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March 1, 2006

Short Supply: A New Era of Scarce Resources

China's emergence as a voracious consumer of raw materials has raised concern about resource scarcity. Does the world have enough supplies of essential commodities such as iron ore, copper, molybdenum, oil and even water?

In 1798, the English demographic and political economist Thomas Malthus predicted that spiraling population growth eventually would surpass the planet's ability to produce enough food to support its inhabitants.

Malthusians reappear periodically, especially during periods when essential commodities are in short supply. High prices for metals, oil and natural gas made the past two years one of those times. With oil around $70 per barrel, iron ore up 86%, molybdenum up 500% and copper at more than $2 per pound, a queasy feeling sets in. It's not a stretch to wonder whether we really are running out this time. Some theorists predict that dwindling oil reserves will provide the first test for the industrialized world.

The reserve estimates for raw minerals and energy deposits kept by the U.S. Geological Survey (USGS) and the Energy Information Agency (EIA), among others, show generations worth of supply still in the earth for nearly every commodity. Bauxite and iron ore are among the most abundant minerals in the earth's crust.

If anything, the USGS reserve statistics are conservative, and best viewed as a snapshot of information on how much is economically recoverable at a given point in time. The numbers aren't recalculated frequently enough to keep pace with technological advances and new discoveries. With each recalculation, despite the consumption during the intervening years, reserves continue to increase.

That queasy feeling this time has more to do with strained extraction and refining capacity than a lack of raw material. To realign supply with higher consumption is entirely possible, but the response time is anything but rapid.

Metals analyst Eli Lustgarten, senior vice president at Longbow Research in Independence, Ohio, characterizes the low prices at the early part of the decade as a period of inventory liquidation. The sharp recovery in the U.S. industrial economy in 2004 and 2005 was an about-face that left planners off-balance. “In some markets, it looked like three years of recovery in one,” Lustgarten says. “Many industrial markets, including construction equipment, were up as much as 30% and 40%,” while planners were anticipating growth in the 8% to 10% range.

China's increasing consumption of raw materials jolted the market, while stronger than expected demand from domestic manufacturers further tightened raw material supplies.

China's share of global metals consumption has skyrocketed to a range of 20% to 30%, up from only 9% a decade ago, says R. Wayne Atwell, metals analyst and managing director at Morgan Stanley in New York. China became a major net importer of alumina, iron ore, nickel and copper, “so those materials have been very tight. China is now so big that it really matters,” says Atwell, who predicts that consumption will continue at high levels.

India, with 85% of China's population, is expected to follow the same growth pattern, trailing by 10 to 15 years, he adds. (See Forward, Nov/Dec 2005.)

Opening up the supply tap, though, is a slow and costly process. During periods of equilibrium in demand and supply, such as the past several decades, there were no economic incentives to expand capacity. Even in the best of times, adding production capacity is an exercise in caution, given the extended lead times for development and capital investments measured in billions of dollars.

And what appears economically viable during the multi-year process of feasibility studies and obtaining permits quickly can become overbuilding if the market swings in the opposite direction.

Moreover, the ability to expand capacity is further hampered by shortages in everything from mining trucks and the special tires they require, to rail cars, barges and skilled labor. Permits that once took six months to obtain now take years, in part because of complex environmental rules.

The high costs for metals are going to linger a while, Atwell predicts. He envisions a 10- to 15-year stretch of high prices, interrupted by peaks and troughs. “I think we're close to a cyclical peak in a lot of commodities right now, but the correction will be much milder than we've seen in the past.” The era of low metals prices, kept down by technology and improvements in efficiency, are past. “We're going to see real pricing in metals for the first time in 30 years,” he asserts.

Even if prices moderate over the short-term, Atwell anticipates that capacity expansion plans underway will continue because of industry consolidations that have resulted in larger and better-funded companies.

IRON ORE
Demand for steel worldwide pushed iron ore prices up by as much as 86% on the world market in 2005. Estimates for Brazilian ore delivered to Rotterdam were upwards of $105 per ton. Forecasts for price increases this year range from 5% to 20%.

North American iron ore pricing has little to do with seaborne ore supply and demand. Peter Kakela, a professor of natural resources at Michigan State University, pegs iron ore prices around the lower Great Lakes at approximately $45 per ton, while estimates for merchant ore were close to $60 to $65 per ton, an increase of about 50% from 2004.

Morgan Stanley Research projects growth in Chinese steel production to leave the iron ore market in a deficit position or level at best in 2006. China is consuming more than 300 million tons of iron ore per year. Kakela, who has followed iron ore for 25 years, says China's domestic ore supply is of such low quality that by using imported high-grade ore, it can double the output from its blast furnaces.

