It has been a bumpy and unpredictable past 12 months in the metals and mining sector, and prices have swung from one extreme to the other. With funding in short supply, Helen Castell asks who is left ready and willing to finance the industry?
From boom to bust in 12 short months, the global metals and mining market saw it all in 2008. During the early golden months to mid-year, surging commodity prices helped lift even single-asset miners out of the trade arena to the heady world of equity finance. Then, as the banking crisis gripped, so too did commodities crash – meaning the party still had to be paid for, but there was now no credit to bankroll it.
What now then for miners and the banks that finance them? Will junior players fold en masse, wiping out an important client base for trade banks? Or will the shift back to traditional trade structures – even among big names that in recent years have shunned them – spell a resurgence for trade teams?
The first half of 2008 was a great time to be a miner, and perhaps an even better time to be financing one. Metals and energy commodities were at multi-year highs, and while this meant constant expansion of credit lines, bankers were more than happy to help.
“Then what happened, of course, is crisis, crisis everywhere, and we saw commodity prices crashing,” says Bernard Zonneveld, global head of structured metals and energy finance at ING Bank in Amsterdam. And in cost-intensive industries like metal production and mining, lower prices are serious indeed. “When the price of aluminium drops below US$2,200 per tonne, 90% of the mini-producers face problems,” he adds.
Keeping prices in perspective
The high prices of early 2008 also made recovering fairly thin reserves appear economically viable – an illusion that was swept away following the subsequent price crash, says John MacNamara, managing director, head of structured trade and commodity finance at Deutsche Bank in Amsterdam.
It is important though to get the price slump in perspective. In 1999, when nickel was trading at US$4,000, analysts dismissed, for instance, much of Cuba’s reserves as unviable, unaware that within less than a decade the price would shoot as high as US$55,000. With prices now back down to US$10,000 “people are saying nickel’s crashed”, remarks MacNamara.
Although prices are down a painful 70% from their 2008 peaks, he observes: “We are still higher than the prices we saw in 2005. So on that basis, things aren’t so bad.”
This view is shared by Sean Gilbertson, managing director at Gemfields and partner at its parent Pallinghurst Resources. In 1998, the FOB (free-on-board) coal price at Australia’s Newcastle port, the world’s biggest coal export terminal, was below US$20, he notes. Coal prices on the globalCOAL Newcastle weekly index act as a benchmark for traders in China. By autumn 2008, it had leapt to US$170 before declining in mid December to around US$95.
“When you look at some of the graphs, over the last four years or so, you see tremendous growth. In the past six months you see this incredible collapse. But when you draw the line back in time, in reality you’ve only undone something between four and five years of bubble,” says Gemfields’ Gilbertson.
And although prices could have further to fall, he adds: “I don’t think there’s a fundamental reason as to why we’d go back to the prices of seven or eight years ago.”
Metals could enjoy some support into 2009, especially considering the speed at which miners have already slashed output, says Damien Hackett, global head of metals and mining research at Canaccord Adams in London.
“The dollar is going to be a key factor going well into 2009,” Hackett notes. “If the dollar were to weaken, that’s going to put the dollar price of commodities higher.”
And with hedge fund redemptions cutting demand for dollars, combined with concern growing over the US government’s now massive debt, this may well happen.
Whatever happens to prices later this year however, much of the damage has already been done. A plunge in the value of assets at the very time that the cost of servicing debt has spiked means those companies that in recent years used debt to buy up rivals are now struggling, says ING’s Zonneveld. Many have been forced to resell their acquisitions after being hit with margin calls they couldn’t afford to pay. “It’s a total reverse – instead of buying companies, you now see assets being sold by all the big companies. And not for favourable prices.”
Hackett at Canaccord Adams adds: “Takeovers will continue as small companies get themselves increasingly into trouble.
“I think they’ll be coming to the majors looking for help, rather than the majors having to lead the game.”
“The big diversifiers will use their cashflow and get to pick up a number of projects at ten cents in the dollar,” he adds. “This is what always happens.”
Availability of finance is the key factor that will separate the weak from the strong in 2009, says Michael Howard, former leader of Britain’s Conservative Party and now non-executive chairman at Entrée Gold, which as of December, had a cash cushion of US$60mn. “Those companies which are heavily borrowed are going to find it difficult. Companies like ours, which are very strong in terms of available finance, are going to be in a stronger position.”
Coal of Africa is another miner with cash to spare, says the company’s managing director Simon Farrell. As well as raising the bulk of its funding before last year’s big spike in coal prices, after recently bringing one of its three major projects to production, “we’ll still be left over with £100mn in cash and no debt”, he notes.
And even if the company needed to raise money this year – which Farrell says it won’t – “I don’t think the equity markets will be ready for significant capital raisings at reasonable prices in that time”.
Although focusing on getting its current mines into production, “there are some unbelievably tempting opportunities out there at the moment”, he says. “I would suggest that in the middle of next year, there’s going to be some amazing buying opportunities for people that are cashed up like ourselves.”
“This is one of the most exciting times in the market from an investment perspective – if you have money,” says Gemfields’ Gilbertson. “One of my colleagues’ favourite sayings at the moment is ‘every dollar you have is worth two dollars.’ Because there just isn’t any money out in the field.”
“Nobody wants to lend anything,” he adds. “You just can’t get debt for love or money.”
Comparing H1 2008, when “no one was even considering debt because equity was so easy to get,” with the second half, when “people were trying to trot out equity deals with bank deals”, miners are now finding it hard to raise any cash at all, says Mark Tyler, head of mining at Nedbank in London.
