Crude Decline Cut Both Ways for Miners
The plunge in oil prices is a double-edged sword for many miners, lowering the cost of production but at the same time cutting the value of the commodities they produce.
At first glance the 57 percent tumble in Brent crude since June last year would seem to be an unambiguous positive for many commodity producers, given their heavy reliance on diesel to operate mines and transport output to ports.
This is especially the case for Australian coal and iron ore mines, which use diesel not only for mining vehicles but to generate electricity as well, given their remote locations.
Diesel-fired train locomotives help miners move their commodities across hundreds of kilometres (miles) and there may even be savings on charter flights used to ferry workers to and from remote mine sites, given the lower cost of aviation fuel.
Research by Morgan Stanley (MS), published on Jan. 25, said that oil and diesel made up between 9 and 12 percent of the total production costs for bulk commodities such as coal, iron ore and bauxite, but only 3 to 5 percent for metals.
The major impact of the declining oil price is to shift the production cost curve lower, effectively meaning more mines will be profitable, even at the current low commodity prices.
The spot price of iron ore in Asia <.IO62-CNI=SI> dropped to a 5-1/2-year low of $62.80 a tonne on Tuesday, and is down 67 percent from its peak of $191.90 reached in February 2011.
Spot thermal coal from Australia's Newcastle port , an Asian benchmark, was at $61.97 a tonne in the week ended Jan. 23, close to a six-year low and 54 percent below its post-2008 recession peak of $136.30 in January 2011.
The question is whether costs have fallen enough to offset lower commodity prices, and the answer is no.
But they have fallen enough to allow some producers, who would have otherwise been forced to shut down, to remain in business.
This has the impact of keeping supply in the market, which in the case of commodities such as iron ore and coal keeps downward pressure on prices.
Part of the reasoning behind the massive capacity expansion by the big three iron ore miners was that they would force higher-cost, smaller producers out of the market.
And to some extent Brazil's Vale and the Anglo-Australian pair Rio Tinto (RTNTF) and BHP Billiton (BHPLF) have succeeded, with a spate of recent mine closures and signs that Chinese domestic output is declining.
But the fall in oil prices is providing some relief to miners, allowing them to stay in the game, thereby causing commodity prices to drop further.
Morgan Stanley's research paper said that in iron ore, every $1 decline in the price of a barrel of oil resulted in a saving of 8 cents a tonne, while in thermal coal it was 3 cents and 5 cents for metallurgical coal.
Nonetheless, a typical underground thermal coal mine would now only be $1.95 a tonne better off than when oil prices were $115 a barrel in the middle of last year. This is only the benefit to the cost of production and doesn't take into account the cost of transport, or any other factors.
Over the same time period, thermal coal has dropped by around $21 a tonne, meaning the lower oil price has helped, but not that much.
CURRENCY MOVES BIGGER HELP
Of far more significance has been the almost 17 percent drop in the value of the Australian dollar against its U.S. counterpart since the middle of 2014.
This has had the affect of actually increasing coal prices in Australian dollar terms, with Newcastle prices rising from a 2014 low of A$71.94 a tonne in September to A$78.40 last week.
It's not just Australian producers that have benefited, with Indonesian miners enjoying a near 11 percent depreciation in the rupiah against the dollar since April last year, while South African producers have seen the rand drop almost 13 percent since last May.
But while miners may cheer low oil prices and a firmer U.S. dollar, it's those two factors that are helping keep supply in the global market and preventing a recovery in commodity prices.
By Clyde Russell
