Global Commodities Outlook

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Why Are Commodity Prices Falling?

DEC 15, 2014

Jeffrey Frankel, a professor at Harvard University's Kennedy School of Government

http://www.project-syndicate.org/comment...el-2014-12

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http://www.cnbc.com/id/102314476

Not just oil: Are lower commodity prices here to stay?
John W. Schoen | @johnwschoen
5 Hours Ago
CNBC.com


Oil isn't the only commodity that's gotten cheaper.

From nickel to soybean oil, plywood to sugar, global commodity prices have been on a steady decline as the world's economy has lost momentum. That lower demand helps explain, in part, why nearly everything from crude oil to cotton has been getting cheaper.

Sure, some commodity prices are rising. Local supply constraints have pushed prices higher in some parts of the world; transportation costs can also have a big impact on local prices. In the U.S., for example, a drought in California caused the price of vegetables and other food products to spike last year.

Prices are also rising for some commodities, especially meats such as beef and chicken, thanks to growing demand from an expanding middle class in the developing world.

Read MoreOil's plunging—why hasn't gasoline fallen faster?

But the global cost of most commodities has been on a long-term, downward trend since the Great Recession. The chart below is based on global prices, in dollars, assembled by the World Bank.

Now, as much of the world slogs through a faltering recovery, there are fears that falling prices in slow-moving economies such as Europe and Japan could spark and extended period of deflation, when the consumer prices of finished goods fall over an extended period.


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Deflation can be difficult to reverse if businesses and consumers start to cut back on spending and investment, waiting for prices to fall further, setting off an economic contraction that can deepen.

European central bankers are scrambling to avoid that amid signs that prices in the euro zone have all but flattened. On Monday, the latest data showed that German inflation slowed to its lowest level in over five years in December; prices inched up at an annual rate of just one-tenth of one percent, down from 0.5 percent in November.

A widely watched inflation index of the entire euro zone is due out Wednesday. Some analysts think it could show a negative reading for the first time since October 2009.

Read MorePrice plunge puts oil patch jobs at risk

Much of the downward pressure is coming from oil prices, which have plunged since July as producers have flooded the world with oil. Unlike past price plunges that have prompted cutbacks by OPEC producers, the cartel has vowed to keep pumping.

The oil price crash has rattled investors this week. But some analysts say the price break is good news for a global economy struggling to gain momentum.

"There's good deflation and bad deflation," said David Kelly, chief global strategist at J.P. Morgan Funds. "Lower oil prices are a clear positive for the U.S. economy, for the Chinese economy and the European economy. This stimulates the economy's growth; it doesn't depress it."

It's far from clear how much further prices will fall, and where they'll stabilize in the long run. Kelly is among those who expect lower oil prices to spur demand and crimp production, sending prices back up above $80 a barrel in two years.

Earlier this week, Moody's Investors Services said it expected lower profits for oil companies would force them to cut back investment in capital spending on new production. If oil prices average $75 a barrel this year, North American exploration and production companies will likely reduce their capital spending by around 20 percent from last year; an average oil price below $60 a barrel would cut spending by 30 to 40 percent, according to Moody's.


The overall decline in commodity prices is also creating winners and losers among consumers and producers.

In Asia, for example, China's energy bill has been falling along with crude prices. Other big commodity consumers like India are also seeing lower import costs for fuel and raw materials, helping to ease downward pressure on the rupee. Indonesia, one of the world's biggest oil importers, is getting a break on lower crude prices.

But as a big exporter of coal, Indonesia has also seen those revenues fall by a quarter this year. Australia, which relies heavily on coal and iron ore exports, has seen revenues fall, raising the prospect of the country's first recession in 20 years.

Read MoreCrude price slide hits oil exporter currencies

If global growth picks up, stronger demand could help reverse the slide in commodity prices. But there are other forces at work that could continue to depress prices over the longer term.

One is the ongoing strength in the dollar, which is getting a lift from the relative strength in U.S. growth. That's attracting investment that had been moving to developing economies that have weakened, especially countries that rely heavily on commodity exports. Because commodities are priced in dollars, the strength of the U.S. currency accounts for some of the downward pressure.

But shifting investment also helps explain the longer-term decline in a wide range of commodities, following a boom in commodity investment that has been unwinding since the Great Recession.


