This time last year, when coronavirus cases started sweeping the world, Rio Tinto’s Jakob Stausholm was doing the same thing as most other chief financial officers of big global businesses: steeling himself for a period of economic disruption.
China, which consumes half of the world’s metals, had been plunged into lockdown – halting industrial activity, casting a cloud over demand for Australia’s commodity exports. Copper prices crashed 20 per cent. Iron ore, which makes up the bulk of Rio’s earnings, began losing ground.
“I must say, we were in a bit of shock,” Stausholm, now the mining giant’s chief executive, tells The Age and The Herald.
For the Australian economy, the biggest story of 2020 was one of severe decline. As COVID-19 closed borders and confined people to their homes like never before, demand for many exports such as oil, gas, coal all but vanished, wiping out billions of dollars. Gross domestic product (GDP) took a dive. And before long the nation entered its first recession in 30 years.
Midway into the second quarter, however, Stausholm and his colleagues in the Anglo-Australian miner’s Singapore and Shanghai teams – who keep a close watch on data points like traffic in China’s cities and production flows – noticed something remarkable was happening.
“China was actually motoring ahead,” Stausholm recalls. “And the way they were stimulating their economy was very commodity-intensive.”
From as early as March, as Chinese cities began emerging from heavy-handed lockdowns, Beijing unleashed a program of extraordinary fiscal stimulus aimed at construction and infrastructure – bridges, roads, utilities, railways. When you have a building boom, what you need is lots of steel. And fortunately for Australia, that requires one essential ingredient – iron ore – the nation’s single most valuable export.
“No one of us would have believed [that] the worst recession since at least the Depression in the 1930s could lead to almost a manufacturing boom,” says Stausholm, “but that’s the outcome, and it’s been for the benefit of Rio Tinto.”
The scale of this benefit has been laid bare this week with the financial results of the country’s top three miners – BHP, Rio Tinto and Fortescue – all of which delivered a shareholder cash bonanza with record-breaking dividend payouts on the back of soaring 2020 profits.
“It feels like we’ve been handed a windfall Christmas gift this week,” says Glyn Lawcock, head resources analyst with investment bank UBS. “But we actually haven’t seen a step-up in payout ratios other than in BHP – what we’ve seen is the outcome of what happens when prices go up strongly.”
Bumper shareholder returns aside, it’s difficult to understate the importance of iron ore to Australia’s budget. According to Treasury estimates, a sustained $US10 rise in iron ore prices corresponds to an extra $4.4 billion rise in nominal GDP and $300 million in extra company tax receipts.
After an unexpected price rise to five-year highs in 2019, caused mainly by a fatal dam collapse in Brazil, mining CEOs, analysts and the Australian government had long been bracing for things to taper off. By the end of the year, the price had retreated from $US120 a tonne to $US90 a tonne. A deeper slump was expected to follow.
“Iron ore is exhibiting all the elements of a failed souffle,” accounting giant Deloitte remarked in 2019, “promising the world but ultimately falling flat on closer inspection.”
Yet iron ore has remained surprisingly robust. Despite a temporary slide at the onset of the COVID-19 crisis, benchmark prices for seaborne iron ore cargoes gained a staggering 75 per cent over the course of the year, sealing its spot as one of 2020’s best-performing commodities. Recently, that ascent has continued, with iron ore touching a nine-year high of $US175.
Driving iron ore prices on the demand side was China’s huge post-COVID-19 economic stimulus spending, which ramped up production in its vast steel sector to an all-time high of 1.05 billion tonnes of crude steel in 2020. Iron ore is combined with coking coal in huge blast furnaces, heated at more than 1000 degrees, to churn out liquid steel.
But importantly, price support came on the supply side, too. Brazil’s Vale, the world’s second-biggest iron ore shipper, has been experiencing production problems ever since the 2019 Brumadinho waste-dam collapse, and last year faced outbreaks of coronavirus infections and lockdown limits that crimped output further.
In the vast Pilbara region of Western Australia, iron ore’s heartland, the situation was starkly different.
From the onset of COVID-19, mining companies and governments acted swiftly and collaboratively to set stringent health and safety protocols that could ensure the industry could continue operating. Workers were relocated from the east coast to the west, and fly-in, fly-out rosters were overhauled. Nurses were stationed at airports to check workers for high temperatures. Split shifts were introduced. Social distancing rules were established on sites. Some companies even started developing smartphone apps to prevent the spread of the virus among their workforces.
