Elevated Supply Risks To Continue Into 2013

We expect many of the risks and challenges facing the mining industry in 2012 to be replicated over the coming twelve months. Companies are deferring their expansion plans in the face of waning Chinese demand, increasing cash costs and declining ore grades, while at the same time battling the rising tide of resource nationalism. Indeed, the mining sector in 2012 was stuck mostly in reverse gear as China's rebalancing process began in earnest and commodity prices continue to head south. Elsewhere in Asia, mining activities have come under increasing scrutiny from governments seeking to gain even more value from the growing resource wealth in their respective countries. Here, we reflect upon some of the key events that took place within Asia's mining economies in 2012 and outline our views on how the industry will shape up going into 2013.

Metals Drift Lower On China's Growth Concerns
Select Commodity Prices, Rebased

Australia: Mega Miners Batten Down The Hatches, But The Worse Is Over

In line with our expectations, 2012 marked a tumultuous year for Australia's mining industry, however we expect the worst is now over. More than US$246bn of planned investments were frozen in light of high cash costs and sliding revenues. Chief among these include BHP Billiton's decision to shelve the Olympic Dam expansion project, capital expenditure cuts to Aquila Resources' West Pilbara Iron Ore mine, and Rio Tinto's plan to reduce costs by US$5bn over the next two years. Furthermore, the Australian government has been adopting an increasingly interventionist stance towards the mining sector , most notably with the imposition of a carbon taxation scheme and a 30% super-profit tax on coal and iron ore miners . Un surprisingly, falling commodity prices have been squeezing miners' profit margins and cost rationalisation is once again becoming a critical issue. There has been an appreciable shift over the past few months as companies across the board exercise greater control and greater discipline to their capital allocation plans, with a large number of them choosing to narrow their focus on core, existing assets. Looking ahead, we expect that the worst is over given the size of project cancellations thus far. Indeed, whilst we expect China's slowdown to continue from H213, Australia will remain one of the most competitive places for mining investment.

Table: Australia - Delayed Projects Pipeline
N/A = not available. Source: BMI, Company Announcements
Company Project/Mine Location Estimated Cost (A$bn)
BHP Billiton Olympic Dam uranium South Australia 30
Cameco Kintyre uranium Western Australia 1
GVK Kevins Corner coal Queensland 6.6
North Queensland Bulk Ports Corp Abbot Point coal terminal expansion Abbot Point, Nth Qld 9
Port Waratah Coal Services Kooragang Island T4 coal expansion Newcastle 5
Rio Tinto Mt Pleasant coal New South Wales 2
Sinosteel Midwest Blue Hills iron ore Western Australia na
Xstrata Wandoan coal Wandoan 6

China: Grip Tightens On Mining Sector, Industry Consolidation To Continue

As 2013 ushers in the third year of China's 12th Five-Year Plan (2011-2015), we expect the changes and reforms enacted in 2012 to continue. In a bid to curb overcapacity and reduce environmental pollution, the government plans to close smaller and less efficient mines, whilst mid-sized miners will be merged and production consolidated into giant vertically-integrated state-owned outfits. We expect increasing tax burdens on the Chinese mining industry as part of the industry consolidation plan. In February 2012 additional taxes were imposed on the mining of tin, iron ore and other minor metals. There is an increasing emphasis on the negative environmental impact of mining activities, with the imposition of an environmental tax on certain industries and the introduction of a 'green standard' for the rare earths sector to curb emissions. Significant progress has also been made on the crackdown of illegal mining activities, with the Ministry of Land and Resources announcing in 2012 that more than 280 illegal mines, including coal and rare earths mines had been shut down.

India: No End In Sight To Mining Woes

The poor legislative and regulatory environment in India has continued to dampen investment flows and sparked off a series of mining scandals in the country, as best exemplified by the Coalgate scam in August 2012. According to an audit report by the Comptroller and Auditor General (CAG), the Indian government failed to effectively allocate 57 of India's coal mining blocks, resulting in lost revenues of roughly US$33bn between 2004 and 2009. In the ensuing months, the Indian state of Goa was ordered to suspend production after an expert-led panel formed by the federal government revealed serious irregularities in mining operations. With a production capacity of more than 50mntpa (million tonnes per annum), Goa is the second-largest iron ore producing state and a top exporter of the mineral in India. We have long argued that much of the downturn in India's mining industry has been self-inflicted. Corruption concerns, policy paralysis and project delays have combined to sap investor confidence in the country's mining prospects. Mining projects are a multi-decade undertaking and unless credible efforts are taken by the Indian government to create a sustainable investment climate, we believe the industry will continue to struggle to achieve its full potential.

