Low oil price challenges mining sector

by: Casper Burgering

The sharply lower oil price means that energy costs for mining companies are falling. Under normal circumstances, the mining sector wouldn’t complain about a lower diesel price and lower energy costs. But current circumstances are far from normal. After all, oversupply is looming and that will hit the sector hard. And with weaker demand for metals due to the coronavirus crisis, the sector’s problems will only increase.

Cost structure of mining companies

On average, energy costs make up about 15% of total mining costs. This can rise to as much as 40% for the mining of some specific metal ores. Mining companies meet their energy needs largely from fossil fuels, such as oil, coal and gas. This means that highly volatile prices for these fuels lead to highly unpredictable costs.

The commodity analysts at Morgan Stanley have calculated how these costs are distributed per base metal (see: Mining Journal: ‘Cheap oil is a blessing and a curse for miners’, 18 March 2020). Diesel, for example, accounts for 5% to 10% of the total costs of mining metal ores such as copper, nickel and zinc. Total energy costs for the refining of metals are especially high for aluminium and nickel. In the refining of these metals, energy can account for 30% to 50% of production costs.

Lower oil price, lower energy costs

The sharply lower oil price has therefore led to a significant reduction in operating costs. This greatly reduces the financial stress for many mining companies, now that metal prices have fallen sharply. But there is a downside to this.

Lower operating costs are often an incentive for many mining companies to maintain or even expand production. This incentive to continue producing will eventually lead to oversupply in many metal markets, especially now that the demand for metals is weakening. And this could translate into relatively low metal prices in the longer term.

Frail economic perspective

These are far from normal times. The coronavirus crisis is having a major impact on the global economy. Along with the human suffering, the crisis is also paralyzing many economies. ABN AMRO expects a deeper global economic contraction in the short term. We also expect a longer economic slowdown before a strong and sustainable recovery takes shape.This will severely impact the demand for metals. Economic uncertainty remains high for the time being, which will keep prices of many base metals at a relatively low level in the coming quarters.

An oil price recovery will not go smoothly because weaker demand, larger stocks and oversupply will severely limit the upward price potential in the coming period. ABN AMRO expects the oil price to reach USD 50 per barrel at the end of 2021. This means that a relatively low oil price will continue to challenge the mining sector. It also implies that marginal and unprofitable mines will be able to continue producing for some time to come.

This column was also published in Dutch newspaper de Telegraaf on 30 March 2020