“It’s going to be very difficult for them to raise the capital to build new projects, which I suppose is not a bad thing considering that demand for metals has dropped quite considerably.”
One effect of the bumper commodities prices in recent years was that the actual quality of some mining assets was overlooked, he notes. “Over the last three or four years, people have been bringing to market things that are a little bit substandard – in fact some substantially substandard – and they’ve been able to raise the finance for that.”
Return to trade finance
With the shortage of credit comes tightening of debt terms and many miners are now gravitating back to trade finance structures.
“In the short term, the supply of financing and credit is the main problem for everybody,” says Olga Vallverde, global head of energy, metals and mining, commodity finance at Santander. “Producers are demanding an extension of payment terms for imports of raw materials and exports are being affected by the inability to open LCs. But even top-tier names are resorting to more structured deals. So the good news is that our trade commodity finance business is very active.”
Since the crisis kicked in, deals have become more structured and short-term, and 2009 should see this trend continue, says Mauro Albuquerque, Santander’s head of trade, export and commodity finance for Brazil.
Also, while deals are certainly flowing, banks are “going through a little more of a painstaking process to get them on the road,” he says. “There’s more senior management and committees involved who have to approve these deals, but there’s no specific retraction as far as we’re willing to do less. We just want to do as much as we were doing, but to make sure that the terms and the pricing reflect the real conditions.”
Metals companies have indeed returned en masse to traditional structured commodity finance, using pre-export deals to generate cash, ING’s Zonneveld says. The “drastic” increase on such deals’ pricing, as well as the stricter collateral structures now being used, have clearly benefited trade banks, he notes.
Metals and mining companies are even returning to export credit agency (ECA) or multilateral-backed structures, “which they don’t necessarily like because it’s a time-consuming process and terms are a little less flexible than with pure bank deals,” says Santander’s Albuquerque. “But if you lack liquidity, or you lack the ability to distribute risk in the market, those may be the first [deals] that we see in the pipeline.”
Indeed, despite the hammering commodities prices took from H2 last year, most banks’ trade and mining/metals teams did well in 2008, asserts Zonneveld.
Banks lapped up the stream of deals that a flurry of cross-border mining acquisitions created in the first half, and none more than ING, which during the half was the sector’s biggest loan syndicator in Russia, he says.
And even after the bearing second half, “all banks [in metals] had an astonishing year”, he says.
Nedbank’s trade team has benefited from the launch of its mining desk in London, says John Vowell, head of structured trade and commodity finance (STCF) in London.
“We’ve had some big traders coming to us, talking to us about interesting deals in sub-Saharan Africa, and we wouldn’t normally automatically be within their international banking group,” he says. “We’re beginning to break into the circle of banks that they would pick up the phone to speak to. That’s a change. And hopefully in 2009 we can convert those enquiries into some interesting deals.”
This is taking place while many traditional mining and STCF banks scale back their exposure to such businesses, he notes. “Not because they’re bad businesses, but because they’ve probably been hit on general balance-sheet issues. And the easiest business to pull back from is one of the most liquid – the revolving, uncommitted business, which is typically what we look at,” says Vowell.
Nedbank’s mining team vast knowledge of mines bolsters the work of the trade team when customers enquire about trade finance for specific mining assets, he adds. “If the teams work together, there’s a great synergy there.”
Some geographical markets are a more natural fit for trade finance. “With the deal we’ve got in Georgia, they’re digging copper ore out of the ground, and they can only process it as far as copper concentrates. And then they ship it out, because there’s no further refining or smelting capacity in the country,” says Deutsche’s MacNamara. “For someone doing pre-export finance, that’s perfect, because it gives a strong economic push to export. There’s no value at home unless they export it.”
Opportunities have meanwhile opened up in South Africa, which historically “was a bit too good for us to finance with pre-export finance”, he says. Previously dominated by a handful of big international corporates, a combination of regulation and legislation has now fragmented the market, he notes.
However, “if you look at the copper belt in Zambia and the Democratic Republic of Congo, we’ve been told projects left, right and centre are being put on hold while people wait to address the outlook for their copper prices”.
“Latin American companies are doing very well, despite the bearish market for metals and mining,” says Vallverde. “They are in a very strong position.”
“They learned the lessons from the last fifteen years,” she continues. “In the good times, during the first half of the decade, they dedicated a significant part of their cash generation to paying down debt. And that means that most companies have enough cash now, in hand, to cover their short-term debt.”
For a country like Brazil, where commodities account for some 65% of its exports, China’s continued growth is pivotal to its future, says Albuquerque. “China was one of the main engines behind the price increases these past 18-24 months, because of the sheer demand.” But if China’s pace of growth drops to the 5% predicted by some analysts, rather than the 8%-plus predicted by Beijing, the metals and mining sector can expect to suffer.
It is of course already suffering. But how much harder it’s going to get is as difficult to predict as how long the global recession will grip.
Ultimately though, “mining is not a short-term business. Its prospects are not going to be decided by what happens tomorrow or next week. Its future is going to be decided by what happens over the next few years,” notes Howard. “If you look at the kind of world we live in, the need to improve standards of living across the globe, that will in my view inevitably lead to a resurgence in the demand for minerals. And that will present great opportunities.”
However, “how long the crisis will last, and when that moment will arise, nobody can say”.
“There’s a lot of doom and gloom out there in the market,” but “it’s not as bad as it sounds – it’s going to get better”, says Tyler. “And much of the pessimism and pain is simply down to comparing current market conditions with the bubble of yesteryear,” he argues.