While the supplies of seaborne iron ore are short, one major U.S. iron ore producer reports that supply and demand within North America is in balance. “Demand is strong,” says Dana Byrne, a spokesman for Cleveland Cliffs Inc. based in Cleveland, the primary iron ore supplier to U.S. companies. “The mines are running full out. There's very little capacity to be added domestically,” he says. The company is expanding its operations in Australia.

Rio Tinto Ltd., based in Melbourne, Australia, has a $1.3 billion expansion of iron ore capacity underway in the Pilbara region. Other expansions are underway in Brazil. New Millennium Capital Corp. in Quebec is pursuing development of a new iron ore mine in Labrador. Even domestic producers are expanding output where they can, Kakela says.

 

 

 

COKE
Shortages of coke, the product refined from metallurgical coal, drove prices up about 28% in 2004 and a further 111% in 2005 to $125 a ton, reports Morgan Stanley. The squeeze came from reduced capacity, as a number of coke-making facilities closed from low demand during the cycle when the steel industry was depressed.

The Platts International Coal Report says prices for coking coal and coke should ease in 2006 from their current levels because of increased supply in China and a slight weakening in global steel production. The report notes that U.S. prices are likely to remain high due to freight costs.

“Because the major U.S. companies are coke self-sufficient, either with their own supply like U.S. Steel and Mittal North America, through joint ventures or long-term coke supply agreements, it's a difficult decision whether to build new coke batteries,” says Andrew Aloe, president of Shenango Inc., an independent coke producer near Pittsburgh.

“It's hard to base a 20-year process” on a shorter-term market cycle, Aloe says, adding that his Canadian friends say anticipating coke prices is akin to “nailing Jell-O to a wall.” One new coke-making facility came online in the first quarter of 2005 from Sun Coke in Haverhill, Ohio.

BAUXITE
As the third most plentiful mineral in the earth, bauxite reserves appear almost infinite. But alumina, the product of refined bauxite used to make aluminum, is not so plentiful. The material is in high demand from India's and China's developing economies. China currently uses about 21% of bauxite production.

Unexpected production delays contributed to an alumina deficit that sent prices surging to 16-year highs in December. The Platts Metals Week high at year-end was $600 per metric ton for Australia alumina. Morgan Stanley projects 2006 alumina inventories to remain somewhat tight, at the equivalent of two days of demand. That compares to spot prices of $160 in 2002.

With processing capacity stretched, producers are expanding facilities and investing in new ones. Montreal-based Alcan Inc. expects to complete its $1.3 billion expansion of its Gove alumina refinery in Australia in 2007. Alcan also has developments underway with partners in Oman, India and West Africa. Also in Australia, Comalco, a subsidiary of Rio Tinto, commissioned its first new refinery in many years and began expanding its Weipa bauxite mine. Other bauxite mining expansion is underway in Australia, Brazil and Russia while China is rapidly increasing its alumina producing capacity.

COPPER
Following three years of production deficits, world commodity exchange inventories of refined copper are at their lowest levels in more than 30 years, the International Copper Study Group (ICSG) notes. ICSG estimated there was a cumulative shortfall of 1.36 million tons on the world market between 2003 and 2005. Copper prices reached record highs in late 2005 and climbed even higher in early January when copper for March delivery hit $2.11 a pound. As recently as the late 1990s, it averaged less than 75 cents a pound. ICSG forecasts a modest refined copper inventory surplus of 300,000 tons this year but expects demand to continue to grow over the next several years.

While copper reserves appear lower than reserves for other minerals, the numbers can be misleading, warns USGS Commodities Specialist Daniel Edelstein. Technology has enabled producers to mine lower grades of copper, which has driven availability up exponentially, he says. The reserves and reserve base continue to increase as new deposits are developed.

With prices high, some previously shuttered copper mines are resuming production. In Zambia, tailings from some high-grade mines are being reprocessed. The Robinson Mine in Nevada, formerly owned by Australia-based BHP Billeton and inactive since 1999, reopened in 2004 after its acquisition by Quadra Mining, a company founded in Vancouver, British Columbia, four years ago. Expected production is 165 million pounds of copper a year over a 10-year period. New copper mines are coming onstream in Asia and Australia. Toronto-based Inco Ltd. is developing its Voisey's Bay nickel mine in Labrador, which is expected to produce 70 million pounds of byproduct copper in concentrate annually when in full production.

