China – the mining industry's canary – is still singing

Writing for The Economist, Bill Gates suggests “when historians write the book on the COVID-19 pandemic, what we’ve lived through so far will probably take up only the first third or so. The bulk of the story will be what happens next.”

Gates reminds us that in difficult times, our feelings and actions have a tendency to become myopic. Right now we need to work a little harder to see the big picture. We need to look beyond our immediate challenges and remember what the long view of history can teach us about how to plan for the long-term future.

Looking to China for the future of mining

Just as the rest of the world first began looking to China for answers on how far it would fall and how quick it would be to recover from the pandemic, the mining and metals industry would do well to examine China’s influence over the past two decades to inform its business planning for post-COVID-19 global demand in the future.

In the last twenty years, China has grown from the economic size of Italy to the size of the entire European Union. Some analysts predict its GDP could surpass that of the US beyond 2030.

Even at a relatively slowed GDP growth rate of 6.1%, China was still adding more value in 2019 than at its peak growth rate of 14% in 2007. Its behemoth economic engine now consumes^[1] an astonishing percentage of the world’s mining, metals, and industrial materials:

• 60+% of all cement and concrete
• 50% of all nickel
• 50+% of all coal
• 50% of all steel and copper
• 47% of all aluminium
• 27% of all gold
• 14% of all oil

Since 2005, the growth in Chinese demand has been a multiple of the rest of the world’s combined, driving core commodities’ global prices. The connection has been so significant that major mining and metals companies’ cash flows are inextricably dependent on what happens in China and the industry’s response.

Understandably, current economic events have left the industry anxious. But while it’s true that COVID-19 has brought a never-before experienced fallback in global economic output, China’s emergent recovery following fierce lockdown measures indicates hope that the impacts may be short-term. In five years’ time, the COVID-19 pandemic could be just a blip on China’s economic growth graph.

One important understanding is that for all its global dominance, China has a relatively small GDP/capita at $10,000, just 20% of the GDP/capita of the US. While the mix of GDP is shifting from industry to services, with a population that’s double that of the US and the EU combined, it still has plenty of room to grow and plenty of appetite for mining commodities to consume.

History lessons: what China’s impact on mining in the past has taught us about how we need to manage our businesses today

When we take a closer look, several important lessons can be learned from the history of China and the mining industry that both industry investors and owners can benefit from.

1. Beware of gold rush fever–trust in independent reviews. China’s astonishing growth has been a tempting bandwagon to jump on. But we’ve seen firsthand how past CEOs and their financial advisors get caught up in the excitement of big deals and big success fees and override both internal and independent investment review processes, even when those reviews revealed fundamental problems with the evidence for viability on technical, commercial, and financial grounds.
2. High commodity prices aren’t a guarantee of success. Today, developing new remote ore bodies is a technical and economic challenge to deliver something on time, on budget, to nameplate capacity, while earning and maintaining social licence to operate. Many sensitive moving parts require the engagement of specialist expertise. Even with China’s insatiable demand, commodity prices are supply-dependent and are seldom guaranteed. A new project must focus on achieving its lowest possible unit cost; this is the ultimate measure of its prospective viability.
3. Perform multi-scenario financial modeling. It’s important to stress test project and sponsor resilience to fluctuations in supply, commodity prices, and price competition warfare using multi-scenario or probabilistic financial modeling. No project is immune to the kind of uncertainty that arises from events such as COVID-19, but deep-dive evaluation that has thought through and tested for a range of possible scenarios is more resilient to unexpected changes.
4. Add margin before capacity. China’s stunning growth has led many existing companies and new entrants to add major capacity over these years. This unprecedented influx of supply has meant that even some of the biggest players have experienced the commodity price chill of oversupply and suffered negative EBITDA as a result. Increasingly, the factor distinguishing resilient and long-term successful businesses is their focus on adding margin before capacity. This is done through a holistic analysis of every possible option for cost savings, production efficiency, and the application of new technologies to increase unit cost margins.

China is already recovering economic activities from the impact of COVID-19, and is doing so ahead of and faster than any other large economy. Supplies to China will continue to be the mining industry’s flotation device amid the economic slowdown across the rest of the world. And the country’s growth in demand will not stop post-COVID-19.

We certainly haven’t seen peak China yet despite prior predictions, and perhaps not even a global pandemic can significantly divert its trajectory. This is the good news for the mining industry. But a ship does not steer itself and some have hit the rocks despite or because of strong commanders. Objective, independent, deep-seated, and well-tested expertise has been a vital protection and enhancement of technical, commercial, and financial viability for operators and their investors/lenders. Have you taken the lessons learned from China and applied them to your long-term business strategy? Your success depends on it. 

Reference

[1] Statista, MC Group, World Steel Association