Industry and the financial crisis
Meanwhile, in the real economy...
Oct 16th 2008
>From The Economist print edition
>http://www.economist.com/business/displaystory.cfm?story_id=12429604
How the world’s most basic industries are coping with the crash
IT IS about as far as you can get from the
woes of Wall Street and this week’s dramatic rescues of American and European
banks. The mucky business of digging ore out of the ground, shipping it across
the oceans and turning it into steel, the feedstock of industry, is at the
other end of the economic food chain from the trade in credit-default swaps,
collateralised debt obligations and other esoteric financial instruments. So the
recent fall in raw-material prices and the decline in shipping costs indicate
just how far-reaching the consequences of the global financial crisis will be
for the global economy.
Since the early summer the prices of various
kinds of steel have fallen by 20-70%, iron ore is down by a third and the key
rate for bulk shipping of commodities such as iron ore, coal and grain is down
by more than four-fifths. There is even talk of grain cargoes piling up in
ports in the Americas. Their buyers’ letters of credit have not
been honoured, because of a lack of confidence in the banks that underwrite
them. At least one Australian producer has had the same problem with iron-ore
shipments. And shipowners are struggling to finance new vessels they have
ordered.
The most spectacular reflection of falling
activity has been the Baltic Dry Index (BDI), which traces prices for shipping
bulk cargoes such as iron ore around the world from producers such as Braziland
Australiato markets in America, Europeand China. The index has plunged 86%
after hitting a
record high of 11,793 points in late May (see chart). It fell by 11% on October
15th alone, to its lowest level since February 2003. The BDI is a leading
indicator of international trade and, by extension, of economic activity. In
the past couple of years the index has been driven up by the boom in China, as
the world’s fastest-growing big economy
sucks in raw materials in bulk-carrying ships and pumps out finished products,
which are exported in huge container vessels.
Some industry forecasters predict a recovery
in the BDI of about 30% in the fourth quarter, but further weakening is
foreseen in late 2009, extending into 2010. This is due both to the slowing
growth of world demand, and the arrival of new capacity following the recent
boom in shipbuilding, which will cause supply to grow faster than demand. There
are also signs of slowing growth in the market for the container ships that
take China’s manufactured goods to Western markets.
The latest forecasts show growth in demand for container shipments from Asiato
Europefalling from 15% a year to barely 5%.
Shares in shipping companies fell sharply this week in response to the plunge
in the BDI.
Steel prices have also been falling fast
from record highs. In Americathe price of coil steel, used to make cars
and white goods, has fallen by 20% since May. The price of steel billets, which
are traded on the London Metal Exchange (though most steel deliveries are
governed by inter-company contracts), has fallen even further, having tumbled
by 70% since May.
As prices fall, steelmakers are moving to
cut production. ArcelorMittal, the industry leader, was one of the first to
move in September, signalling a cut of 10-15% in production during the third
quarter. The company said the cuts were a temporary measure until inventories
fell. Since then, however, Russian and Chinese steelmakers have also announced
cuts. Severstal, Russia’s biggest producer, is cutting by 25% in Russiaand by
30% in some of its western European
and American mills. China’s biggest steelmaker, Baosteel, is reported
to be reducing output by 10% this quarter, and the four second-tier producers
(Shougang, Hebei, Anyangand Shandong) by 20%.
Shock and ore
Although China’s iron-ore imports in the first nine months
of the year were up 22% on 2007, there are fears among Australian mining firms
that the cuts in Chinese steel production could presage a pause in China’s
boom. MountGibson, an Australian producer, has warned that
stockpiles of ore are mounting up in China, and says some of its customers have
asked
it to delay shipments. Iron-ore prices on the spot market have fallen by
roughly half since the beginning of the year, to $100 a tonne or less. The
prices of copper, nickel and zinc have also fallen by around half this year,
and aluminium is down by a third. Those drops, in turn, have battered the share
prices of mining companies.
BHP Billiton and Rio Tinto, two giants that
are big exporters of iron ore from Australiato China, agree that China’s
appetite for natural resources is
moderating. But both say they are among the most efficient producers, and so
will not be badly hit by falling demand. They do expect rivals with higher
costs to rein in their output of iron ore and other minerals, however.
To some extent, that is already happening.
Ferrexpo, a Ukrainian iron-ore producer, has said it will postpone a decision
about whether to expand. Rio Tinto itself has reduced output at one of its
Chinese aluminium mills; China’s other smelters, it maintains, are in
worse shape. Alcoa, a big American aluminium firm which reported a sharp fall
in profits earlier this month, has shut a smelter in Americaand plans to halt
investment on projects
that are not near completion. Other firms have scrapped planned nickel and zinc
mines. More of the same is likely the longer prices stay at this
level—especially when hedges that protect some higher-cost producers expire.
Nonetheless, the bigger mining firms are far
from despair. Alberto Calderon of BHP points out that the Baltic Dry Index is
extremely volatile; in his view, it is not a good indicator of the long-term
prospects of the mining industry. He expects the Chinese economy to keep
growing by 6-9% a year for the next five years. Rio Tinto is even more
sanguine: it does not foresee China’s growth falling below 8%. Tom Albanese,
its boss, says the Chinese economy is merely “pausing for breath”.
Both firms point out that some metals, such
as copper, are still in short supply, and that the credit crunch will only make
it harder to finance new mines. By delaying expansion and squeezing marginal
producers, it may actually sow the seeds for a recovery in metals prices sooner
than most analysts expect. At any rate, BHP is determined to press ahead with
its hostile bid for Rio Tinto—an indication, presumably, that it still thinks
raw materials is a good business to be in.
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