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Much of that investment flowed into derivatives, investments in paper backed by commodities, not the underlying goods themselves. That investment helped artificially force commodity prices higher than the underlying demand.

Read MoreWinners & losers: Oil's effect around the globe

Now, with that speculative wave unwinding, the world may see cheaper commodities prices for some time to come, said Brian Reynolds, chief market strategist for Rosenblatt Securities.

"Wall Street structured the equivalent of $22 trillion worth of commodities through OTC commodity derivatives and now they're unwinding," he said. "This is a permanent decline, for probably five to 10 years."



John W. Schoen
CNBC.com Economics Reporter

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Commodity prices face more pressure as China’s growth to fall
MICHAEL BENNETT THE AUSTRALIAN JANUARY 12, 2015 12:00AM

UBS chairman Axel Weber will kick off the bank’s annual conference in Shanghai today. Picture: Sam Mooy Source: News Corp Australia

PRICES for iron ore and other commodities exposed to China’s building sector will remain under pressure this year as construction falls and the Chinese government holds firm in its push to become a more services-orientated economy, a leading economist has warned.

Ahead of UBS’s annual conference beginning in Shanghai today, the bank’s chief economist for China, Wang Tao, said the ­nation’s property construction “adjustment” would continue this year as developers lighten inventories to improve cashflow.

She said home starts would this year decline a further 10-15 per cent, while sales would fare better as inventory was ­“digested”.

“So more (home) sales and relatively less construction, but it’s the less construction that matters for the iron ore and steel demand,” Ms Tao said.

“We do expect steel demand probably will decline this year. Last year was flat. That means there will continue to be some pressure on the commodity front.”

Dwindling demand from China pushed the price of iron ore, Australia’s biggest export, down 47 per cent last year. On Friday, the spot price was trading at $US71.36 a tonne, up from a pre-Christmas low of about $US66.

The headwinds for commodities and the outlook for China’s property and banking markets will be key areas of focus at the UBS annual two-day “greater China conference”, attended by about 1700 delegates.

UBS chairman Axel Weber will kick off proceedings today.

Also presenting are Harper Reed, chief technology officer of US President Barack Obama’s 2012 re-election campaign, tennis champion Li Na and several industry and business experts from UBS and other major companies.

Ms Tao, who expects China’s GDP growth to slow to 6.8 per cent this year, said the biggest talking point would be China’s transition away from “rapid growth” to more domestic consumption and services.

She said the transition was likely to include more “policy support” in the form of infrastructure spending on railways, urban transport networks, energy power transmission and environmental projects, but also further interest rate cuts to ease debt repayment pressure on companies.

The government would also want to accelerate reform to open up services sectors and promote foreign capital inflows, she said.

UBS expects the People’s Bank of China to make a further 50 basis points of interest rate cuts this year, taking the lending rate to 5.1 per cent.

“(But) I’m afraid that as we think about China’s transition to a more balanced growth model, its reliance on commodity heavy type industries will decline. I suppose that’s not that positive for Australia but at the same time as China promotes the welfare of increasingly older and more affluent citizens, it will also focus on food and food safety,” she said.

“That’s another area Australia is trying to develop into China further. Also educational services, tourism and so on. So I think the industry focus will shift.”

Despite the concerns about a Chinese “hard landing”, there ­remained bright spots, such as the stockmarket and growing ­demand in industries such as technology, healthcare and pharma­ceuticals, Ms Tao said.

She added that investors were “getting more used to” China’s growth slowing to below 7 per cent.

“The labour market has been pretty resilient and we have done some analysis on it and we estimate even 6-7 per cent growth this year can generate as many new urban jobs as 11 per cent in 2008 as the economy is much larger,” she said.

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Good read - Financial Engineering Unwinding...

What’s really driving the plunge in commodity prices
BUSINESS SPECTATOR JANUARY 14, 2015 12:15PM

Stephen Bartholomeusz

Business Spectator Columnist
Melbourne


THE across-the-board sell-off of all commodities has driven the Bloomberg Commodity Index to levels last seen in 2002 despite record imports of commodities by China last year.

There’s something more than physical supply and demand at work here.

There is no dispute that the commodities boom was driven by China and its frenetic growth rate post-crisis. Equally, the “slowdown” and shifting patterns of activity within China has played a major role in the collapse of commodity prices.

