Cork Gully on. Natural Resources. Outlook for Energy and Mining

Transcription

1 Cork Gully on Natural Resources Outlook for Energy and Mining May 13

2 Outlook for Energy and Mining May 13 Contents Introduction 1 World economic update Focus on the natural resources sector Outlook for Mining Outlook for Energy Based on a solid heritage we are an advisory firm bringing clarity to complex restructuring, recovery and insolvency situations. The firm remains as committed to our founding principles today as we were a hundred years ago. Our partners and staff have worked together over many years, reorganising operations and structures to deliver sustainable stakeholder value. The current trading environment is increasingly complex, so the solutions we provide for our clients are more creative, more responsive and more effective than ever. Appendix 1 - Number of formal defaults in the natural resources sector in Great Britain 1 The Scope of our Services 11

3 Outlook for Energy and Mining May 13 Introduction World economic update This report analyses trends in the natural resources sector. It also provides an update on the global economic outlook. The latest data suggest that 13 will be another challenging year for the global economy. Junior firms in the mining sector saw a challenging environment last year, with several firms on the Alternative Investment Market (AIM) struggling as investors flocked away from junior mining firms perceived as risky investments in the current economic climate. While junior firms in the energy sector saw a relatively better performance last year, recent cooling commodity prices in 13 have hit these firms too. 13 to date has been characterised by continued economic contraction in the Eurozone, a significant softening of most hard commodity prices and fears that the BRIC economies may be slowing. Year-on-year GDP growth in China of 7.7% in 13 fell short of consensus expectations of.% growth although still impressive. Concerns about key portions of the global economy have fed through into hard commodity markets, causing prices to decline. March saw a month-on-month 7.1% decline in metal prices and a.1% decline in energy prices. The price of Brent crude oil dropped from over $11 per barrel at the start of the year to close to $1 per barrel by mid-april. Formal defaults for British-based firms in the natural resources sector were higher in than in. The latest global economic developments suggest that formal default could rise slightly in 13. Lower commodity prices, risks to demand and an investor flight away from riskier junior mining and energy investments mean that 13 will not be an easy year for the smaller players in the industry. Looking further ahead, prospects for the global natural resources sector remain bright, with world economic growth supporting demand for metals and energy. The sector will see considerable changes over the coming years reflecting a wide range of factors. The mining industry has become increasingly reliant on China as a source of demand in recent years, with the country now accounting for over % of global metal consumption. As China s economy becomes more services-based as it develops, its growth in demand for metals may start to moderate, with implications for the mining industry. In the energy sector, shale gas potentially presents huge opportunities, though question marks remain over the size of the opportunities in many parts of the world. An increasing shift towards alternative energy sources will also lead to a big change in the energy supply mix going forward, with the renewable energy share of global electricity generation expected to rise from % in to 31% in 35. The Eurozone remains stuck in recession, while there are renewed concerns about an economic slowdown in Emerging Markets. This has led to a softening in commodity prices. The global economy is still suffering from the aftereffects of the global financial crisis and the world economic outlook remains variable. In its April World Economic Outlook publication, the International Monetary Fund (IMF) noted that what was a two-speed recovery strong in developing countries but weaker in advanced economies has now become a three speed recovery, with the Eurozone faring much worse than other advanced economies. The IMF expects the single currency area s economy to contract by.3% this year amid fiscal austerity, resulting in higher unemployment and rising frictions both within and across countries. The United States is looking at stable but unremarkable growth this year. The sequester of public spending in the US looks to have had some impact on the labour market, but overall economic growth rebounded strongly in the first quarter of 13 after nearly stalling in. The recovery of the housing market should support the economy and see it through the early stages of fiscal consolidation. Japan will probably have limited success in boosting its economy by swamping it with liquidity. After many years of economic stagnation, policy makers have decided to throw the full weight of monetary policy behind a push for inflation, which they hope to lead to more growth. However, the effectiveness of quantitative easing is uncertain and may simply lead to asset price bubbles. The emerging markets are not growing as strongly as they used to, as exemplified by China s reduction in GDP growth. Year-on-year GDP growth of 7.7% in 13 fell short of consensus expectations of.% growth although still very impressive. Other BRIC (Brazil, Russia, India and China) countries are not performing as strongly as was expected a couple of years ago. Brazil is struggling to keep inflation in check even as growth has moderated, Russia seems to be reaching a turning point as consumer spending suffers and India has not yet found the way back to fast-increasing prosperity - though their medium-term outlook remains bright. The major risks to the global economy are still the same as in previous months, namely a possible implosion of the Eurozone and a sharp slowing in BRIC countries. The fiasco over Cypriot bank deposits has shown that the leaders of the Eurozone are incapable of strong crisis management. With the periphery heading further into recession, the gulf between strong and weak economies is widening, implying a rising likelihood of more crises down the road. It remains to be seen if the common currency is a sustainable political and economic project. Commodity prices have fallen in response to declining dynamism in emerging markets - reflected in the IMF Commodity Price Index shown in Figure - signalling a deterioration of the terms of trade and thus a downgrading of the growth outlook for those in the natural resources sector. Oil and many metals have seen their prices decline amid easing demand growth. 1

