Eoin Treacy's view -
The principal drivers of cost inflation vary by commodity, so we have identified and projected the most important costs for each commodity. In the 2000 to 2013 period, cash cost inflation for the marginal producer has been close to 20 percent annually for copper, iron ore, and potash (coal has been lower at around 11 percent), primarily due to the geological factors just described.
Inflation is influenced by external factors (for example, local consumer prices, increase in wages and diesel prices, and local-currency appreciation versus the US dollar) and internal ones (for example, productivity, metal grade, and geological mine conditions). Assuming a scenario of lower oil and diesel prices and a strengthening US dollar versus the local currencies of mining producers, our analysis suggests that external cost factors will be flat, or even negative, for most commodities.
Inflation due to internal factors, however, is here to stay. Even with productivity gains, mines will increasingly suffer from declining ore grades and deteriorating mine conditions, such as deeper shafts, worsening stripping ratios, and longer hauling distances. We expect the level of geological cost inflation will continue to be the main determinant of cost increases, and that total inflation will average 4 to 7 percent per year going forward.
In the extractive sector supply and demand data are endlessly picked over for clues to how prices might respond. However it is important to consider that demand growth is much less volatile than supply. The global population continues to expand, not least because people are living longer. Additionally, living standards, on aggregate, are improving. Higher standards of living require greater use of resources such as Energy, steel, copper, zinc, tin, soy etc. so demand tends to trend higher over time.
The re-entry of China onto the global market as a major consumer of commodities resulted in an acceleration in the pace of demand growth which is now being unwound. Demand growth is not negative but the pace of that growth has moderated.
The problem for the mining and oil sectors is that they invested fortunes in developing new supply to cater to demand growth numbers that are no longer relevant. This is why the sector continues to underperform and it will continue to do so until supply contracts enough to cater to the reality provided by the market today.
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