The Economist: “Overblown expectations of the mining sector”

The government of Mozambique remains confident that its mining boom is set to accelerate in the coming years, despite weak sentiment in the global mining industry. Rising coal production and an eventual rebound in global prices will spur some growth in Mozambique’s mining sector in 2016‑20 but we expect that, weighed down by infrastructure deficits and non-competitive policies, it will remain a relatively small contributor to GDP growth.   

Mozambique has untapped coal reserves estimated to be in excess of 20bn tonnes, as well as commercial quantities of aluminium, gold, titanium, graphite and gemstones. Plus, it benefits from a long coastline and geographic proximity to mineral-hungry markets in Asia. At the peak of the commodity super-cycle, investor interest in Mozambican mining soared; the contribution of the mining sector to GDP increased from 1.6% in 2009 to 3.2% in 2013, while government earnings from the sector swelled from US$40m in 2009 to over US$1bn in 2014.

A short-lived boom 

Rio Tinto’s experience in Mozambique serves as a warning, however. The British-Australian company acquired assets in the coal-rich Tete province in 2011 for US$3.7bn but, faced with high costs and transport bottlenecks, it sold these assets in 2014 to an Indian consortium, International Coal Ventures Limited (ICVL), for just US$50m. Through much of 2015, the assets were costing ICVL some US$7.5m a month.

Of Mozambique’s other coal mining companies, the two largest firms (Brazil’s Vale and India’s Jindal Steel and Power) were also loss-making in 2015 and a smaller company, the UK’s Beacon Hill Resources, went into administration in late 2014. Elsewhere in the mining industry, year-on-year production was down by 19% in 2015 at the Moma heavy sands mine and, in January 2016, its owner Kenmare Resources defaulted on its debt. By contrast, Mozal (an aluminium smelter, majority-owned by Australia’s South32) quadrupled its profits in 2014/15 (financial year, July‑June) in local-currency terms, on the back of high global aluminium prices and a weakening of the Mozambican metical against the US dollar.

Companies play the long game

Somewhat contrary to the government, which expects the mining sector to drive overall real GDP growth to 7% in 2016, mining companies are more cautious about the near-term outlook:

• Vale will ramp up production in a bid to reduce costs, making use of its new railway and port infrastructure. The company expects production to increase to 10m tonnes/year (t/y) in 2016, from around 1.8m t/y in 2015, before gradually expanding to full production of 18m t/y by 2019. The expansion is significantly more gradual than the company’s initial projections of 20m t/y by 2016 and, based on Vale’s cost projections and our price forecasts, Vale’s Mozambique operations will not break even until 2018.
• Jindal will continue to produce well below capacity, since exports to India are unprofitable. However, earnings will be boosted in the near term by supplying thermal coal to the regional power industry and by renting out its logistics capacity. The company expects its Mozambique operations to break even in 2016 but, by comparison, Jindal’s coal operations in South Africa and Oman should remain profitable, even in the current low-price environment.
• ICVL has stopped production at Benga mine while it negotiates a cheaper management contract. Once production resumes (likely to be mid‑2016), monthly production is planned at 24,000 tonnes of export-quality coking coal and 22,000 tonnes of thermal coal—well below the mines monthly capacity of 440,000 tonnes. With no buyer for the thermal coal, stockpiling it will weigh heavily on the operation’s profitability.
• Kenmare Resources will benefit from improved power infrastructure near the Moma mine, thereby reducing costs and paving the way for a recovery in production volumes, but prices for ilmenite (its main product) are set to remain weak in the near term.
• Aluminium prices have dropped by some 15% since the end of South32’s 2014/15 financial year. Although we expect a rebound from mid‑2016, softer prices will inevitably weigh on the outlook for the Mozal smelter.

With hefty in situ investments already made, the existing mining companies will wait for a recovery in prices; most can afford this strategy, but investment plans will be deferred, jobs will be cut and earnings will be truncated—all of which will weigh heavily on the Mozambican economy.

Investment slump set to continue

In addition to low commodity prices and the difficulties in attracting financing, Mozambique’s mining industry remains a relatively uncompetitive environment. Its ability to attract new investors is therefore doubtful.

The country’s Mining Law (which was not applied retrospectively to existing projects) was drafted in 2014, at the top of the commodity cycle, and includes costly provisions that mining companies must use local services and create local jobs. Poor transport infrastructure further increases costs and deters mining companies from bringing new capacity on stream.

Sena railway is being expanded, but the port that it serves, Beira, is already at capacity; plans to expand Beira port will not be realised by 2020 and proposals to develop a third railway have been shelved. Transport bottlenecks will therefore re-emerge, even with Vale’s new infrastructure fully operational.

There are still some shoots of activity. Of the more advanced projects currently in the planning phase, UK-based Xtract Resources plans to bring Manica gold mine into production in mid‑2017, but it is still awaiting government approval and is yet to conclude a feasibility study. Several Australian firms are also actively promoting graphite projects, but their ability to attract financing in the current market is far from assured. Significant development work on these projects is unlikely to begin until the latter part of our forecast period, at the earliest, with production pushed back until well beyond 2020.

Overblown expectations

The mining sector will expand in 2016, driven by rising coal production at Vale’s mine, and an uptick in prices in 2017 for coal and aluminium (11% and 14.6% respectively, according to our forecasts) will further boost the sector. These anticipated price rebounds do, however, come after several years of plunging prices and, based on our expectation that investment into the mining industry (and the logistics infrastructure upon which it depends) will remain low, mineral production is likely to level off at a relatively unspectacular level.

The mining industry is therefore set to remain a relatively small component of Mozambique’s growth story. Indeed, even in 2012—when coal production increased by over 800% in volume terms and prices across the commodity basket were still relatively buoyant—the mining sector’s contribution to total real GDP growth was just 1.1%.

Meanwhile, the non-mining sector has consistently registered real GDP growth in excess of 6% over the past five years. We maintain our view that real GDP growth in Mozambique will be brisk in 2016‑17 (at a yearly average of 6.5%), in comparison to the regional average (3.8%), but, with growth in the mining sector unlikely to register a rapid acceleration, the government’s target of 7‑8% growth seems overoptimistic.(Source: The Economist Intelligence Unit)