4 Outlook for Energy and Mining May 13 Figure 1: World GDP - annual growth Figure : IMF Commodity Price Index - annual % change 1% % % % % % -% -% % % % % % -% -% Focus on the Natural Resources sector -% Emerging market and developing economies World Advanced economies -% Mar- Sep- Mar-9 Sep-9 Mar-1 Sep-1 Mar-11 Sep-11 Mar-1 Sep-1 Mar-13 Source: IMF What was until now a two-speed recovery, strong in emerging market and developing economies but weaker in advanced economies, is becoming a threespeed recovery. Emerging market and developing economies are still going strong, but in advanced economies there appears to be a growing bifurcation between the United States on one hand and the euro area on the other. - IMF April 13 World Economic Outlook An economic slowdown in BRIC countries, cooling commodity prices and recession in the Eurozone all pose a risk to mining and energy companies operating in the UK and abroad. Junior firms in the sectors could be seen as risky investments this year, placing them at risk of formal defaults as sources of funding dry up. However, despite short-term risks, the medium-to-long term prospects for the mining and energy sectors remain robust, with strong demand growth in the developing world supporting prices. As Figure 3 shows, formal defaults for British-based firms in the natural resources sector, on a four quarter rolling average, picked up in following a decline in. In, formal defaults remained elevated compared with levels, with firms becoming insolvent compared with 3. The mining and energy sector in the UK and overseas faces significant challenges this year, related to concerns about the strength of the global economy. IMF forecasts show developed world economic growth failing to pick up this year as the Eurozone remains in recession. The latest data also point towards worse-than-expected economic performance in BRIC countries, meaning that the IMF s forecasts for emerging market economies may be overly optimistic. As Figure shows, world trade volumes have slowed significantly in recent months, with trade growth standing far below the typical levels seen over the years -7, providing further evidence of weak global growth at present. The weakness of the global economy implies subdued demand for commodities and for energy, and markets across the globe have adjusted to the latest economic data. Hard commodity prices have for the most part cooled in recent weeks amid renewed demand concerns. This is reflected in IMF commodity price indices for metals and energy shown in Figure 5. Comparing March 13 with February 13, there was a 7.1% decline in metal prices and a.1% decline in energy prices significant drops over such a short time frame. Brent crude oil was trading at over $11 per barrel at the start of 13, but by mid-april the price was close to $1 per barrel. The short-term outlook for commodity prices, as reflected in futures prices, points to declines across most main commodity groups. Overall, the IMF expects commodity prices, as measured by its Commodity Price Index, to decline by % in 13 (year over year). This reflects improving supply prospects for all main commodity sectors as well as relatively weak demand for some commodities given the subdued economic backdrop. Cooling prices are likely to pose some challenges to firms particularly smaller firms in the natural resources sector in the short-term. However, the medium-to-longer term prospects for the sector remain tilted on the upside, with rising prices expected for most hard commodities. Going forward, upside risks to commodity prices appear more prevalent than downside risks. On the supply side, a return of problems that affected metal and energy markets in the past decade (accidents, project delays, shortages of equipment and skilled labour) could again lead to supply shortfalls and higher prices. Additional concerns include geopolitical tensions in the oilproducing regions of the Middle East and Africa, which could trigger an oil price surge. 3