“The pandemic was concerning for everybody,” Federal Resources Minister Keith Pitt says. “But we went in with a pretty clear strategy of working with industry, working with other state and territory ministers, making sure we could put in place what was necessary to keep everybody safe, to stay operational. I think it’s pretty clear that we were incredibly successful.”
‘Iron ore was $120 billion in 2020 alone – our biggest export by far.’
Keith Pitt, Federal Resources Minister
Being able to continue operating safely meant Australia’s producers could fully capitalise on iron ore’s extraordinary price rally. In the past six months, the Andrew “Twiggy” Forrest-backed Fortescue Metals Group shipped a record-breaking 90.7 million tonnes of the commodity from WA. BHP shipped a record 145 million tonnes. Rio Tinto ramped up to 330 million tonnes across the full year.
“I think for a lot of people across the country, you talk big numbers and their eyes glaze over,” says Pitt. “But iron ore was $120 billion in 2020 alone – our biggest export by far.”
As China’s aggressive economic recovery continues and vaccines are rolled out around the world, miners and their investors are turning their focus on what happens next. Has iron ore peaked? Will prices remain elevated or will they come under pressure?
According to BHP’s analysis, before prices can meaningfully correct from their high levels, “one or both of the Chinese demand and Brazilian supply factors will need to change materially”.
Fortescue says there is no sign of China slowing. “Our view is the market will remain robust for some time,” chief executive Elizabeth Gaines says. “We are seeing continued elevated activity levels in China given the usual seasonal slowdown as a result of Chinese New Year hasn’t happened at the same rate.”
Confidence in the outlook is also coming from a rebound in steel production outside China.
“The rest of the world’s steel production is back to what it was … making up for increasing supply out of Brazil,” Plato Investment portfolio manager Peter Gardner says. “We like the long-term iron ore fundamentals.”
There are some other factors that could swing the fortunes of iron ore and its major producers. First, a regulatory fallout from Rio Tinto’s destruction of two ancient Aboriginal rock shelters last year – which led to global condemnation, the resignation of former CEO Jean-Sebastien Jacques and a federal inquiry – remains unknown.
WA’s mining sector is now facing the prospect of slower approval times for new supply projects amid a move towards tougher heritage laws and recommendations for a pause on permits for works impacting culturally significant sites. Stausholm, who has made restoring trust with traditional owners one of his top priorities, travelled to Perth last week to meet the Puutu Kunti Kurrama and Pinikura (PKKP) people to “express my deep regret about the damage we caused”. Stausholm insists he is optimistic that Rio and traditional owners can find mutually beneficial growth options.
“We are learning tough lessons around how to work effectively from our side in partnership with the traditional owners and it will require work,” he says. “I remain optimistic, despite the challenges going through these processes, that we can continue to develop our iron ore business.”
Then there is the prospect of a flood of new supply in the years to come, the most significant of which may well be the vast Simandou deposits in Guinea. Amid the souring diplomatic tensions between Canberra and Beijing, the potential for West African supply to displace or diminish the Pilbara’s hold over China’s steel industry has been brought into focus. Analysts, however, believe this project will be at least another five years away.
On Tuesday, BHP chief executive Mike Henry dialled into a conference call with shareholders and delivered his brightest forecast yet for the global economy, growth and commodities. Vaccines are rolling out. Governments are unleashing mammoth stimulus programs. And the world is accelerating the clean-energy transition, which will call for huge amounts of steel to manufacture green infrastructure such as wind turbines, while nickel and copper are key ingredients in electric batteries.
At one point, Henry was asked if he thought the world could be on the cusp of a commodity “super-cycle” – periods when commodity prices enjoy an extended boom. Metals prices are already back at their highest levels in years, while oil has rebounded to above $US60 a barrel.
“I don’t want to get caught up in the terminology, per se,” said Henry, but he acknowledged there were mega-trends powerfully in favour of strong demand growth. Coupled with a sharp pull-back in minerals exploration and oil and gas investment, it “points to a pretty constructive outlook for commodities,” he said.
UBS’s Lawcock also tries to avoid using that terminology, noting “every time we’ve said that in the past, it ends in tears”.
“We have set ourselves up extremely well with under-investment, massive stimulus by the governments, a 50-year high GDP growth rate globally … but as always higher prices will encourage more investment, stimulus will generate inflation, and governments will then have to tighten to slow things down,” he says.
“It’s called a cyclical industry for a reason.”
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Business reporter for The Age and Sydney Morning Herald.