Global Industry Overview - Mining Mid-Year Update: Key Themes For 2017 - JULY 2017

At the mid-way point in the year, we are assessing the performance of our Mining key themes for 2017, as outlined at the end of 2016 ( see 'Key Themes For Mining In 2017 ' , December 5 2016). Thus far, most themes are playing out or else still in play.

Update Of Mining Key Themes 2017
Theme Description Played/Playing Out? Metrics Comment
Source: BMI
Improving Prices To Herald Gradual Recovery Metal prices will improve in 2017, supported by ongoing fiscal spending in China's infrastructure sector, which will increase the country's metal demand outlook and boost investor sentiment on industrial metals. Theme has played out. We are now neutral on industrial metal prices over H217. Track metal price performance; S&P GSCI industrial metal index; LME 3-month forward metal contracts Metal prices in general have improved in 2017, especially in Q117, but they did not repeat the rally recorded in 2016 as we predicted. The S&P GSCI Industrial Metal Index is up 4.7% year-to-date as of June 21.
Improving Performance, But Miners To Remain Cautious While commodity prices will improve over the years - leading to higher revenue flows and better operating cash flows - miners will remain steadfast in their debt reduction drives, liquidity enhancement strategies and cost-cutting measures. Theme is playing out. Major miners' capex guidance, cash flow, debt level; relative stock performance against indices Most diversified mining companies posted positive net incomes for the first time in years in FY2016 (announced in March 2017) and were also successful at debt reduction. Despite the improvement in performance, they remain disciplined in terms of supply and cost-cutting.
Capex Outlook While aggregate spending will continue to fall, mineral sectors with relatively stronger price outlooks will see progressing project pipelines. Furthermore, major miners will increasingly direct capex towards innovation through the use of technology and automation. Theme is playing out. Global mining capex % change; brownfield vs greenfield investment Our projects database shows greater capex spending on copper projects while coal projects fare worse. Major miners have also prioritised spending on technological innovation.
Key Challenges: Political Flashpoints And Regulatory Risks Political and regulatory uncertainty in key mining markets will pose downside risks to industry value growth and production outlooks in 2017. Theme is playing out. Mining FDI inflows; mining employment rates. All of our predictions regarding global risks have played out or are playing out (see table on risks below).
Regulatory Case Study: China The Chinese government's efforts to balance the country's economic growth with the reform of oversupplied industries will continue to evolve, especially with the upcoming 19th Party Congress in the fall of 2017, leading to high volatility in global metals markets. Theme is playing out. GDP; y-o-y mining output growth; domestic metal prices; ore/metal imports China has remained the major driver of metals prices as the government's policies continue to evolve. Q117 saw a strong rebound in metal prices as the Chinese government frontloaded fiscal spending on the infrastructure sector.

Theme: Improving Prices To Herald Gradual Recovery

BMI View In December 2016: We maintain a positive view toward metal prices over a 12-month horizon. However, the broad-based H216 rally in commodity prices means that we are sceptical that spot prices will be significantly above end-2016 levels at the end of 2017. The longer-term outlook for metal prices to experience a stabilisation (rather than any significant rebound) will inform a gradual recovery in mining industry value.

Key Developments In H117: As per our prediction in December 2016, metal prices in general, with the exception of iron ore and nickel, have improved modestly in the year-to-date (ytd). The S&P GSCI Industrial Metal Index is up 4.7% ytd as of June 21. A frontloading of fiscal spending on the infrastructure and construction industry in China led to steel being the biggest winner with a 14.6% ytd gain. The collapse in iron ore prices post-April 2017 arose from elevated stocks and reaching peak demand at blast furnaces. Other metals including zinc, copper, lead and aluminium have registered modest improvements between 2.5% to 10.3% in the ytd.

Outlook: Our outlook for industrial metal prices over the rest of 2017 is slightly bearish. After being above consensus regarding industrial metals prices over most of 2016, we turned more cautious on prices in Q117 and have been holding below-consensus price forecasts so far this year. Signs of slowing economic growth in China and waning optimism surrounding robust US fiscal stimulus will be a drag for metals in the coming months. Looking on a multi-quarter horizon, we continue to expect non-ferrous metals to be on an uptrend in the medium term while ferrous metals will head lower (see 'Steel: Prices To Head Lower But Not Collapse In H217', June 7 and our Country Risk service 'BMI Vs Consensus: China And Australia Growth To Continue Underperforming', June 13).

Stabilisation For H217 After Peak In Q117
S&P GSCI Industrial Metals Index
Source: Bloomberg, BMI

Theme: Miners To Tread With Caution Despite Better Performance Ahead

BMI View In December 2016: Most mining companies will see better performance and financials over the coming years as most commodity prices have now bottomed. Miners will also continue their drives to reduce debt to more healthy levels going forward, and we expect this trend to intensify over the next two-to-three years. Additionally, with limited access to capital, companies will try to improve their liquidity and financial standing, as well as looking towards alternative sources of finance.

