It was only a matter of time, as a fourfold increase in power costs for some heavy consumers, on top of environmental carbon emissions levies, have finally proved too much for some European metals producers.
Nyrstar, the huge Belgium-based zinc producer, is the first major smelter — but it likely won’t be the last — to announce cutbacks.
According to Reuters, the group will reduce output by up to 50% from Oct. 13 at its three smelters: Budel in the Netherlands, Balen in Belgium and Auby in France.
Most heavy users, like Nyrstar, operate on variable power cost depending on the time of day. As such, cutbacks are likely at peak times to manage input costs.
According to a post by S&P Global, Nyrstar’s fully electrified zinc smelter in Budel-Dorplein has an annual production capacity of around 300,000 mt, about 2% of global zinc supply. It is one of the largest smelters in Europe. The Balen smelter is one of the world’s largest zinc smelters in terms of total production volume, with approximate zinc production of around 200,000 mt/year as well as zinc alloy output of a further 200,000 mt/year.
Chinese iron ore prices have certainly been on a roller coaster ride this year, hitting a record high in value terms after a period in which the price had risen and fallen sharply.
Futures on the Dalian exchange for delivery in January 2022 are now trading at RMB 777 per ton. That compares with about RMB 1,221 in May. However, prices are on the rise again, with futures climbing 50% in just the last three weeks.
The market is facing all kinds of contrarian dynamics.
On the one hand, steel production is rising in many provinces following power and environmental shutdowns over the summer.
On the other hand, debt-laden property group Evergrande is just the (admittedly very large) tip of the iceberg that is the Chinese property market. That is a market Beijing is clearly intending to curb and bend to its will.
While arguably overdue, the fact remains, construction absorbs some 25% of Chinese steel production. A slowdown in the sector will have a profound impact on Chinese domestic steel demand.
Huge uncertainty surrounds where prices are likely to go.
We have written twice over the last week concerning the energy crunch, first in China and then India.
Thermal coal prices have risen to record levels, threatening to impact GDP growth as a result of electricity rationing.
The Financial Times observes that China has suffered a triple whammy of emissions restrictions on power generation, a shortage of coal, and price caps on electricity that mean demand is unaffected as input costs have risen.
India, which relies heavily on coal for its thermal power plant, is facing tight supplies and record prices. Nationally, it has only four days of stocks left.
But energy — whether it is in the form of coal, natural gas or oil — is a global commodity. Both Europe and the U.S. find themselves with their own set of challenges, more skewed to the tight natural gas market and rising global oil prices.
The U.K. is not alone but is possibly the most acutely exposed to Europe’s reliance on imported natural gas, particularly from Russia.
U.S. gas contracts for November delivery surged nearly 40% this week to hit £4 per therm (having started 2021 below 50p).
But a surprise announcement by Vladimir Putin yesterday saying Russia was prepared to increase supplies to stabilize prices prompted a sharp sell-off, sending the price down to £2.87.
Whether it stays there will depend in large part on whether Russia can honor that commitment in the months ahead. Russian state gas supplier Gazprom has come under intense criticism for deliberately shipping to no more than its minimal contractual obligations this year. The reality is Russia’s own inventory levels are also depleted after a harsh winter.
It is probably fair to say Europe’s energy markets are particularly exposed to supply disruptions despite supposedly being highly integrated.
Many large industrial consumers have complained that the E.U.’s Green Deal to make the bloc climate neutral by 2050 will only push up energy prices further. In turn, that could ultimately lead to social unrest. For example, high energy prices resulted in the French “gilets jaunes,” or yellow vests, demonstrations in 2018-2019.
Inflation, energy cost impacts
Rising energy prices have fueled inflation that was already being stoked by commodity price increase and supply chain problems for much of this year. Rising energy costs and inflation have been contributing factors in the August fall in German industrial orders. Orders fell 7.7%, a far sharper fall then economists had expected.
Meanwhile, rising energy costs have prompted the closure of large energy consumers across Europe, such as ammonia and fertilizer production. Meanwhile, in the U.S., oil prices this week hit the highest level in seven years after OPEC+ decided to maintain current production levels, which will see a planned increase of just 400,000 barrels a day from November.
U.S. administrators have talked about release from the strategic petroleum reserve and even limits or a ban on U.S. exports of crude oil to limit domestic oil price rises. The average price of gas at the pump has reached $3.19 a gallon, the highest in seven years.
The U.S. economy does not appear to be unduly hindered by the price rises yet. The private sector added a higher-than-expected 568,000 jobs in September, the biggest rise in three months. However, with midterm elections next year, high gas prices will not go down well with voters.
