Oil Claims Another Victim as Cheap Fuel Keeps Metals Glut Going

  • Drop in energy costs eases pressure on mines to reduce output
  • Metals surplus expands as China slowdown curbs world demand

The collapse in oil and coal prices isn’t just bad news for the energy industry. It’s also compounding a global surplus in metals.

Ores are extracted with diesel-engine diggers and trucks, while smelters that process metal run on electricity from coal-fired power plants. Energy accounts for as much as a third of the industry’s costs at a time when everything from aluminum to zinc is mired in a prolonged slump and more mines are losing money. With oil tumbling about 70 percent in the past two years to less than $30 a barrel, cheaper fuel is allowing metals companies to delay production cuts needed to halt their own slide in prices.

“There is an incredibly powerful link between base metals and oil prices,” said Dan Smith, a commodities analyst at Oxford Economics Ltd. in London. “If we see oil going down to $20 or even lower, it’s going to mean lower metals prices. Short-term, things look pretty tough.”

The biggest commodity rout in seven years has forced mining companies like Glencore Plc to trim operating costs and output, sell assets and shares, and reduce their debt. BHP Billiton Ltd. and Rio Tinto Group, the two largest producers, said in August that lower energy bills aided profits, as did weaker currencies in countries where they operate mines. Since then, Brent oil has tumbled about 50 percent.

Energy is the single biggest expense in the mining process, according to Macquarie Group Ltd. It’s about 16 percent of what the industry spends on average to produce every metric ton of copper, and about 35 percent for aluminum, according to Macquarie. The drop in oil and the dollar’s rally against currencies including the Chilean peso and Zambian kwacha will cut copper-mining costs by about 11 percent in 2016, London-based researcher CRU Group estimates.

Energy Slump

Coal, which generates about 41 percent of the world’s electricity, is the cheapest since at least 2007 in Europe, where supplies are ample. Crude slid below $30 last week for the first time in more than a decade as Iran moved closer to boosting exports and global economic growth slowed. European prices for diesel, a product refined from oil and which moves almost in lockstep with crude, are the lowest in 11 years.

More energy declines won’t fix the long-term problem for the metals industry. As China’s economic slowdown erodes demand, mining companies have increased production capacity after years of investments following an earlier commodities boom. While lower costs can help, they won’t help ease the surpluses.

“We still need more cuts in most metals,” said Colin Hamilton, head of commodity research at Macquarie.

BHP has also taken a hit from the drop in oil. The company said Friday it will write down the value of its U.S. shale assets by $4.9 billion. The shares slid 43 percent in the past year in Sydney.

A rally in the dollar, the currency used to trade metals internationally, also provided a relief for mining companies that pay workers and buy equipment in local money. The Brazilian real, South African rand, the Russian ruble and Chile’s peso are among the worst-performing monies in the past year.

Rio Tinto said in August that lower energy costs and favorable currency moves in the first half of 2015 helped offset almost 40 percent of the $3.6 billion impact of lower commodities prices. BHP said the drop in diesel contributed to a $518 million increase in full-year underlying earnings before interest and taxes.

Antofagasta Plc, the copper miner controlled by Chile’s richest family, said cheaper energy, along with a weaker peso, helped save $198 million in the first half of 2015. Energy prices are among the most important part of company cost savings, Ivan Arriagada, Antofagasta’s chief executive officer, said on an Aug. 25 investor call.

“The leg lower that we’ve seen in oil prices has certainly created another wave of deflationary effect," said Nicholas Snowdon, an analyst at Standard Chartered Plc in London. "We are expecting some production-cut announcements in the next results period, but it’s very tough to argue that will be the sort of signal that we’ve reached a bottom.”

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