India's Dominance Increasingly Threatened
Global - Iron Ore Production By Country (2010)

Indonesia: Moving Up The Value Chain

Indonesia's burgeoning economy has led to the introduction of increasingly protectionist, and in some cases, nationalistic policies. This phenomenon has been especially true of the mining sector, where a spate of new regulations over the past year have begun to undermine the industry's competitiveness. In May, the Indonesian government slapped a 20% duty on 14 mineral ore exports ahead of a complete ban in 2014. The ban is part of the government's initiative to establish a 'value added' mining industry, whereby onshore smelting and processing of most minerals would provide a considerable boost to state revenue while allowing the country to seek greater control over its resource extractive industry. The rules, however, do not apply to major miners such as Freeport McMoRan Copper & Gold and Newmont Mining Corp, which together with coal, are not affected by the recent changes in the country's mining code.

Malaysia: Lynas Corp Riding The Rare Earths Investment Wave

Australian rare earths producer Lynas Corp started processing rare earths at its Kuantan ' s Advanced Materials Plant in November after a delay of more than a year due to opposition over health fears. The US$900mn plant is the world's largest rare earth facility outside of China and has been mired in controversy since the company ' s planned investment was announced. The elevation in rare earths prices during 2011 sparked a wave of interest in the sector amongst global mining players. Elements such as niobium, neodymium, dysprosium and cerium underwent a spectacular price rally, with niobium prices increas ing by over 1,000%. While prices have since fallen from their recent peaks, we believe new mining projects will remain in the pipeline as prices remain in an overall uptrend. Moreover, China's near monopoly of the market has allowed it to exert significant influence globally over both price and supply, incit ing concern over unfair trade practices and creat ing impetus for the development of alternative sources of supply. Nevertheless, we caution that China maintains the upper hand in the global market and that investors should be prepared to tolerate a certain degree of volatility, at least in the near-term.

China's Stranglehold To Loosen
Global - Rare Earths Production By Country (2011)

Mongolia: Resource Nationalism Back To Haunt Oyu Tolgoi

In a move that made the country's investment climate look increasingly shaky, the Mongolian Parliament approved a budget for 2013 that calls for a renegotiation of the Oyu Tolgoi Investment Agreement with Rio Tinto. The former is seeking to extract more than US$319mn of additional royalty payments from the Oyu Tolgoi copper-gold project, which is scheduled to start operation next year. We highlight that the revision to Rio Tinto's mining code came following the implementation of a new law in May 2012, which seeks to cap foreign investment in strategic sectors of the economy. Although the surge in nationalist sentiment of recent months will restrict investment activity in the near term, we believe the government will gradually reach the realisation that it can only afford to push so far with the foreign investment community. Certainly, the mining sector is of paramount importance to Mongolia's overall economy, contributing more than 20% to the country's GDP.

Myanmar: Government Plays All Its Cards To Attract Investment

From international pariah to frontier investment, the turnaround in Myanmar's business environment has been as widespread as it has been sudden. For the first time in recent history, the government is on a massive drive to boost foreign investment into the country's nascent mining sector, reversing more than half a century of self-imposed segregation. While reforms to Myanmar's existing 1994 mining law is currently under way and will only be finalised in early 2013, we believe the eventual passing of the new law will set the stage for considerable investment over the coming years. Under the draft law's provisions, foreign companies would be able to own 100% of mining projects, take leases of up to 50 years and enjoy tax holidays during the first five years of operation. In addition, plans to implement a global anti-corruption drive by joining the Extractive Industries Transparency Initiative (EITI) are currently under way, as the country seeks to improve transparency in its endemically corrupt natural resources sector.

Philippines: Mining Law On Hold, Investment Targets Slashed

In line with a trend that we have witnessed in the global mining arena, the elevated commodity prices of recent years have encouraged greater resource nationalism with the Philippine government looking to revise its tax structure on miners from the current rate of 2% to between 5-7%. A recent assessment by the Philippines' Mines and Geosciences Bureau (MGB) has seen mining investment targets for the next four years slashed by 218% to US$3.1bn due to deferred developments in a number of key projects. The new mining policy, laid out in an Executive Order by President Aquino, prohibits the issuance of mining applications until a new law rationalising the revenue-sharing scheme between the government and mining firms is implemented. We believe the mining sector will experience a continued slump in investment until at least mid-2013, when we expect Aquino's Liberal Party and its coalition partners to retain broad control of congress. Highlighting this, Xstrata's plan to develop the US$5.9bn Tampakan copper-gold mine has been delayed by three years, from 2016 to 2019. The mine, which would be the Philippines' single largest foreign direct investment, is estimated to hold more than 15mnt (million tonnes) of copper and 17.6moz (million ounces) of gold. Indeed, the uncertainty and destruction of value caused by sudden changes in government's policy cannot be understated.

