slowed to a crawl; very few auctions cleared all the equipment being offered. Now that prices have fallen so far, buyers are finally returning as they find bargains on this equipment.

The silver lining of this trend is that it will force companies to use their capital (expensive equipment) and capacity (storage) more efficiently. With the actual cost of entering the mining market declining, it looks like a good turning point for the industry as a whole once the long and painful shakeup has run its course.

 

The opinions and forecasts herein are provided solely for informational purposes, and should not be used or construed as an offer, solicitation, or recommendation to buy or sell any product.