China’s economy is, however, still growing at around 7 per cent a year off a base more than twice as large as it was pre-crisis, and its demand for commodities is growing, albeit at a more subdued rate. Iron ore imports, for instance, grew by almost 14 per cent last year and copper by about 6 per cent.

The extraordinary price levels for commodities reached at the peak of the boom did produce a dramatic supply-side response and has resulted in an oversupply of all the major commodities, ranging from iron ore to oil. That in turn has produced an equally dramatic collapse in prices, interestingly for both hard and soft commodities.

The fundamentals of supply and demand explain much of the action in commodity markets over the past half dozen or so years, but not the exaggerated impact on prices that created the level of oversupply which is now wreaking havoc on producers and those businesses that underpin them.

The other piece of the puzzle that underlies the violent shift in commodity prices is the emergence of hard commodities as financial assets over the past decade and particularly in the post-crisis period, when credit was cheap and returns from conventional asset classes were meagre.

Until the crisis, commodity derivative markets were quite underdeveloped, with little liquidity. Post-crisis they have grown quite dramatically, with a proliferation of exchange-traded funds holding either or both physical commodities or commodity derivatives, a lot of hedge fund activity and both over-the-counter and indexed-based derivative trading.

Commodities became a financial asset class, attracting the big Wall Street banks and investors, with prices reflecting not just near term supply and demand balances but speculative overlays that built the “stronger for longer” thesis into prices and created a feedback loop between pricing and production.

The nearing of the end of the quantitative easing program in the US (and thus the prospect of the end of the era of ultra-cheap funding), the consequent surge in the value of the US dollar (the base currency for almost all commodities), some wobbles within China’s economy and financial sector and the extent to which the prices had encouraged oversupply burst what, with hindsight, can be seen as a bubble.

The Bloomberg index peaked in April 2011 and has fallen about 42 per cent since then, with an acceleration of the slide occurring through last year.

The dramatic spike in prices at the height of the commodity bubble didn’t just attract more supply but high-cost supply and it inflated costs more generally across the entire sector.

Now it isn’t just commodity prices that are deflating but those broader costs as the sector struggles for survival in the new pricing environment. Much of the higher-cost supply will simply disappear in a process being quickened by the strategies of the big traditional low-cost producers like Rio Tinto and BHP Billiton in iron ore or the Saudis in oil. Their emphasis on driving volume into an oversupplied market is exaggerating the price declines and increasing the pressure on higher-cost rivals.

There is a chicken-and-egg element to any assessment of what has occurred and is still occurring within commodity markets.

It would seem reasonable to assume that the physical market — the shortfall of supply that occurred as China’s demand for commodities soared — led and encouraged the financial market activity. It would also seem reasonable to conclude that the levels of financial activity and the leverage associated with them got out of kilter with the real markets for the commodities.

In the physical market, the consequences are obvious and brutal. The supply of the commodities will have to be brought back into line with demand and will have to do so on the basis of far lower prices.

The low-cost supply from the Rios and the Saudis will continue to drive prices down and to drive a lot of production and producers from the market until there is a more even relationship between demand and supply.

In the financial markets there has been and will be losses for investors in commodity producers, their suppliers, ETFs, hedge funds and financiers and big, self-fuelling flows of funds away from commodity exposures to asset classes seen as safer havens. Given the strengthening of the US dollar, those funds have been and probably will continue to be driven towards the US bond and equity markets.

What we don’t really know is the extent to which the financial engineers within Wall Street structured leveraged products around commodities, although there have been some speculative estimates that more than $US20 trillion of derivative products were created during the boom period.

Whatever the magnitude of the financial overlay to the markets, however, it was clearly very substantial and its unwinding is playing a role in the implosions in prices and will continue to do so and represent an overhang on the markets until prices stabilise.

The rebalancing of the commodity fundamentals of supply and demand may not, if the unwinding of financial exposures has yet to be completed, be the only prerequisite for more orderly commodity markets.

It will make it difficult, if not impossible, to assess whether prices, having overshot during the boom/bubble, are now overshooting in the other direction.