More Project Deferrals On The Horizon
Philippines - Mining Investment Targets (US$bn)

Vietnam: Tan Rai Alumina Refinery Back In The Game

Vietnam is gradually realising its potential to become a major player in the world aluminium raw material markets as the US$460mn Tan Rai alumina plant, which had faced a series of delays since 2011, started production in mid-December. The alumina refinery, situated in Lam Dong Province, is the first alumina production plant in the country with a production capacity of 630ktpa (thousand tonnes per annum). We note that the government's initiative to move up the value chain, with the construction of smelters and refineries, reflects a global trend in resource-rich countries where the development of the downstream facilities is expected to generate more value from the mining sector.

Key Takeaways: Where To From Here?

China's Rebalancing Won't Be Easy For Miners

Although China's economy has shown signs of recovery in recent months, and iron ore prices have staged an impressive comeback to US$145/tonne, we believe the recent bounce in economic activity should be considered within the context of a broader hard landing in which growth will seriously underperform consensus expectations over the coming years. We are forecasting real GDP growth of 7.1% in 2013, compared with Bloomberg consensus estimates of 8.1%. The rebalancing of the Chinese economy away from fixed asset investment will significantly crimp demand for commodities and cast a dark cloud over the future prospects of the mining industry.

Boom Years Of Commodity Import Growth Over
China - Select Commodities Imports (% chg y-o-y)

Frontier Markets To Attract Increasing Interests

Against the backdrop of rising resource nationalism, declining ore grades and increasing cash costs in traditional mining regions, we believe companies will be encouraged to undertake investment opportunities in frontier markets. We expect countries such as Myanmar and Vietnam to experience significant growth and be on the radar of many foreign investors in years to come. In contrast, Australia, Indonesia and India remain vulnerable to further debilitating regulatory reforms that will hinder growth in an otherwise promising sector.

Resilience To Fade Beyond Q113
China Iron Ore Import Price, 63.5% Grade (US$/dry metric tonne, CFR)

Brownfield Projects To Take Precedence

We believe miners will become increasingly focus on expanding their existing core assets at the expense of developing large new mines from scratch. Indeed, brownfield projects are generally less capital-intensive and time-consuming than greenfield developments, which often require years of exploration before achieving its first production.

Governments To Continue Eyeing The Mining Prize

As evident from the wave of tax increases across the global mining industry, we expect the threat of resource nationalism to persist over the coming years, as governments around the world seek to gain a larger share of profit from mining companies. This could come in the form of a gradual creep in taxation, special royalty payments, foreign ownership restrictions to the outright nationalisation of mines.

Table: Government Intervention In Asia
Source: BMI
Country News
Australia Under the Mineral Resources Rent Tax (MRRT), a 30% tax on iron ore and coal miners with an annual profit of more than US$79mn is imposed.
China Increased mining taxes on iron ore, tin, molybdenum, magnesium, talc and boron (effective February 2012) in a bid to control production output.
India The recently proposed 2011 Mines and Minerals Development and Regulation (MMDR) bill seeks to improve transparency and introduce better legislative environment for attracting mining investment.
Indonesia Foreign investors are required to divest at least 51% of their ownership in Indonesian mining assets 10 years after initial production. Furthermore, a 20% duty on 14 mineral ore exports is implemented ahead of a complete ban in 2014.
Mongolia The government is seeking to extract more than US$319mn of additional royalty payments from the Oyu Tolgoi project.
Myanmar Plans to reform the existing 1994 mining law is currently underway. Under the draft law's provisions, foreign companies can own 100% of mining projects, take leases of up to 50 years and enjoy tax holidays during the first five years of operation.
Philippines The government has issued a ban on all new mineral extraction contracts and is looking to increase the excise tax on mining firms from the current rate of 2% to between 5-7%.
This article is tagged to:
Sector: Mining
Geography: Asia, Australia, China, Indonesia, India, Myanmar, Malaysia, Philippines, Vietnam

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