5 Outlook for Energy and Mining May 13 Figure 3: Insolvencies in the natural resources sector in Great Britain Figure 5: IMF commodity price indices (January =1) Jan- Feb- Mar- Apr- May- Jun- Jul- Aug- Sep- Oct- Nov- Dec- Jan-13 Feb-13 Mar is likely be another challenging year for junior miners. Outlook for Mining Figure : World trade volumes - annual % change 5% % 15% 1% 5% % -5% -1% -15% -% -5% Number -quarter rolling average Energy Feb-3 Sep-3 Apr- Nov- Jun-5 Jan- Aug- Mar-7 Oct-7 May- Dec- Jul- Feb- Sep- Apr- Nov- Jun- Jan-13 Average -7 Metals (includes: copper, aluminium, iron ore, tin, nickel, zinc, lead and uranium) Source: The Insolvency Service CPB World Trade Monitor, IMF With China consuming more than % of all metals, data pointing to cooling economic growth in the country is bad news for the global mining sector. The 7.1% monthon-month decline in metal prices seen in March was led by a 9.% decline in iron ore prices due to a rapid buildup in Chinese steel inventories and improved shipments from Brazil and Australia following poor weather and logistical problems earlier this year. Zinc prices declined 9.% on a rebound in Chinese production following a weather-related drop in January and February. Aluminium prices decreased.9% due to record high stocks, relatively weak demand, and continued capacity expansion in China. Similarly, nickel prices fell 5.% on sluggish demand, record high stocks, and rising production. Finally, copper prices also declined 5.1% due to a climb in inventories, weaker import demand in China, and ongoing supply expansion. Figure illustrates the year-on-year declines in metal prices seen in March 13 and shows a relatively broad decline in prices over the past year. Against a backdrop of economic concerns and cooling commodity prices this year, a number of mining sector firms could find themselves in difficult circumstances particularly junior companies listed on markets such as AIM which could be seen as risky investments. Junior miners saw a terrible market performance in, as reflected in Figure 7. The market capitalisation of AIMlisted mining companies fell by 3.5% between January and December. Further, market capitalisation has declined sharply since the start of 13, suggesting ongoing concerns about the outlook for junior mining firms. Global economic volatility and uncertainty have made investing in such firms a more risky proposition than in the past. Without this investment, some firms could shortly find themselves in financial trouble and potentially unable to operate. The outlook for metal prices and thus mining is tightly bound to developments in China, which accounts for over % of global metal consumption. Recent concerns about a slowdown in BRIC economic growth are a key reason for the decline in metal prices seen over the past few weeks. Looking further ahead, growth in China s metal demand is expected to moderate as the economy rebalances toward services. There are still plans for large infrastructure projects, but the global mining industry will have to adjust to a slower pace of metal demand growth from China in the medium-tolong term. 5

