Zinc increasingly vulnerable to disruptions: Barclays

UNITED STATES February 28 2014 3:09 PM

LONDON (Scrap Register): The parts are starting to fall into place for a supply-driven tightening in zinc fundamentals, said Barclays. There is now very little slack should new supply not perform, though unreported inventories will cap price upside and time spread tightness for the time being.

The zinc mining industry is approaching a pivot point. For some time now, there has been a widely anticipated tightening in zinc mine supply that has yet to materialise. However, the most recent zinc mine corporate production data suggest that the bullish supply story may be starting to take shape.

The reported production that we track, covering almost 20% of global supply, fell 4% y/y, with production contracting at half the mines. GlencoreXstrata’s Q4 13 results and subsequent newsflow have been particularly revealing. GlencoreXstrata’s zinc production dropped 9% y/y in 2013 due to the shuttering of two big mines – Perseverance and Brunswick. Production at Kidd also fell due to greater operational complexities.

The new Bracemac McLeod mine is ramping up, but will only offset half of the lost production at Perseverance. Likewise, expansions at Mt Isa and McArthur River in Australia are expected to increase GlencoreXstrata’s zinc output in H2 14.

In fact, ex-China zinc mine supply is going to be very dependent on GlencoreXstrata since it has a stake in the top three sources of new supply in 2014. One of those mines, Perkoa in Burkina Faso, was slated to add 65Kt to supply this year. This is the reason the news on 14 February was so interesting.

Blackthorn Resources, a joint venture partner with GlencoreXstrata in the Perkoa mine, announced that GlencoreXstrata had submitted a business plan considering, amongst other things, putting the mine on care and maintenance in response to current trading conditions. Blackthorn Resources plans to “constructively challenge”

GlencoreXstrata’s review and aims to have a final plan for the mine by the end of March. In the meantime, Blackthorn Resources has suspended open pit operations (which produce only lead and gold) because of weak metal prices and “unacceptable” financial results.

Whether or not this mine is put on care and maintenance is important because the slim margin between new zinc mine supply and closures/attrition leaves very little slack should new supply not perform. All of this suggests the zinc market is increasingly vulnerable to disruptions and slippages. Indeed, in January our equity analysts lowered their forecast for 2014 GlencoreXstrata production from 1.56Mt to 1.446Mt which is 10% below guidance provided by GlencoreXstrata at the investor day in September 2013.

Data from the International Lead and Zinc Study Group (ILZG) this week further illustrated the softer ex-China production performance: ex-China mine production did not grow at all in 2013.

The other part to the supply picture is China, where growth is slowing sharply. After years of double-digit percentage growth, mine production grew only 4% in 2013. That’s even slower than the official data suggest; NBS data show Chinese production up 9% y/y. In the past, Chinese production tended to surprise to the upside, and that certainly remains a risk.

“We think some mines could resume production given a strong enough price signal, but this is only likely at the margin. The industry is fragmented, inefficient and suffering from a sharp decline in ore head grades. Thus, the scale and sustainability of any future upside supply surprises are likely to be limited and high-cost. Overall, we think the parts are starting to fall into place for supply-driven tightening in zinc fundamentals,” Barclays added.

“However, we expect this to develop gradually. Concentrate and refined metal stocks will provide an initial buffer: we estimate unreported stocks of refined metal built by 600Kt last year, for instance. It could attract on-exchange during periods of tightness in spreads, which happened nine times in 2013, and could restrain backwardations, temporarily at least.”

“We think there are reasons to be bullish on zinc prices on a 12-month view and see more than 10% upside between now and the end of 2014, with most of that happening in H2 14 with Q4 14 prices forecast to average $2,200 a ton,” Barclays concluded.