Buyers of European components may expect to see some inflation in prices this year and next. Cost increases are coming, not just from metal prices but energy, wage costs and continuing logistics delays in Europe.
It is to be hoped the continent copes through this winter and cost increases do not derail the recovery. While manufacturers have been riding a wave of unprecedented demand recovery, it should not be mistaken as unstoppable.
A number of factors are converging to push up costs while potentially dampening demand. That makes a toxic mix for a still fragile recovery.
You do not have to look too hard to find failures of state-run economies around the world. Since the collapse of the Soviet Union, there is less enchantment with the model — outside China, anyway — than there once was.
But what we remain plagued with is the idea government has a role in the ownership, operation and pricing of “strategic assets.”
We wrote recently about power rationing in China due in part to a political spat with Australia. As a result, Beijing decided it was a good idea not to buy Australian coal. In turn, it deprived the country’s power sector of a major source of supply.
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India coal crisis
This week, we cover India. The state’s ownership of the monolithic Coal India mining company has for years led to underperformance, underinvestment and inefficiency.
A Reuters article paints a dire picture of the perilous state of the Indian electrical generating sector. Coal stocks have gotten so low that many generators risk running out of supplies.
As of Sept. 29, the post reports, 16 of India’s 135 coal-fired power plants had zero coal stocks, quoting Central Electricity Authority (CEA) data. Over half of the plants had stocks that would last fewer than three days. Meanwhile, over 80% had less than a week’s stock left.
China has previously been cast in a sinister role with respect to restricting the production and export of critical rare earth metals, usually salts, used to produce a host of products. Those products include magnets for consumers electronics and electric cars, defense equipment and advanced ceramics.
But while the country deliberately created a near monopoly position in the global rare earths refining market, it created a horrendous environmental problem in the process.
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Rare earths consolidation and rising prices
In an effort to clean up its environmental act and to gain better control over what had become a wild west mining and refining landscape, Beijing engineered consolidation in the industry to fewer but larger entities.
However, that’s when the criticism started, as China capped exports, causing a spike in prices.
That was largely short-lived. Prices returned to earth after a spike in 2017. However, prices have been rising strongly again this year due to surging demand, both within China and without.
Prices are up between 20-50% this year alone. Surging demand has fueled a bidding war for supplies in a constrained market. With China holding some 85% of global refining capacity and the only mine to refined products supply chain, it not only has a unique position but a unique responsibility in the market.
Much is being made of Beijing’s efforts to meet its environmental emissions targets — the country states it will hit peak emissions before 2030 and carbon neutrality by 2060 — and its restricted steel and aluminium production.
But a recent Reuters post by John Kemp suggests output is being impacted more by a widening electricity crisis than by enforced shutdowns to meet environmental goals.
Kemp explains that China is in the grip of a severe shortage of both coal and electricity. Coal output has not kept up with rising electricity demands from a rapidly recovering economy.
China’s electricity generation increased by 616 Terawatt-hours (13%) in the first eight months of 2021 compared with the same period last year. The largest rises came from the service sector and primary industries.
However, most of the increase has been supplied by thermal generators, principally coal-fired power stations, Kemp explains. Those generators increased output by 465 TWh (14%) in the first eight months.
Other power sources, such as hydro-electric output, have actually fallen slightly this year due to water shortages. Unfortunately, nuclear in China is a tiny fraction of power generation, dwarfed even by renewables like wind and solar.
Europe’s drive to reduce carbon emissions is taking many forms, from government support for R&D to investment in electric vehicle (EV) charging structures, hydrogen fuel technology and infrastructure, to name just a few.
So much for the carrots.
On the stick side, the E.U. has a carbon emissions trading scheme that grants credits to major emitters. However, it still raises the cost of electricity for both industrial and residential consumers.
Rising steel prices have sounded like a broken record. As we get closer to 2022, will we ever see them peak? Sign up for the next installment in the MetalMiner webinar series on Thursday, Sept. 30. MetalMiner experts will discuss the steel market outlook, contracting mechanisms, buying guidance and more.
Polish copper producer looks to nuclear power
For those countries most reliant on coal-fired power production, the problem is most acute.
Poland, with 70% of its power generation dependant on coal, is one of the hardest hit.
It’s not surprising, then, that major consumers are looking to diversify their power sources. However, rather than the obvious choice of natural gas — or renewables like wind and solar — Poland’s second-largest power consumer, copper producer KGHM, is turning to nuclear.
In an interview with the Financial Times, the firm outlined plans to partner with NuScale Power of the U.S. to develop an initial four small modular nuclear reactors (SMR). Each would be capable of producing 77 MW of power and would be operational from 2029.
