As a short-lived frenzy of metal buying begins to abate, the cost-cutting challenges facing many of the world's biggest miners are becoming more obvious.
Prices for iron ore, copper and other key industrial commodities jumped earlier this year, when signs of renewed infrastructure building in China set off a buying binge. Iron ore, to take one example, surged from $38 (U.S.) a tonne in January to above $70 in April.
But prices for the metal have since slid back to around $53 a tonne and further declines may be on the way. Vale SA, the Brazilian mining giant, reiterated on Thursday that it was preparing to unleash even more supply on the market, with production slated to begin late this year at its giant S11D mine.
The rise and fall of iron ore demand is typical of the volatility in many industrial commodities over recent months. Investors attempting to ride the upswing in Chinese demand created a mini-boom in the prices of many base metals, but those gains are now fading.
That leaves miners once again eager for ways to keep a lid on expenses. The problem is that their record on controlling costs may not be anywhere as good as it appears at first glance.
The world's big five iron ore miners, for instance, have slashed their break-even cost of production in half over the past three years, according to a Citigroup analysis last month. But the big hero in cutting the industry's break-even costs from $64 a tonne to $32 a tonne wasn't management ingenuity – it was a fortuitous combination of weak currencies and falling freight rates.
"Those are two factors totally outside of management's control and could both easily reverse in a rising iron ore market," the analysts wrote. By their calculations, only 19 per cent of the total cost reduction stemmed from factors under executives' sway.
In a report on Thursday, Heath Jansen of Citigroup extended the analysis to look more broadly at the cost performance of the Big Five miners over all their production. He credits them with cutting their average unit costs by 37 per cent between 2012 and 2015, as the commodity supercycle ebbed.
However, once again, the dramatic savings were the result of outside factors more than internal penny pinching. Weaker local currencies helped many miners slash their production costs in comparison to metal prices, which are denominated in U.S. dollars.
Lower oil prices also provided a powerful boost to miners' bottom lines. The slide in petroleum prices over the past couple of years resulted in big savings at mine sites, which gobble up enormous amounts of fuel. In addition, lower oil prices reduced freight costs, an important consideration for miners such as Vale, which produces ore in Brazil to be shipped to China.
Over the past decade, there's a close to perfect correlation between oil prices and miners' unit costs, according to Mr. Jansen.
To be sure, the extremely close relationship between oil prices and unit costs doesn't bode well for the big miners if petroleum rebounds to anywhere close to its levels of a few years ago.
A strong rise in oil prices could bring back some of the cost inflation that plagued miners during the commodity supercycle. Average unit costs of miners' production spiralled higher at a 10-per-cent annual clip between 2005 and 2012, according to Mr. Jansen.
The rampant price increases of that period were followed by a savage deceleration in costs between 2012 and 2015, when the average unit cost of production fell by 14 per cent a year.
Mr. Jansen expects miners to watch their expenses in the years to come and keep cost inflation down to near zero, helping to swell margins as metal prices recover. However, the industry's vulnerability is demonstrated in the title of his report: Cost cutting: An uphill task for the miners going forward.
With a file from Bloomberg News