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As commodities fall, some investors see reasons to buy
LESLIE JOSEPHS THE WALL STREET JOURNAL JANUARY 27, 2015 12:00AM

Operations During A Cotton Harvest As Drier Weather Aids CropsUS farmers are planting less cotton after prices tumbled 28 per cent last year Source: Supplied < PrevNext >
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A FEW brave investors are betting the gloom oppressing global commodity markets is on the verge of lifting.

The world’s farmers, mining companies and oil producers spent billions of dollars over the last decade to increase output. The result: huge surpluses and sharply lower prices for commodities ranging from oil to sugar to iron ore.

The magnitude of the decline has exceeded the expectations of most investors and analysts. The Bloomberg Commodity Index, tracking 22 commodities, fell for a fourth straight year in 2014 and is down 3.1 per cent this year.

But some investors see the seeds of a recovery in daily reports of plunging prices. They are buying some of the hardest-hit commodities, in a bet that low prices will quickly force producers to cut back, erasing the global surpluses behind the slide.

Many of these money managers acknowledge that a rebound may still be months off but say they are willing to endure short-term losses rather than miss an opportunity to get in early on the next rally.

“I don’t think commodities will go down much more,” said Christopher Burton, portfolio manager at Credit Suisse Asset Management’s commodities group. “We … are positioned for a bullish move in commodities.”

Mr Burton has bigger exposure to diesel and copper than his benchmarks outline, as he said he expects prices to rebound this quarter. Copper and diesel are both down about 11 per cent in 2015.

Last year typified commodities’ recent struggles. The Bloomberg Commodity Index ended 2014 down 17 per cent at a 5½-year low. Many commodities have extended losses in the new year. US oil prices dropped below $US45 a barrel for the first time since April 2009 and copper prices have reached a 5½-year low.

Despite record supplies, investors are hanging on to bullish bets in some markets that declined steeply in recent years, including corn and soybeans, according to data from the Commodity ­Futures Trading Commission. Many investors see agricultural commodities bouncing back fastest because farmers can adjust the size of their crops from season to season. Growers watch futures prices right up until the start of the planting season. If they ratchet back the number of hectares ­devoted to a crop, global supplies can fall in a matter of months, sending prices soaring.

In Brazil, the world’s top sugar producer, dozens of sugar-cane processors have closed or been idled by their owners over the past few seasons as prices slumped. The price of sugar fell for a fourth consecutive year in 2014 but is up 4.5 per cent this year. Growers have been planting less cane, and some of the mills that stayed open are running below capacity.

That is likely to result in global sugar production falling below demand for the first time in five years, according to estimates from Rabobank. The bank expects prices to reach US35c a kilo this year, up from US29c at the end of 2014. US farmers are also changing course. The US Department of Agriculture predicts the land US farmers devote to corn will drop slightly to 36 million hectares this year.

Prices for cotton tumbled 28 per cent last year to $US1.21 a kilo. The USDA said farmers would likely cut back this (northern) spring, leading to a production decline of 13 per cent.

In the futures market, some investors are even buying oil and petroleum products, among the commodities in the Bloomberg index that fell the most last year.

While many analysts expect supplies of oil to keep ballooning, suppressing prices, some investors are betting on a bounce as ­demand hits records in big ­importers like China and oil companies slash budgets.

About half the world’s oil isn’t economical to produce when prices are below $US50 a barrel, Nomura Securities said in a recent note. “We’re at price levels where you’re seeing a lack of interest in reinvesting” by producers, said Jonathan Berland, senior managing director at Gresham Investment Management, which specialises in commodities.

Still, some commodities prices may remain depressed for some time. Some mining firms and drillers are reluctant to shut down mines and oil wells that can be expensive to restart. Many companies borrowed to fund expansion during the boom years and must keep producing at high rates to pay off debt. And of course, there were plenty of investors who bought commodities on the dips in the last couple of years and got burned when prices kept falling.

WSJ

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China’s ‘new normal’ a risk to mining exports, warns EFIC
THE AUSTRALIAN MARCH 26, 2015 12:00AM

Rowan Callick

Asia Pacific Editor
Melbourne
The Australian government’s risk assessment agency warns in its latest analysis of world risk developments, that “China’s new economic growth model is likely to keep pressure on Australia’s mining exports”.

The Export Finance and Insurance Corporation said yesterday that “while fuelled primarily by lower commodity prices, a slowdown in opportunistic buying has also weighed on China’s import volumes.”

