JOHANNESBURG — The plunge in oil prices is a double-edged sword for many miners, lowering the cost of production, but at the same time cutting the value of the commodities they produce.
At first glance, the 57% tumble in Brent crude since June last year would seem to be an unambiguous positive for many commodity producers, given their heavy reliance on diesel to operate mines and transport output to ports.
This is especially the case for Australian coal and iron ore mines, which use diesel not only for mining vehicles but to generate electricity as well, given their remote locations.
Diesel-fired train locomotives help miners move their commodities across hundreds of kilometres and there may even be savings on charter flights used to ferry workers to and from remote mine sites, given the lower cost of aviation fuel.
Research by Morgan Stanley, published on Sunday said oil and diesel made up between 9% and 12% of the total production costs for bulk commodities such as coal, iron ore and bauxite, but only 3% to 5% for metals.
The major effect of the declining oil price is to shift the production cost curve lower, effectively meaning more mines will be profitable, even at the current low commodity prices.
The spot price of iron ore in Asia dropped to a five-and half-year low of $62,80 a tonne on Tuesday, and is down 67% from its peak of $191,90 reached in February 2011.
Spot thermal coal from Australia’s Newcastle port, an Asian benchmark, was at $61,97 a tonne by the end of last week, close to a six-year low and 54% below its post-2008 recession peak of $136,30 in January 2011.
The question is whether costs have fallen enough to offset lower commodity prices, and the answer is no. But they have fallen enough to allow some producers, who would have otherwise been forced to shut down, to remain in business.
This has the effect of keeping supply in the market, which in the case of commodities such as iron ore and coal keeps downward pressure on prices.
Part of the reasoning behind the huge capacity expansion by the big three iron-ore miners was that they would force higher-cost, smaller producers out of the market.
And to some extent Brazil’s Vale and the Anglo-Australian pair Rio Tinto and BHP Billiton have succeeded, with a spate of recent mine closures and signs that Chinese domestic output is declining.
But the fall in oil prices is providing relief to miners, allowing them to stay in the game, thereby causing commodity prices to drop further.
Morgan Stanley’s research shows in iron ore, every $1 decline in the price of a barrel of oil resulted in a saving of 8 cents a tonne, while in thermal coal it was 3c and 5c for metallurgical coal.