Outlook for metals and minerals - Investor seminar

26 November 2007

The following paper from Rio Tinto chief economist Vivek Tulpulé has been issued today to coincide with the Rio Tinto Investor seminar.

Executive summary

• Commodity markets are entering a fifth straight year of growth with mineral and metal prices at levels well above their long term average and in many cases above levels at the start of this year.
• Firm global economic activity led by China is expected to support strong increases in demand for most metals and minerals over 2008 and 2009.
• With low stocks and a likely continuation of supply side difficulties, most commodity prices are expected to remain well above their long run trend over the short and medium term.
• It is too early to suggest that the current price cycle has peaked across the range of commodities.
• While the central case is positive, we are mindful of the short term risks associated with the predicted slowdown in the US economy.
• But, it is important to recognise that the United States is now significantly less important in world commodity demand than it was just five years ago.
• Additionally our analysis suggests that even a sharp slowing in the US economy would have only a small impact on Chinese and Indian economic growth and consequent demand for commodities.
• Viewed from a longer run perspective recent history and the IMF's forecasts suggest that we are currently going through a period of global growth not seen since the period of fast growth and reconstruction in OECD economies following World War 2.
• Specifically, there has been a structural shift favouring rapid growth in developing countries with large populations such as China and India. Growth in these economies will be resource intensive as they industrialise and urbanise.
• The implications for commodity markets are nothing short of profound. Projections for iron ore, aluminium and copper suggest that demand could double and even triple over the next 25 years.
• In time production can be expected to expand to meet faster growth in demand at more sustainable prices. But that pricing environment is expected to be significantly stronger than would be implied by historical trends.
• It is expected that prices of many minerals and metals will remain elevated above trend for longer than has been the case in the past because of constraints on the speed with which production capacity can be expanded over the next few years.
• Also most prices are expected to assume significantly higher average levels over the very long run than has been the case historically due to structural increases in industry costs.
• We present case studies relating to markets for aluminium, copper and iron ore - three commodities that are expected to be drivers of the industrialisation and urbanisation process in developing countries.

Iron ore

• Substantial growth is expected in the demand for iron ore reflecting expected strong growth in steel demand related to the processes of ongoing industrialisation and urbanisation in the developing world.
• Reflecting the current tight market spot prices have risen sharply over the last few months with Indian ores currently selling in China at around $190/tonne double their price at the beginning of 2007. Australian and Brazilian ores are selling at a substantial discount to this spot rate given current freight rates.
• A substantial amount of high cost production will be required to meet growing demand over the long term. This strongly suggests the possibility of higher long run prices & higher margins for traditional lower cost producers.

Aluminium

• Prices are currently in the range of $2450-2550/t - levels supported by industry cost structures.
• Aluminium consumption has grown the fastest of all non-ferrous metals over the last 5 years and is forecast to grow rapidly over the next 20 years.
• There has been enormous recent growth in Chinese consumption and production but aluminium has benefited from increasing intensity in many other regions including the OECD.
• Constraints on China's domestic bauxite production suggest that the country's massive investment in aluminium capacity will remain reliant on imported bauxite. This combined with China's high power cost environment mean that Chinese aluminium capacity will continue to be high cost on a global scale.
• Additionally, Chinese production will also be disadvantaged by a stronger currency as the RMB edges toward fair value over time.
• The implied increase in the marginal cost of production for alumina and aluminium means that their prices are unlikely to revert to the lower levels implied by historical trends.

Copper

• Reflecting the tight market situation, copper prices are currently in the range of $6400/t-$7000/t - about three times higher than their average level through the 1990s and well above levels achieved in the early part of this decade.
• Prices could remain near current levels as long as production growth continues to under-perform against the underlying demand trend creating a need to ration supplies.
• Strong Chinese demand growth is expected next year and on the supply side the likelihood of ongoing disruptions and possible constraints on the availability of sulphuric acid affecting SxEw operations are issues.
• The importance of investment funds in exchange traded commodity markets means that large price movements could take place on the back of commodity specific speculative shifts or broader shifts in investor sentiment - well in advance of any fundamental change in physical markets.
• Looking to the long run, strong demand growth prospects are based on the expected resource intensive development of economies such as China and associated investment in power distribution networks and other infrastructure.
• On balance, we believe that, as for many other commodities, there has been a structural shift in copper costs supporting the expectation of significantly higher long run prices than would be implied by historical trends.

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