While in the first two months of this year, China’s iron ore imports fell 45 per cent, year on year, in value terms, they also declined — by 1 per cent — in volume.

However, EFIC said, China’s Premier Li Keqiang also foreshadowed measures to increase efficiencies and strengthen market forces, promising during the recent annual session of the ­National People’s Congress a greater role for private business and a halving of the number of ­industries in which foreign investment is restricted.

Such reforms, EFIC said, “along with new consumer demand, promise new opportunities for Australian exporters” that may help balance out the continuing blows to the miners.

The agency noted that almost two thirds of China’s provinces missed their growth targets in 2014, with underperformance especially marked in heavy industrial regions led by Shanxi, followed by Hebei, Heilongjiang, Inner Mongolia, Liaoning and Ningxia, each more than two percentage points below target.

Hebei, whose steel production capacity is bigger than the output of Japan and South Korea combined, was four percentage points below its target. Every province in the country cut its initial target for 2015, except for Tibet — which kept its target constant — and Shanghai, which abandoned the concept. “Deep-seated problems in development are surfacing,” said EFIC, “including a stalled property market, high debt levels, excess capacity in industry, and disinflation.”

This slowdown is being cushioned through monetary and ­fiscal stimulus, the agency said in assessing the announcements made during and since the NPC, with interest rates cut this month for the second time in three months and with the government planning to increase spending by 11 per cent this year.

However, EFIC said, “reform priorities will see China rebuff expansion at all costs. Li heralded a ‘new normal’ of slower growth and vowed to fight pollution and corruption, control China’s debt surge and put the economy on a more sustainable footing after three decades of rapid growth.”

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Pain at the top as big miners take $202bn hit
THE AUSTRALIAN JUNE 05, 2015 12:00AM

Paul Garvey

Resources Reporter
Perth
Loading of iron ore on very big dump-body truck - generic Careerone - TOWNSVILLE BULLETIN USE ONLYThe 40 mining majors surveyed had a combined market capitalisation of $US947bn — about half of four years ago. Source: Supplied < PrevNext >
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The world’s biggest miners lost a combined $US156 billion ($202bn) in value over the past year, PricewaterhouseCoopers has found.

And the bulk of that pain was felt by companies from Australia, Britain and North America, adding to the balance shift in the upper ranks of global miners away from their traditional base towards companies from China and other non-OECD nations.

PwC’s latest annual report into the health of the global mining majors highlighted cost-cutting efforts in progress across the majors and the sharp focus on lifting dividends to satisfy increasingly yield-hungry investors.

While the combined market capitalisation of the world’s 40 largest miners fell 16 per cent, or $US156bn, dividend yields jumped from 4.3 to 5 per cent.

Free cashflow also improved significantly, from $US3bn in the red to $24bn in the black.

With the prices of most major commodities continuing to fall over the past year, the improvement in free cashflow reflected cost-cutting ­efforts and deep ­recent cuts in exploration and capital expenditure.

The study found costs at the mining majors had fallen 5 per cent over 2014, although PwC’s Australian mining leader, Jock O’Callaghan, said the figure could be lower than expected given the sharp management focus on cost-cutting over the year.

In addition, the 5 per cent ­figure included savings from factors beyond management’s control, such as favourable currency movements and lower energy costs

“Five per cent isn’t too shabby in an industry with large projects where it is hard to turn things around quickly, but within that were a couple of free kicks like currency and energy,” Mr O’Callaghan said.

“More in the order of 3 or 4 per cent (cost savings) is not what you would call a compelling outcome from an industry that has had a full year of lower costs.”

The 40 majors had a combined market capitalisation of $US947bn — about half the level of just four years ago.

A greater proportion of that value is now tied up in companies from nations such as the BRICs — Brazil, Russia, India and China — with Chinese trio Zijin Mining, China Coal and Yanzhou Coal all gaining more than 30 per cent over the past year. Miners from the OECD lost an average of 21 per cent last year, compared with just a 7 per cent fall among miners from China and other non-OECD nations.

The geographic divide also ­extends to acquisitions, with fewer traditional miners likely to compete for deals.

“Many more of those BRICS companies with significant government ownership certainly have greater access to cash to make acquisitions.

