In the beginning of the resource bull market, all commodities were created equal. They all rose together, with the exception of a few products like aluminium and rubber, which lagged the rest of the group. Now, things are different. Call it the great energy sorting.
What does that mean? Investors are going to have to begin considering the embedded energy costs in tangible goods. Everything in life takes energy, from making your scrambled eggs in the morning to smelting aluminium. Some resources are more energy intensive than others.
Take the Mexican stand off between BHP Billiton (ASX: BHP) and Rio Tinto (ASX: RIO). BHP feels its exposure to coking coal, oil, and gas gives it an earnings advantage over Rio. Not so!, says Rio. Rio says its exposure to iron ore, copper, and aluminium means it will grow is earnings more and sooner than BHP.
Energy earnings versus metals earnings. It kind of reminds you of the Priority Dispute between Newton and Leibniz over who invented the calculus, doesn’t it? Chicken, egg. Egg, chicken. Cluck.
Aluminium is an energy-intensive metal, and therefore more price sensitive in an energy-scarce world. This is to Rio’s advantage, the company reckons. “The price for aluminium now has a new base,” Rio’s chief economist Vivek Tulpule told investors in Melbourne last week.
“Margins for existing aluminium producers who have cheap energy, their own bauxite, and who aren’t exposed to the Chinese currency, go up. This is a phenomenon that people have only started to clue on to very recently.”
Tulpule also said that, “Though Chinese aluminium supply had traditionally risen in tandem with demand, keeping a lid on prices, soaring energy costs in China and rising bauxite costs had made Chinese producers the most expensive in the world.”
In gold, the mantle of lowest-cost producer has always been coveted. In resource, the mantle of lowest-energy-intensity may be the key to figuring out which resources will go up the fastest. Energy-sensitive resources will see producers get hit hard by rising costs. This will cause some to close up shop, reducing production and supply. Prices will rise.
“An energy shortage in Chile may do for copper what cuts in electricity supplies did for platinum in South Africa spark a record-setting rally in prices,” according to Heather Walsh at Bloomberg. “Chile may be forced to limit power use for the first time since 1999 because a drought has reduced water levels at hydroelectric reservoirs.”
Proximity and possession of energy may even better than access to cheap capital in coming years. Energy is a kind of capital, isn’t it? If that’s the case, Australia has a huge capital base, with its reserves of coal, natural gas, and uranium.
Thermal coal prices are set to double from US$55 to US$125. That’s based on the agreement between Japan’s Chubu electric power and Xstrata which should be come the benchmark for 2000-09 contract prices. Spot prices for thermal coal have tripled in the last year. Spot coking coal (steel marking) prices have quadrupled in the last 12 months, and in the last two months they’ve doubled. Notice a pattern?
“The value of announced cross-border acquisitions by China so far this calendar year is now US$24.5 billion from 56 deals according to Thomson Financial-already almost equaling the record of $US29.8 billion for all of 2007,” according to Colleen Ryan in the Financial Review. As usual in the financial world, the easiest way to find where asset prices are headed is to follow the money.
“China’s acquisitions of foreign targets reached US$15 billion in the mining sector-the most active sector, largely comprising companies engaged in metals, mining, and chemicals-rising from just US$243 million in the same period last year,” Ryan writes. Are you listening BHP?
Markets and Money