By Scott Patterson and Timothy Puko
Glencore PLC Chief Executive Ivan Glasenberg says his company is
reaping the rewards of a bold and risky strategy: Using its
dominance of the zinc market to orchestrate a supply shortfall and
send prices vaulting.
Zinc prices jumped 7% on the day in October 2015 when the
Switzerland-based miner and commodity trader said it was shutting
down production amounting to 4% of global production of zinc.
Prices for the steelmaking ingredient have climbed 70% since as
demand outpaces supply, outperforming copper (up 15%) and aluminum
(up 20%) during a broad-based global commodities rally.
Mr. Glasenberg is outspoken about Glencore's approach to
managing supply and thus market prices, something that is typically
verboten for mining executives, who are wary of complaints about
market power.
"When we cut back our zinc production, we looked at the benefit
it had on the rest of our zinc production," Mr. Glasenberg said on
an earnings call last month. The result for prices: "A very
positive effect," he said.
While the prices of zinc and other commodities have been powered
by Chinese demand, analysts said zinc's greater buoyancy was a
demonstration of one company's market power that is rare in the
commodity market. Other miners such as Rio Tinto PLC and BHP
Billiton Ltd., which have large positions in iron ore, have decided
against pulling back production to lift prices.
On the earnings call, Mr. Glasenberg said zinc prices had fallen
so low in 2015 that it made more sense to keep it in the ground for
the long run. He credited zinc's price rise with Chinese demand and
"voluntary cutbacks" of supply like Glencore's, "one of the leaders
in that area."
Analysts agreed. The price rally has "been driven by Glencore's
decision, " said Vivienne Lloyd, a metals analyst at investment
bank Macquarie Group.
Glencore has said it can pull it off because it combines one of
the world's largest mining divisions with a savvy commodity-trading
house.
Glencore is the world's largest zinc miner, accounting for 8% of
global mined output, according to Macquarie, ahead of Teck
Resources Ltd. (6%) and Vedanta Resources PLC (4%). Glencore also
controls about half the world's trading of zinc metal and the raw
material that makes it, excluding domestic Chinese production,
according to Wood Mackenzie and other analysts, roughly the same
level it last publicly disclosed in 2011.
The company began mining zinc in the 1980s, when the firm was
run by the late financier Marc Rich. Its acquisition of miner
Xstrata in 2013 expanded its production assets in a heavily traded
metal that is expected to become more widely used in developing
economies such as India and China. Zinc is a key ingredient in U.S.
pennies and is used as an anti-rust coating on many
automobiles.
At about $2,800 a ton, zinc prices are historically high, though
still about 35% below their peak in late 2006.
The rising costs can translate into higher auto prices and make
steel used for construction more expensive. In the lightly
regulated global zinc market, there are few rules governing a
company's market share beyond some countries' antitrust regulations
for mergers.
Instead, international commodity traders and miners generally
resist cutting output for fear of losing market share to
competitors. Miners like BHP and Rio Tinto say they have focused on
producing the cheapest iron ore instead of holding back output to
increase prices.
Glencore is different.
Zinc traders often compare Glencore to the Organization of the
Petroleum Exporting Countries because, like the oil cartel in the
1970s and 1980s, it controls what is known as marginal supply. That
means it can produce enough of a product -- or withhold enough of
it -- to send supply and demand into a surplus or deficit.
For example, Mr. Glasenberg said in February that Glencore
calculated that reducing its zinc production to one million annual
tons from 1.5 million annual tons could move the price "a certain
amount for you to get the benefit."
Analysts at Macquarie estimate that the zinc market is currently
in a short supply of about 500,000 tons a year, equal to the amount
Glencore cut in 2015.
Glencore has ways of offsetting revenue it might lose from the
production cuts. It says its trading arm can make money no matter
which direction commodity markets are moving in, making up for
weaker commodity prices.
"They will know where people want zinc, they will know where
people can get their hands on it, and they'll run zinc around the
world," said Clive Burstow, investment manager at Baring Asset
Management, which bought shares of Glencore last year.
Glencore's zinc supremacy is illustrated at its San Juan de
Nieva plant in northern Spain on the Bay of Biscay. The world's
second-largest zinc smelter produces about half-a-million tons of
nearly pure metal a year.
But Wood Mackenzie estimates that about 200,000 tons of zinc sit
unsold there, showing that even when zinc is produced, Glencore
doesn't have to sell it. A Glencore spokesman declined to comment
on the estimate.
Glencore also enjoys extremely low production costs at its zinc
mines, which can pump out the metal at essentially zero expense in
part due to added revenues they get from gold byproducts.
The company's zinc shutdowns were announced at about the same
time it launched a comeback plan from a disastrous summer 2015,
when investors concerned about its high debt sent the firm's share
price down to record lows.
Glencore returned to profit in 2016, with net earnings of $1.4
billion thanks in part to zinc, which was responsible for 26% of
its mining arm's earnings before interest, taxes, depreciation and
amortization, according to securities filings.
Rising prices for coal and copper -- two of its biggest earnings
drivers -- strong trading gains, and billions in cost cuts and
asset sales were also instrumental in its comeback. Glencore cut
its net debt almost in half to less than $16 billion, leading
S&P Global Ratings to upgrade the company's credit and call its
outlook positive.
The zinc strategy has risks. As prices rise and production
becomes more profitable, other miners are more likely to increase
output or restart idled operations, pumping more supply into the
market, said Morgan Stanley analyst Menno Sanderse.
If demand in China cools unexpectedly, prices could plunge. Mr.
Glasenberg has said he expects demand in China to remain strong,
but he also said in February: "We don't understand China, exactly
what may or may not happen from one day to the next."
Mr. Glasenberg has said Glencore also tried to lift copper and
coal prices with supply cuts, though with less effect on those
larger markets.
Write to Scott Patterson at scott.patterson@wsj.com and Timothy
Puko at tim.puko@wsj.com
(END) Dow Jones Newswires
March 17, 2017 10:17 ET (14:17 GMT)
Copyright (c) 2017 Dow Jones & Company, Inc.
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