“And secondly there’s very few of those OECD mining companies that either have a mandate for growth through acquisitions or ­indeed that are going to get adequately rewarded for going out and making acquisitions,” Mr O’Callaghan said.

“The imperative to CEOs and down is all about managing what you’ve got, and we wouldn’t expect that’s going to turn around.”

The study found the top 40 incurred $US27bn in impairment charges over 2014, an improvement over the $58bn in writedowns in 2013. But Mr O’Callaghan said market capitalisations were shrinking closer ­towards net asset values and there could be more impairments.

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• OPINION

• Jun 23 2015 at 10:24 AM

• Updated 53 mins ago
Miners' M&A sinks in sea of dud deals


by James Thomson
Think long term. Show some vision. Be bold. Don't mortgage your company's future prospects by simply handing back capital to shareholders. Do something!
If like me you've had these thoughts about the current state of corporate psyches, then this might make you think again – big miners are apparently terrible at mergers and acquisitions.
According to research from Citi, the world's biggest miners have now written off about 90 per cent of the value of the assets they have acquired via M&A since 2007.
Ninety per cent! This suggests the bulk of deals done by our big miners have been pretty much worthless for shareholders. A sea of dud deals. Billions in wasted capital.
According to Citi's numbers, miners have written down the value of assets by $US85 billion in the past seven years, representing about 18 per cent of their assets base.
The worst offender was our very own Rio Tinto, which has "impaired" 34 per cent of its asset base, thanks in large part to its Alcan acquisition, which ensured aluminium assets were the most impaired at $US25 billion.
Iron ore, with $US10.3 billion worth of impairments, and nickel, with $US7.8 billion of impairments, were the next worse commodities for writedowns.
And Citi suggest there are likely to be big writedowns still to come in coal, where both thermal and metallurgical coal prices are low and likely to stay that way, meaning fair value tests will push impairments higher.
Clearly, the period measured here brings deserves some context. This was the mining boom, when every big deal looked smart and the China-driven good times looked like they could last forever. And it's only with the aid of good old Captain Hindsight that you can tell a dud deal from a good one.
But, it's little wonder that fund managers' common response to the question of what to do with excess capital is "give it back to us".
As the Citi research argues, when miners buy an asset they tend to overpay.
Even when they build assets, they tend to do it at the wrong point in the cycle – which is a very interesting point given that every mining expert under the sun is tipping a new wave of M&A in mining, although this time it will occur at the bottom of the cycle and be driven by bargain hunters.
Citi says miners need to be "resolute" about the way they spend capital and it's hard not to agree with the analysts.
Just because an asset is cheaper now that it was a few years ago doesn't mean you can't over pay for it.
And with commodity prices likely to stay lower for longer, it would seem a big risk to add to the terrible record of the past seven years.

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http://www.smh.com.au/business/mining-an...huyeo.html

Mining write-downs all but wipe out cost of deals since 2007
Date
June 23, 2015 - 7:48AM

Mark Mulligan
Markets and economy reporter

Citi says over the last seven years, the world's largest miners have built up impaired assets worth $US85 billion ($110 billion) and this represents 18 per cent of their average asset base. Photo: Peter Braig
The world's largest mining groups have written off about 90 per cent of the value of mergers and acquisitions completed since 2007, according to a report by Citi which is critical of a range of deals in recent years.

The US-based investment bank says the figure calls into question the companies' capital allocation strategies, and warns that more write-downs are inevitable, particular in coal.

The bank calculates that, overall, miners have built up impaired assets worth $US85 billion ($110 billion) over the last seven years, and this represents 18 per cent of their average asset base.

Most affected were Rio Tinto, which has 34 per cent of its asset base impaired, and Anglo American, with 23 per cent impairment.

Brazil's Vale do Rio Doce, the world's biggest iron producer, was least affected with just 8.5 per cent of its average asset base impaired since 2007.

In terms of commodities, aluminium – thanks to Rio Tinto's ill-fated $US38 billion takeover of Alcan - accounted for the biggest chunk of total impairments, at $US25 billion, followed by iron ore, with $US10.3 billion and nickel, at $US7.8 billion.

Rio's Alcan acquisition was heavily criticised by investors and analysts.

Addressing the annual meeting of Rio's London shareholders in 2013, chairman Jan du Plessis apologised for the deal.