ALLOYING METALS
The price of molybdenum soared some 500% within two years after decades of prices below $4 per pound. Platts Worldwide Dealer molybdenum oxide prices that averaged $7.95 per pound in early January 2004 rose to more than $32 per pound a year later. In mid 2005, the Platts Metals Week price hit a high of $37 per pound before falling back to the $24 range at the end of 2005.

Molybdenum production increased in 2005, both as a primary product and as a byproduct of copper, but demand increased as well. Production problems in China, which swung between being a net exporter and a net importer of the ore from month to month, added to the squeeze. U.S. Geological Survey commodity specialist Michael J. Magyar notes the supply chain bottlenecked at various roasting facilities where the concentrate is processed, delaying product deliveries. Additional roasing capacity coming onstream in Chile appeared to balance supply and demand by the close of the year, he says.

At least one new domestic facility is in the works. Idaho General Mines Inc., of Spokane, Washington, announced plans to develop the Mount Hope molybdenum deposit in Nevada, which the company reports has more than a billion pounds of recoverable molybdenum. The project is in the permitting stage. Limited roasting capacity and another surge in steel consumption could lead to a supply deficit, Magyar warns.

Nickel consumption, growing at almost 8% a year between 2002 and 2004, according to USGS data, reached an all-time high in 2005 partly due to rising stainless steel production, which accounts for two-thirds of nickel use. China's production of stainless steel, which has more than doubled since 2000, is expected to put additional pressure on demand for nickel, as will the growing popularity of hybrid vehicles which use nickel-based batteries.

Morgan Stanley nickel price forecasts call for maintaining 2005's $6.50 per pound price throughout 2006, with longer-range price forecasts moderating as anticipated new production comes onstream.

One new source is Inco's Voisey's Bay mine in Labrador, which began shipping nickel ore in November. The company projects annual capacity of around 110 million pounds of nickel concentrate, which also contains 5 million pounds of cobalt and up to 15 million pounds of copper. CVRD, a Brazilian company headquartered in Rio de Janeiro, is investing $1.1 billion in development of the Onça-Puma nickel mine to produce 57,000 tons a year. Production is scheduled to begin in 2008.

Titanium has followed the pattern of higher demand depleting inventory, sending prices soaring. The Platts Metals Week price for 70% ferrotitanium produced in the U.S., an average of 6.54 per pound in early January 2005, rose to a high of $16.50 per pound in April before falling back to the $8 to $9 per pound level at year-end. Decreased supply from Russia, coupled with recovery in the commercial aircraft market, higher demand from the steel industry and strength in ground-based military systems has brought titanium sponge production to about 90% of capacity, says Edwin Kraft, an advanced materials consultant based in Vancouver, Washington. Investment to expand production is underway in Russia, Japan and the U.S.

China has been the leading supplier of tungsten, but with its domestic consumption increasing, supplies around the world have tightened and prices hit record highs. The Platts Metals Week U.S. tungsten price rose to $98 from $94 per short ton unit at the beginning of 2005 to $250 to $260 per short ton unit at year end.

Development projects that were mothballed when the price of tungsten was low now are undergoing re-evaluation. Investments such as the development of a new tungsten mine in Vietnam by Tiberon Minerals Ltd., Toronto, with joint venture partners are expected to ease supply constraints eventually. Production from that mine is scheduled to begin shipping in 2008. North American Tungsten Corp. in Vancouver, British Columbia, reopened its Cantung Mine in the Northwest Territories following new investments to shore up its financial position, and began shipping ore in October 2005.

For buyers, cobalt has been a bright spot. As a byproduct of nickel, cobalt has been the beneficiary of increased nickel production. Inventories in 2005 remained adequate and prices relatively stable. Platts cobalt prices at the beginning of 2004 were $23 to $24 per pound, fell to $19.25 in early 2005 and then declined further to $15.25 to $16.25 per pound at the end of the year.

Production problems in Zambia and Norway could cause prices to shoot up, however, if aerospace fabricators continue even the same rate of growth.

 

 

 

NATURAL GAS
The U.S. Department of Energy projects natural gas to be the “fastest growing component of world primary energy consumption” in its International Energy Outlook. From 2002 to 2025, it projects worldwide consumption to increase nearly 70%.

Will there be enough? “It's a huge resource globally,” Lynch says, citing the large Indonesian discoveries as evidence of a continually increasing reserve base. “The bottleneck is the infrastructure. That is a problem for the medium-term future.” As China switches from coal to gas, he demand for gas will increase and create a huge potential market, he says.