Key Developments In H117: As per our prediction in December 2016, most large diversified mining companies such as Anglo American, Glencore, Vale and Rio Tinto posted positive net incomes in FY2016 (announced in March 2017) for the first time in years, and were also successful at debt reduction. Despite this improvement in performance, these companies have announced that they will maintain supply discipline and remain committed to further debt-reduction, cost-cutting and innovation, which echo our prognosis.

Outlook: We maintain our view that miners will remain focused on capital and supply discipline, through debt reduction and efficiency enhancements, despite the modest recovery in global commodity prices (see ' Miners ' Strategy: Capital & Supply Discipline To Persist Despite Better Performance ' , June 13). Major mining companies will now perform better over the coming years as 2015-2016 marked the bottoming out of the mining downturn. In terms of financing, improving market conditions will see a return of commercial bank lending to the mining industry. Nevertheless, private equity will continue to play a growing role in mining project finance, and mining companies will increasingly turn to joint-venture partnerships to share risk (see 'Price Recovery To Increase Project Finance Options', June 13).

FY2016 To Be Start Of Better Performance
Select Diversified Miners - Net Income Available to Common Shareholders (USDmn)
Source: Bloomberg, BMI

Theme: Capex Outlook

BMI View In December 2016: Miners' capex will continue to decline over the next three years in terms of absolute value, as they seek to further cut costs and improve operational margins. Miners will increasingly focus on maximising revenue at existing assets and increasing efficiency overall. This will be done by focusing on streamlining mine processes and targeting innovation to improve operational efficiency. Copper, zinc, tin and gold will see relatively strong investment into brownfield and greenfield projects, bolstered by a combination of a more resilient recovery in prices, low production costs, high-grade reserves and favourable regulations over the coming years. Meanwhile, iron ore and coal capex will see a slowdown in project investment as prices will remain at or below costs of production over the coming years.

Key Developments In H117: As per our prediction, in 2017 major miners have either maintained their capex levels from 2016 or reduced them even further. Additionally, miners have expressed their priorities of developing existing projects rather than venturing into greenfield projects in the coming years. As an example, Rio Tinto will focus on developing existing projects, such as Amrun and Oyu Tolgoi, while Vale lowered yearly capex guidance to USD4.5bn from 2017 onwards compared to the USD5.8bn figure in 2016. In terms of projects priority, our view is playing out well, with the global copper project pipeline consisting of 274 greenfield projects and 32 brownfield expansions according to our Global Mines database. This is a significant addition to the 178 copper mines currently in operation worldwide. In contrast, compared to 258 coal projects currently in operation, there are only 168 new coal projects and 24 projects being expanded globally listed in our Global Mines database.

Outlook: We maintain our view that despite improving operating cash flows across the board, capex will remain stringent over the next three years in terms of absolute value, as miners will continue to pursue a strategy of greater capital discipline. This will ensure miners have greater free cash flows going forward to weather market volatility better than in past years. Miners will continue investing in technology - all the more so that technology will help them improve efficiency further - and expanding growth assets, but there will be minimal investment in greenfields projects. We continue to expect miners to invest less in commodities such as coal, iron ore and steel, while investment in copper and tin will hold up (see ' Projects By Commodity: More Tin & Copper, Less Iron Ore & Steel, June 13).

Capex To Remain Stringent
Select Mining Companies - Capital Expenditures (USDmn)
Est = Bloomberg estimate. Source: Bloomberg, BMI

Theme: Key Political Flashpoints And Regulatory Risks

BMI View In December 2016 : Globally, political developments and regulatory uncertainty will pose key downside risks to mining investment and production growth outlooks in major mining markets.

Key Developments In H117 & Outlook: Below, we assess the most pertinent risks we highlighted for 2017 and provide an update on them and our outlook for the remainder of the year.

