From inception, Xstrata’s growth strategy has been based on a conviction, now widely held, that the supply-side of our industry is fundamentally constrained and will struggle to meet burgeoning demand from populous industrialising nations over the medium term. Following a period of interruption during the downturn, this secular trend was again in evidence in 2010, as the impact of falling grades, longer haulage distances, labour disputes and technical problems at existing, ageing operations led to mine underperformance across the industry, while the timing of the onset of new sources of supply fell short of market expectations in most key commodities.
These issues are particularly acute in the copper industry, where a growing deficit is apparent and the development of new copper projects remains challenging due to skilled labour and engineering shortages, more onerous environmental and planning regulatory requirements, community dissent or increased political risk. Challenging conditions in the geographies in which a large proportion of new copper projects are located are likely only to exacerbate this trend. Capital costs continue to rise as mining sector inflation re-emerges in the light of increasing capital expenditure amongst the major mining companies.
In the thermal coal industry, transport infrastructure constraints continue to impact on new supply from Australia and South Africa, where supply growth remains highly dependent on government and private sector investment in rail and port infrastructure. Meanwhile, Indonesian supply, historically the primary source of supply growth, faces dwindling quality and shorter mine lives than Australia, South Africa or Colombia. China is now firmly established as a net importer of coal, with domestic production constrained by increasingly stringent environmental regulations, logistical constraints and the restructuring of a fragmented industry to closer, smaller, inefficient and unsafe operations.
While supply constraints are less pronounced, nickel producers similarly face underperformance issues, in particular from technical difficulties in commissioning or ramping up high pressure acid leaching operations for the laterite deposits which now account for more than half of new supply growth. While nickel in pig iron remains a flexible source of new supply to plug any deficit once prices rise above operating costs, higher coking coal prices, wage inflation, currency appreciation and increased energy costs are putting upwards pressure on these producers’ breakeven costs.
On the demand side, the story may by now be a familiar one to those who follow our sector, but it is nonetheless profound for the future growth in demand for Xstrata’s products. China, India, Brazil and other developing Asian economies will continue to fuel the lion’s share of growth in global commodity demand over the medium term. Over 300 million people will move to cities in China alone over the next 15 years, while rising GDP per capita in China, India and other developing nations is giving rise to inevitable increases in the intensity of metal and energy demand as those countries move up from their positions at the bottom of the global intensity curve.
Export coal demand is rapidly increasing in China, and India has emerged as a major importer of export thermal and coking coal to fuel rising energy and steelmaking demands. Demand for imported thermal coal in 2010 has risen by some 51% and 25% year-on-year in China and India respectively.
Xstrata’s existing portfolio and growth projects are ideally positioned to benefit from these longer-term secular trends, providing industry-leading exposure to copper and mid-cycle base metal commodities and to rising energy demand from coal-fired generation. Our growth plans will see us progressively deliver substantial additional volumes of key commodities into fundamentally constrained commodity markets.
Xstrata Copper’s Lomas Bayas mine in north Chile
Outlook remains positive for commodity demand although risks remain
Global economic growth exceeded most expectations in 2010. Emerging economies continued to record very strong growth rates, notably China and India, where GDP grew by a little over 10% in China and an estimated 9.7% respectively compared to 2009. In the OECD, growth was bolstered by inventory restocking and ongoing government measures including stimulus spending, extended tax cuts and quantitative easing, but these short-term measures were succeeded by a stronger than expected manufacturing-led recovery in the US and Germany.
Looking ahead, leading indicators suggest that the US economy continues to find a reasonably solid track for recovery, with manufacturing activity at a seven-year high, rising retail sales, and unemployment finally starting to decline, despite continued weakness in the housing and construction sectors. In the Eurozone, January data for the manufacturing and services industries reveal the fastest pace of expansion in nine months. In particular, the German economy continues to strengthen, driven by its large manufacturing sector and robust exports. Nonetheless, market confidence in the rate of growth in the medium term is impacted by high unemployment, persistent European sovereign debt concerns and the potential impact on growth of austerity measures.
Importantly for commodity demand growth, developing economies, and China in particular, appear set to continue to achieve wholly respectable high single digit growth rates in 2011, albeit below 2010 levels due to the impacts of inflation and the proactive actions by governments to contain economic growth within manageable levels. Further actions to curb inflation are likely in 2011, following the monetary and fiscal measures imposed by China and India in 2010, but are, in my view, a positive sign that the authorities are proactively managing inflation to avoid the negative impacts of overheating.
Chinese demand for commodities is increasingly supported by growing domestic consumption and from the urbanisation of western China as a substantial component of the government’s efforts to reduce reliance on exports to the West. These factors are further supported by a resurgence of foreign direct investment in China. The twelfth five-year plan includes a target of 20% annual growth in western province infrastructure investment, and 23 major new infrastructure projects worth $100 billion were approved in 2010, all of which augurs well for ongoing growth in demand for early and mid-stage commodities.
The Board’s confidence in the medium-term outlook for Xstrata is reflected in our decision to increase the final dividend to 20 cents per share. Based on average dividend policy prior to the financial crisis in 2009, in which our final dividend has typically been two-thirds of the total for each year, the implied dividend for the year would be 30 cents per share, setting a new platform from which Xstrata will continue its progressive dividend policy.