"In hindsight, this project was not only badly timed at the top of the market, but major structural changes over the last year or two have put the global aluminium industry under tremendous pressure," he said.

"In retrospect, we therefore have to acknowledge that the acquisition has had a significant negative impact on shareholder value and, as our owners, you have every right to expect that we do better."

Citi also warned of further pain ahead in the resources sector.

"We believe there are potentially more impairments to come in thermal coal and metallurgical coal businesses, where we have seen a structural downshift in prices," Citi says.

Fair value calculations to test impairments are usually based on long-term commodity prices.

Slowing Chinese growth and falling costs have prompted a series of downgrades in the outlook for a range of commodities.

Citi, for one, recently downgraded long-term bulk prices for iron ore from $US81 a tonne to $US55 a tonne; for coking coal from $US$170 a tonne to $US125 a tonne; and for thermal coal from $US90 a tonne to $US80 a tonne.

"We argue a buy decision only changes ownership and the biggest risk is of overpaying, while a build decision is subject to a number of risks, including execution risk, time lag, and more importantly the incremental supply for a long period," Citi said.

The bank said most mining companies had made mistakes in both buying and building at the wrong point in the cycle, as shown by "significant impairments and capital expenditure overruns and ramp-up delays".

"The merger and acquisition phase pushed the sector into no-value-add territory, while the capital expenditure phase pushed it into a prolonged value destruction period," Citi said.

"The outlook is set to improve from 2018-2019, but the miners need to remain resolute in our view," it said.

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Mining exploration sector in crisis, warns Boston Consulting
THE AUSTRALIAN JULY 02, 2015 12:00AM

Matt Chambers

Resources Reporter
Melbourne
Boston Consulting Group says the mining exploration sector is in crisis.

It claims that new discoveries have dwindled despite boomtime spending surges, and warns that failure to focus on looking for new deposits amid the current ­productivity drives is a risky ­proposition.

As bigger miners pull back on exploration to focus on productivity and dividends, the challenges for junior explorers continue to grow, with the number of ASX-listed companies filing reports continuing to slide.

Advisory firm BDO estimates that one in five Australian juniors are zombie companies conducting no mining exploration as they struggle to stay afloat.

BCG says between 2010 and 2013 the number of annual discoveries outside iron ore and coal more than halved, from 130 to 60, while giant discoveries have dropped from eight in 2010 to just one in 2013. This was despite global exploration expenditure increasing to record levels of about $US22 billion in 2012 during the boom. Since then exploration budgets have halved.

“Since the end of the resources boom, most mining companies have focused on productivity and cut back on exploration spend, which has exacerbated the depletion of resources and reserves,” Perth-based BCG partner Alexander Koch said.

“Risk-averse companies often forgo greenfield exploration (searching for minerals away from existing mines) in favour of brownfield exploration (near mines), but in doing so they incur more risk than if they had ­balanced the two types of exploration in a portfolio approach.”

BCG, which consulted some of the world’s top exploration executives — including former Newcrest exploration manager Dan Wood, who discovered the big Cadia gold and copper deposits in NSW; Jim Lalor, who discovered Olympic Dam coper and uranium mine in South Australia for WMC; and Douglas Kirwin, who helped discover the Oyu Tolgoi copper and gold mine in Mongolia — said the exploration crisis was not due to geology, industry economics or other external forces.

“Whether you’re a junior, a mid-tier or a major, the big issue is the quality of leadership,” said Graham Brown, a former exploration chief at Anglo American.

“If as a leader you can’t convince your board that you need a certain amount of time and a certain amount of money to do what you have been asked to do, then it’s your problem.”

BDO’s quarterly report on the cash position of junior ASX explorers said the sector had been starved of capital, with one in five companies effectively having ceased operation by spending less than $10,000 on exploration and more than 40 per cent holding cash reserves sufficient to fund just one or two quarters of operating expenditure.

“The signs are worrying for the junior explorers,” BDO corporate finance partner Dan Taylor said. The number of companies reporting since BDO began analysing the sector’s quarterly cash expenditure in June 2013 had fallen to its lowest level.

Only 793 companies lodged reports in the March quarter, down from 814 in December and 861 when the survey started.

“The challenge for many companies at the moment is to try to ride out the next few years until prices become more attractive,” Mr Taylor said.