Select Countries - Update Of Key Political Or Regulatory Risks For Miners In 2017
Country Political Event/Regulatory Risk BMI View In December 2016 Played/Playing Out? Update/Outlook
Source: BMI
US Presidential election - November 2016 The surprise victory of Donald Trump will lend some respite to the US mining sector through deregulation, but the US coal industry will remain in a structural downtrend. Future trade policy and details of Trump's infrastructure plan will also drive the ores and metals outlook. Theme has played out. The US' mining industry value will gradually return to muted growth over the coming years, as improving prices and deregulation under President Trump incentivise project development. In March 2017, US President Trump signed an executive order mandating the elimination or review of environmental regulations deemed to pose a hurdle to energy production, economic growth and job creation, including the Clean Power Plan (CPP). As we previously identified the implementation of the CPP as unlikely due to legal uncertainty, Trump's executive order does not change our negative outlook on US coal production over the coming years ( see ' Coal Outlook Still Grim Despite Executive Order ' , April 6).
Chile General election - November 2017 The outcome will determine the success or failure of Bachelet administration reforms including labour and water regulation. There is potential for a right-wing victory, and a more pro-mining administration. Theme is playing out. To be re-assessed post-elections.
China 19th Party Congress/supply-side reforms and outlook for the ongoing support to the economy Until the party congress, financial support to construction will be provided, boosting metals prices at the same time that supply-side reforms will roll on. Theme is playing out. Government support to the infrastructure sector will remain elevated in 2017 and we maintain our view for China's industrial metal demand to remain positive this year, impeding a collapse in prices. However, authorities have started easing overall fiscal support to the economy and tightening credit conditions in recent months, which will herald a slowdown in the economy in the coming quarters, which will weigh on ferrous metal prices.
Philippines Future of the mining regulations Following the closure of several mines on environmental grounds, we expect more miners to comply with environmental regulations in 2017, bringing about a stabilisation of the mine crackdown. Theme has played out. The mining crackdown has stabilised with the ousting of anti-mining advocate Regina Lopez from the post of Environmental Secretary of the Department of Environment and Natural Resources (DENR) in May 2017. The new head of the DENR, Roy Cimatu, is more adaptive and believes mining and protecting the environment can be achieved simultaneously. We hold firm on our stance that any tightening of environmental regulations in the Philippines will have limited effect on actual production from the country, despite acting as a deterrent to potential new investment (see ' New Foreign Investment To Be Deterred, Existing Production To Grow, May 15).
Indonesia Future of the ore export ban The government's silence on the ore export ban will continue to evoke uncertainty for the country's mining sector. A decision will have to be made by January 2017, as the full ban on the export of ores from the country will take effect then. Theme has played out. In line with our long-held view, the Indonesian government announced in January 2017 its decision to moderate the mineral ore export ban, allowing exports of bauxite and nickel ore. The announcement also came with a strong resource nationalism twist. Foreign miners now have to agree to gradually divest at least 51% stakes in their local operations to Indonesian entities (see ' Ban Moderation To Boost Bauxite, Nickel Ore Production ' , January 16).
South Africa Mining Charter The sector will likely face additional legal and compliance costs with the adoption of the new Mining Charter expected in 2017. Based on the charter's draft, authorities will require the strict restructuring of mining companies in a short time span, which will increase both policy and investment uncertainty in the coming years. Theme has played out. The South African government adopted in June 2017 a new mining charter. As anticipated, the revisions will further solidify the country's negative mining sector growth prospects in the coming years, as updated revisions on black ownership levels and new taxes will raise compliance costs for miners in the country. As a result we have downgraded South Africa's Mining Risk Reward Index score. The operating environment outlook in the country remains uncertain as miners are likely to challenge the charter in court (see ' New Mining Charter Confirms Bleak Growth Outlook', June 20).
Zambia Mineral import tariff/resource nationalism Resource nationalism and increasing demands for raising mineral royalties will remain a political hot topic over the coming quarters. Theme is playing out. In line with our view, Zambia's government has announced stricter measures to clamp down on tax evasion within the natural resources sector. In January 2017, the Zambia Revenue Authority (ZRA) announced that it would begin undertaking forensic audits to establish whether large mining companies have been complying with recent tax legislation introduced by the authority.

Theme: China To Generate Significant Volatility In Metals Markets

BMI View In December 2016 : China will continue to generate significant volatility for the mining and metals industry globally in 2017, as the country is the largest global consumer and producer of most metals and ores. Politics and regulations in China play a major role in determining supply and demand, and the 19th Party Congress in fall 2017 entails major risks as the country continues attempting to balance between maintaining solid economic growth and reforming its oversupplied and inefficient industries. There will be differentiation in the level of reform enforcement in different sectors, which will lead to increasing risks in the sector.

Key Developments In H117: Evolving Chinese government policies have remained a major source of volatility for metal prices in H117. The capacity reduction drives have led to significant speculation in metal markets in H117. For example, although the National Development and Reform Comission announced in May 2017 that China had already achieved 63.4% (31.7mnt) of its steel capacity cuts target for 2017, the country's steel production increased by an average of 4.6% y-o-y during January-April 2017. This reinforces our view that China's capacity cuts in the steel sector will only affect idled mills instead of active ones, thus having no impact on actual production. Additionally, the Chinese government front-loaded fiscal spending (which supported infrastructure investment) in Q117 instead of gradual spending throughout the rest of the year, causing a rally in metal prices.

Outlook: China continues to be a major risk factor in our commodities price forecasts. For example, prices of iron ore and steel could edge higher if Chinese ore production comes offline at a faster rate than we expect, thus decreasing the global ore supply glut. This could occur if central government takes a harder line with provincial governments regarding cuts to production in inefficient sectors. Alternatively, if China's real-estate sector cools faster than we expect with Beijing's more hardline stance on clamping down on a housing bubble, demand could be eroded faster than we expect. Chinese authorities will remain cautious in managing financial risks in 2017, with the central government reiterating its resolution to tackle asset bubbles.