LONDON: The International Zinc Conference is fast approaching.
That means that the annual locking of horns between zinc miners and smelters over concentrates pricing is at its most intense.
If past years are anything to go by, a “benchmark” deal will emerge at the conference, taking place this year in Cancun, Mexico, on Feb 24-27.
As always, the headline figure will come with all the usual baffling paraphernalia of the zinc concentrates world with its “escalators,” “de-escalators” and “free metal.”
The first two denote each side’s cut in the event the “basis price,” which was set last year at $ 2,000 per ton, changes over the course of the year.
Price participation, to give it its proper name, is a concept that disappeared some years ago in the copper concentrates market.
“Free metal” comes about because of the relatively low amount of zinc that is payable in the concentrate, typically around 85 percent for zinc concentrate compared with over 95 percent for just about all other base metals.
Quite why the zinc market has stuck with such an arcane way of doing business is a mystery. But neither miners nor smelters show any particular inclination to change things.
Nor should the devilish detail distract from the importance of this year’s talks.
The outcome will determine not whether the zinc market will be in surplus, which is a given, but how that surplus will manifest itself over the next 12 months.
The global refined zinc market has been in supply-demand surplus since 2006, based on figures from the International Lead and Zinc Study Group (ILZSG).
It was in surplus again last year but the Group’s latest assessment, covering the first 11 months of 2012, was that the surplus shrank to 267,000 tons from 323,000 tons in the comparable period of 2011.
Don’t get too excited.
That apparently shrinking surplus masks two very different dynamics.
While global refined metal production fell by 3.4 percent over the January-November period of last year, that of mined zinc surged by 7.0 percent.
China is the source of this disconnect.
The country’s miners boosted output by 20 percent, accounting for just about all the global increase, as shown in the second graphic above.
China’s smelters, by contrast, slashed refined run-rates by 8.5 percent over the same period. The gap between these two divergent trends implies an accumulation of zinc concentrates in the country.
It’s fair to say that the scale of increase in China’s mined zinc production last year has caused a few raised eyebrows among the metals analyst community.
As ever with official Chinese statistics, though, it’s the trend that probably counts most.
And certainly the combination of the two trends, rising concentrates output and falling smelter demand for those concentrates, would seem to be confirmed by the sharp reduction in the country’s concentrates import needs.
Zinc concentrate imports slumped by 34 percent last year. At 1.94 million tons (bulk weight, not metal contained), they were the lowest since 2006 and just half of what China was importing as recently as 2009.
That in turn implies a build-up of concentrates outside of China as well, although by how much is currently a hotly disputed debating point in this year’s negotiations on 2013 treatment terms.
What happened in China last year is symptomatic, albeit in extreme form, of the miner-smelter profitability divide.
Benchmark treatment terms have swung in favor of the miners over the last couple of years. Last year’s headline figure was $191 per ton, down from $ 229 per ton in 2011 and $250 in 2010.
To understand what this means, look at Nyrstar’s full-year results, released on Thursday.
With production of almost 1.1 million tons of refined zinc last year, Nyrstar is one of the world’s largest producers and one of the world’s largest buyers of concentrates.
It has also been aggressively moving upstream, bulking up its own mine production to reduce that raw materials dependence.
The contrast between the two businesses could not have been more stark.
Profitability on the mine side, based on EBITDA (earnings before interest, tax, depreciation and amortization), rose by 19 percent year on year to 413 euros per ton. Profitability of its smelter operations fell by 40 percent to just 125 euros per ton.
Sure, there were specific drivers for that fall in smelter profitability. The company is particularly exposed to the Australian dollar and took a one-time hit from operational problems at the Port Pirie lead smelter in the second half of the year.
But the core driver of the mining-smelting divide was a 15-percent reduction in the company’s realized treatment charge to $196 per ton last year.
That’s last year’s benchmark after all the esoteric price participation clauses have been factored in.
In China, this profitability split has been exacerbated by the build-out of smelter capacity, bringing with it ferocious margin competition between operators.
Hunan Nonferrous Group has just warned that its subsidiary, Zhuzhou Smelting, one of the largest producers in the country’s zinc-lead sector, will report its second consecutive year of losses.
This amounts to a “de-listing risk alert” with the publicly-quoted unit under risk of being de-listed from the Shanghai Stock Exchange if it extends its loss-making run to a third consecutive year.
Smelters such as Nyrstar are adamant it is time for the profitability pendulum to swing back in their favor.
Speaking on an analysts call, Greg McMillan, chief operating officer, said he was “reasonably confident” that treatment terms would rise this year, although the magnitude of any increase is still being hammered out behind closed doors.
McMillan confirmed the current battle lines with miners negotiating from a base of $ 186 per ton and smelters riposting with an offer of around $ 230 per ton.
Analysts are expecting a neat meeting in the middle at around $ 210-215 per ton.
If realized, the 10-percent jump in terms should stimulate higher smelter production, particularly in China, which has no shortage of spare smelter capacity.
That in turn would shift more of the zinc surplus from the raw materials to the refined metal part of the production chain.
This makes industrial sense since storing refined metal is a lot less hassle and costly than storing large amounts of raw material.
Moreover, given the shuffling of surplus zinc into LME warehouse locations such as New Orleans, where it is both quarantined from consumption hubs and locked down behind long load-out queues, more surplus does not necessarily impact physical premiums.
Now what, you might ask, happened to that expected zinc concentrates shortfall that everyone has been predicting for the last couple of years?
Outside of China, it was an assessment based on the closure of some of the world’s largest mines.
And some, such as Xstrata’s Perseverance and Brunswick mines in Canada, will indeed wind down this year, although MMG’s giant Century mine in Australia will eke out another year or so of operations.
However, miners have not been sitting idly by.
Xstrata will compensate by expanding production from its Lady Loretta zinc project, MMG by developing its Dugald River project.
But it is Nystar itself that probably offers the best example of how mine supply is adapting to anticipated shortfall. The company does, after all, have every incentive to try and mitigate any raw materials squeeze.
It has brought two mines back out of mothballs, namely Langlois in Canada and the Tennessee mine complex in the US.
Without Nyrstar’s intervention, both would have been left quietly to fill with water.
Not only have both been brought back from the dead, but the company pointedly noted that production at Tennessee, running at an annualized 120,000 tons contained metal in the second half of 2012, is now higher than under any previous operator.
Cash costs, meanwhile, are moving the other way, tumbling by 20 percent to $ 1,705 per ton in the second half of the year after an optimization program.
Good news for Nyrstar.
Arguably less good news for the zinc market, which is likely to keep generating surplus units for the next couple of years at least.
Whether they appear in the form of metal or concentrates will depend on the outcome of the negotiations between miners and smelters.
We’ll find out in a couple of weeks’ time.
— Andy Home is a Reuters columnist. The opinions expressed are his own
