Heavy industry
Hurting the real economy
Oct 15th 2008
From Economist.com
The impact of the financial crisis on some of the most basic industries
IT IS about as far as you can get from the woes of Wall Street:the mucky business of digging ore out of the ground, shipping it across the oceans and turning it into steel, the feedstock of industry. So the recent slump 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 real economy.
Since the early summer the price of steel has fallen by 20-70% and the key rate for bulk shipping of commodities is down by more than four-fifths. There are even stories 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 to China. And shipowners are having trouble raising finance for new vessels.
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 from producers such as Brazil and Australia to markets in America, Europe and China. The index has plunged by 85% after hitting a record high of 11,793 points in late May. It 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 that economy sucks in raw materials in bulk-carrying ships and pumps out finished products, which are exported in vessels.
The weakness is because of the slowing of world demand and the arrival of new capacity following the recent boom in shipbuilding. There are also signs of slowing demand for the container ships that take China’s manufactured goods to Western markets. The latest forecasts show growth in container demand falling from 15% a year to barely 5%.
Steel prices have also been falling fast from record highs. In America the 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, has tumbled by 70% since May. Steelmakers, including ArcelorMittal, the industry leader, and Russian and Chinese firms, are moving to cut production.
Although China’s iron ore imports in the first nine months of the year were up by 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. Mount Gibson, an Australian producer, has given warning that stockpiles of ore are piling up in China. Iron-ore prices on the spot market have fallen by roughly half this year, to $100 a tonne or less. The prices of copper, nickel and zinc have also fallen by half or more 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 Australia to China, say that they will not be too badly hit by falling demand. They do expect rivals with higher costs to rein in their output. 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 Chinese aluminium mill. Alcoa, a big American aluminium firm which reported a sharp fall in profits this month, has shut a smelter in America and says it will halve its planned investments next year. Other firms have scrapped planned nickel and zinc mines.
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 expansions and squeezing marginal producers, it might actually sow the seeds for a recovery in metals prices sooner than most analysts expect. At any rate, BHP is still keen to buy Rio Tinto—an indication, presumably, that it still thinks raw materials is a good business to be in.
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