6 Outlook for Energy and Mining May 13 Figure : Year-on-year change in metal prices, March 13 Lead Tin Iron Ore Zinc Copper Nickel Aluminium Uranium -% -1% % 1% Source: IMF Outlook for Energy Shale gas potentially presents huge opportunities, though question marks remain over the size of the opportunities in many parts of the world. Figure 7: Market data for AIM-listed mining companies An increasing shift towards alternative energy sources The International Energy Agency, in its central scenario, 11, 1, 9, will lead to a big change in the energy supply mix going forward, with the renewable energy share of global electricity generation expected to rise from % in to 31% in 35. estimates that global energy demand will increase by over one third in the period to 35, with emerging market economies driving an increasing share of global energy demand. The share of non-oecd energy, 7,, 5, Jan- Feb- Mar- Apr- May- Jun- Jul- Aug- Sep- Oct- Nov- Dec- Jan-13 Feb-13 Mar-13 The IMF expects global energy prices to decline during 13, as reflected in futures prices, led by crude oil. Falling crude oil prices reflect expected increases in non-opec production and declining demand in industrial countries due to improved vehicle efficiency and the effects of recent high prices on consumer and demand is expected to rise from 55% in to 5% in 35. China s demand for energy is expected to rise by a staggering % over the years to 35. Fossil fuels will remain the main source of energy across the globe over the coming years, with demand for oil, gas and coal expected to grow over the years to No of companies Market capitalisation ( million) Source: London Stock Exchange business behaviour. However, natural gas prices are expected to edge higher this year, led by an expected 3% year-on-year increase in U.S. natural gas prices that will help sustain robust shale gas development. 35. The outlook for gas seems optimistic, given the unlocking of unconventional resources in the form of shale gas. The International Energy Agency expects that unconventional gas will account for nearly half of the There continues to be divergence in regional natural increase in global gas production over the years to 35, gas prices, with price differentials driven by whether with most of the increase coming from China, the United gas prices are strongly linked to long-term oil-priced States and Australia. Increasing use of unconventional contracts (which they are in Japan but not in the United resources means that gas could nearly overtake coal as States) or whether the linkage has been loosened (as in a share of total primary energy supply by 35. Europe). Coal prices are expected to decline this year on increasing supply and moderating demand, in part due to environmental constraints. Shale gas could potentially present huge opportunities for firms in the energy sector, though there are considerable uncertainties around this. Because large-scale shale gas Oil and gas companies listed on AIM saw a relatively extraction is still very much in its formative years, there better performance than mining companies last year, are considerable unknowns about the size and quality with market capitalisation declining by 13.% between of the resource base in many countries. There are also January and December, as Figure 9 shows. Recent concerns about the environmental impact of shale gas declines in energy prices mean that some smaller extraction. companies in this sector could also find themselves in financial difficulty. Beyond the short-term, however, the outlook for energy prices is largely on the upside, with rising world demand for energy placing upward pressure on prices. 7

7 Outlook for Energy and Mining May 13 Figure : Year-on-year change in metal prices, March 13 Despite the dominance of fossil fuels in terms of energy supply, renewable energy sources are growing Natural Gas at the Henry Hub terminal in Louisiana Indonesian Liquefied Gas in Japan Russian Natural Gas border price in Germany Crude Oil (petroleum) Australian thermal coal -% % % % % % Source: IMF in importance on the global stage due to a number of major factors namely incentives from governments to encourage a shift towards renewable energy, falling costs and rising fossil fuel prices. The International Energy Agency expects that the renewable energy share of global electricity generation will rise from % in to 31% in 35 under its central scenario. Market capitalisation of alternative energy firms listed on AIM has risen since the start of 13, as shown in Figure Appendix 1 Number of insolvencies in the natural resources sector in Great Britain Figure 9: Market data for AIM-listed oil & gas companies, 1 1. In the medium-term, businesses in the alternative energy sector should benefit from government legislation which aims to reduce usage of fossil fuels as 1 1, 1, 1, 1, 1, 1, Jan- Feb- Mar- Apr- May- Jun- Jul- Aug- Sep- Oct- Nov- Dec- Jan-13 Feb-13 Mar-13 No of companies Market capitalisation ( million) Source: London Stock Exchange 1 well as government subsidies for renewable energy. In the short-term, however, fiscal austerity across much of the developed world raises the prospect of renewable energy subsidies being reined in, having a negative impact on firms in the sector. Alternative energy is a competitive environment, with continuous competition to create lower-cost renewable energy systems. For incumbent firms in the sector, product innovation and lower-cost solutions from other renewable energy firms are a perpetual risk to financial performance. 7 7 Year-on-year change in insolvencies in the natural resources sector in Great Britain Source: The Insolvency Service. Natural Resources Figure 1: Market data for AIM-listed alternative energy companies Jan- Feb- Mar- Apr- May- Jun- Jul- Aug- Sep- Oct- Nov- Dec- Jan-13 Feb-13 Mar-13 - No of companies Market capitalisation ( million) Source: The Insolvency Service. Natural Resources Source: London Stock Exchange 9 1

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9 Contact Stephen Cork Managing Partner Cork Gully LLP 5 Brook Street, London W1K 5DS T: + () 7 15 F: + () e: stephencork@corkgully.com