In total, the project could entail up to 12 SMRs with a total installed capacity of 1 GW. The intention is to make the firm completely grid-independent and guarantee stable, low-cost power in the long term.
Inventory supply chain restocking is driving demand in North America and Europe. That process has been exacerbated by a nightmare global logistics market hampering deliveries and pushing up costs.
But a Reuters article points the finger firmly at a supply-side squeeze, principally in China and to a lesser extent among Western producers.
According to the post, China is in the grip of a power crunch. A shortage of coal supplies, toughening emissions standards and strong demand from manufacturers and industry have pushed coal prices to record highs and triggered widespread curbs on usage.
As a result, China has implemented rationing during peak hours in many parts of the country. Some residential customers are facing cuts and outages.
Indeed, stock markets in China took a heavy fall this week on news that the world’s most indebted construction firm could fail to repay interest coupons due this week and next.
Evergrande was valued at $41 billion in 2020. However, its market capitalization fell to just $3.7 billion now, as it became apparent the highly leveraged company with total liabilities of some $300 billion was struggling to repay a modest onshore interest debt this week.
Evergrande’s woes are merely the symptom of a much bigger problem.
As the Financial Times notes, China’s vast real estate sector, which contributes some 29% of the country’s gross domestic product, is so overbuilt that rather than leading as China’s prime driver of economic growth, it is fast becoming a drag on it.
According to the Financial Times, there is enough empty property in China to house over 90 million people. To put that in perspective, there are five G7 countries – France, Germany, Italy, the U.K. and Canada — that could fit their entire populations into those empty Chinese apartments, with room to spare.
Oversupply has been a problem for several years. But after much prevarication, President Xi Jinping has formulated three red lines to reduce debt levels in the sector. While by no means the only perpetrator, Evergrande has failed all three red lines. Those lines are the ratio of liabilities to assets, of net debt to equity, and cash to short-term debt.
However, it is simply the first and largest to be thrown to the wolves as an example to the rest.
Reports in the media that natural gas prices in the U.K. have more than quadrupled over the last year to highs of 180p per therm from around 40p per therm this time last year are making headlines. This is largely because of the impact on small, startup gas suppliers who have been forced out of business over recent weeks.
However, natural gas — and energy prices, broadly — have been rising strongly. This has been the case, not just in the U.K. but across Europe for much of this year.
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Power prices on the rise
In part, this is weather-related. Exceptionally low winds are failing to generate sufficient renewable energy. However, the situation is also due to the rise of natural gas prices, globally and specifically in Europe.
Demand from China and severe weather in Texas have led to increasing demand and constrained supply. As such, those have created the perfect conditions for speculators to drive prices higher.
Another less talked about contributor is the failure of Russia to supply more than its minimum contractual requirements to the European market for some months. The move is widely seen as the Russian authorities trying to apply pressure on Europe for the approval of the Nord Stream 2 gas pipeline.
The situation is exacerbated by unplanned outages of nuclear power plants this year. Furthermore, fire shut down a main power cable importing electricity from France just this month.
Natural gas surge
The U.K. relies heavily on natural gas for both residential and industrial use. The resulting rise in prices has already led to the closure of two major U.K.’s fertilizer plants.
This has had the knock-on effect of crimping CO2 production. Ir is made as a byproduct and is the source of some 80% of the UK’s supply. CO2 is needed for a wide variety of industrial and agricultural applications.
The U.K.’s second-biggest steel producer, British Steel, is quoted by the Financial Times as saying that the U.K.’s power prices are spiraling out of control.
The company is on variable electricity prices. British Steel has warned it could have to close production in the face of unprecedented price increases.
Electricity costs can represent up to 20% of the cost of converting basic raw materials into steel. The company is quoted as saying it is facing a maximum price at peak times of up to £2,500 per MWh.
Meanwhile, it saw an average of £50 per MWh in April.
Spot prices in excess of £1,000 per month MWh are becoming increasingly common this month after wholesale prices in the U.K. rose dramatically.
Nor is the UK well served with reserves of natural gas. It has just 1% of Europe’s total storage after failing to invest in storage facilities over the last 10 years. So, if supplies from Russia do not increase as the winter season approaches, the U.K. is probably the worst-placed of all European markets in having no alternatives to limited supply and rising prices.
While European steel producers are more protected in terms of energy prices by state rules and long-term agreements, producers in Italy are voicing worries. Rising power costs are said to be behind the current price of steel products in southern Europe, which had expected to decrease on falling scrap input costs but were being hampered by record power costs.
With winter approaching, the situation is likely to get much worse before it gets better.