The slump in the oil price is two-fold as miners benefit from slashed production costs in the short-term, but on the other front it has an impact on the value of the commodity produced.
Brent crude oil has slumped to below $55 per barrel (pb) from $116pb in the past six months and Standard Bank’s global head of mining and metals Rajat Kohli expects another tough year for the commodity.
The bank noted in its forecast that Brent crude oil will rise to $70 per barrel in 2015 and remain flat up to 2018.
Source: Standard Bank
Aluminium, iron ore and coal producers rely on diesel and fuel to transport commodity output through locomotives and to operate mines – specifically in generating electricity.
Research by Standard Bank indicates that the cost of oil as a proportion of total costs for aluminium producers is 40%, iron ore is 35%, coal and nickel is pegged at 30%, while copper and gold each account for 20%.
Source: Standard Bank
The biggest impact of the declining oil price is that mines might be profitable in the interim, due to lower output costs. This is even despite the current low commodity price environment. Iron ore has dropped from $135 per tonne in 2013 to $97 in 2014 and is expected to fall to $70 up to 2018, according to the bank’s estimates. Thermal coal has followed suite, declining from $81 in 2013 to $72 in 2014.
If commodity prices drop in an environment where the Brent crude oil price was still high, then smaller mining counters may have been significantly impacted.
As the oil price falls an expectation of an inflationary environment also declines in the long term, said Kohli.
“When you have a low oil price environment, yes a producer may benefit from low diesel/fuel cost today. But you are taking a degree of inflation out of the system,” he added.
And when inflation is out of the equation, the forward price expectation for mining commodities is more negative, he added. This in turn puts a cap on any upturn in commodity price forecast and impacts investors.
“If you are an investor investing into the commodities sector or looking to undertake M&A (mergers and acquisitions) in the sector or if you are a mining company looking at other targets, the fact that you are looking at an environment which is slightly less inflationary may put a cap on the upside return potential that exists because of low commodity price environment,” said Kohli.