Three of the world's largest oil companies have renewed natural gas exploration in the U.S., as competition and political risks elsewhere make the United States a more attractive venue. ExxonMobil, Irving, Texas; BP plc, London; and Royal Dutch
Shell plc, London, have begun exploring for unconventional gas fields that new technologies will enable them to unlock.

OIL
Oil, the resource that literally fuels the world, grabs the most headlines. Today's worldwide daily production of 87 million barrels barely outpaces global daily consumption of 84 million barrels. With surplus production at only a fraction of a single day's consumption, the supply of oil is especially vulnerable to production-related shortfalls, Katrina-style natural disasters and political risk.

A vocal minority of theorists called the Peak Oil group say growing demand and a limited supply base means the world is on the brink of maximum production, after which output will decline rapidly. The world faces a future, they say, of skyrocketing prices and impeded economic growth. Estimates for the peak vary widely. Some say it is now. In a presentation at the Denver World Oil Conference in November, Thomas Petrie, chairman and CEO of Petrie Parkman & Co., an energy investment bank based in Denver, surveyed the range of predicted dates for peak oil production, and placed it somewhere between 2010 and 2015. Petrie concluded that supply already is limited and demand keeps growing, leaving little margin for error.

For global economic growth to continue unimpeded, world production will need to be 120 million barrels per day by 2020, says another Peak Oil proponent, Matthew Simmons, chairman of Simmons & Co. International in Houston. That number exceeds even the optimists' current predictions. “It's unlikely that we'll hit even 90 million barrels a day by 2020, absent the discovery of some unbelievable new frontier,” Simmons says. He places energy at the head of his list of the top 10 problems for humanity over the next 50 years. Water is No. 2.

But others dispute the alarmists. Thomas Esser, senior consultant and director of oil and gas resources at Cambridge Energy Resource Associates (CERA) in Massachusetts, recently testified before a House Energy and Air Quality Subcommittee that production capacity, rather than a lack of below-ground resources, will present the steepest challenges to a ready worldwide supply of oil. Global oil production could rise from its present 87 million barrels a day to as much as 105 million barrels a day in 2015, he predicted, with the capacity to continue to rise after that.

Esser maintains that Peak Oil conclusions are based on data reported under now-outmoded SEC accounting regulations. In addition, sources now considered non-traditional, such as oil from ultra-deep waters and natural gas liquids, will become more commonplace and could represent as much as 35% of total capacity by 2015, he testified.

Michael Lynch, president and director of global petroleum service for Massachusetts-based consulting firm Strategic Energy and Economic Research Inc., blames faulty methods, such as modeling,which he says is accurate for ores but not for oil. He says that projected reserves continue to grow with every recalculation. Peak Oil doesn't take reserve growth into account, so the peak must move further into the future every couple of years, he says.

As for the high oil prices of 2005, Lynch says this scenario is more normal and the long stretch of high sur-plus capacity was unusual. Eventually surplus capacity goes away, he says, and a disruption of as little as 2 million barrels a day will cause a price spike.

“We're in a two-year cycle that could be over as early as the second quarter. An economic slowdown would advance it and more bad hurricanes would delay it—or bring us back up,” Lynch says.

WATER
A look at natural resources wouldn't be complete without discussing water. It is the resource about which the least is known, including how much we have and how much we will need. Concerns over adequate water supplies are raised by organizations such as the World Bank, the United Nations and the Organisation for Economic Cooperation and Development (OECD).

A study by the National Science and Technology Council (NSTC) sought to determine whether the United States has enough water. Published in November 2004, the first comprehensive study in 25 years concluded with a not-so-reassuring “we don't know.” Water availability is complicated by precipitation and temperature, which are impossible to forecast with precision. It is further obscured by the maze of state regulations that allocate supply.

“Data on water supply and use are not readily available or aren't collected,” the study noted. Although water concerns in the arid western U.S. have been well-reported, the NSTC study said that water managers in 36 states, not all of them in the West, anticipate water shortages over the next decade, even under normal conditions.

Among the recommendations of the study was to evaluate technologies for conservation and supply enhancement, such as reuse and recycling.

Competition for water, minerals and energy is all the more dramatic when compared to past decades of slow growth. In the coming decade, developing nations with bridges to build, housing to provide, and automobiles to manufacture, will need more of nearly everything: steel, energy, aluminum, coal, clean water.

Compared to developed nations, these countries, Kakela said, are still in the basement and that “their growth is not a straight line by any means.” How evenly capacity expands to meet the whole spectrum of demand will determine how smooth or bumpy the coming decade will be.