By Darcy Keith
Of the six major base metals, nickel has been the most volatile performer over the past several months. As we'll soon explain, that's not such a big surprise. This market is faced with a supply-and-demand dilemma that's making for tricky forecasting and treacherous trading.
The Big Collapse
After surging to highs near $25/pound on the London Metal Exchange in May 2007, nickel prices not only retreated, but went virtually into a free fall, dropping to around $12/pound in a matter of a few months. They spent some time consolidating thereafter, only to sink further this spring and summer, bottoming out at around $8/pound in early August. They've been making a tepid recovery over the past few weeks, still trading below $10/pound.
A major catalyst has been slowing global demand for the metal. The troubled U.S. economy and the collapse in the housing sector can certainly be partly blamed. But also important was that stainless steel producers, who account for about two-thirds of nickel's end market, were finding it just too expensive to purchase nickel, as prices surged to those lofty levels last spring.
Japanese and Chinese stainless steel mills cut production, or at least switched to some product lines of stainless steel that consume lower amounts of nickel. According to a recent Citi report, the ratio of high nickel grade stainless production to low grade fell to 55% in 2007 from 75% the previous year. "A reversion of this trend was expected in 2008 [supporting nickel demand] but this is not occurring," the report said.
According to the International Stainless Steel Forum, stainless steel production in the first quarter of this year was down 3% from a year earlier.
There are some signs of a recovery, as stainless steel production was actually up 6.5% when compared with the last quarter of 2007.
But even given this, the outlook for stainless doesn't appear all that rosy. In addition to the weakness in the Asian market, European stainless demand is sluggish, with distributors delaying restocking until there are perceptions that the market has bottomed out.
Nickel has had another problem to contend with: a rise in exports from China of the low-quality nickel substitute pig iron.
It's quite possible that the lower prices now being seen for nickel could be lessening demand for pig iron, and surging energy costs could also be making pig iron less attractive because of higher ocean freight charges. But pig iron for now is still a factor undermining the nickel market.
A Plethora Of New Mine Supply
The supply side of the nickel world is where things get particularly dicey. A flood of fresh mine production is about to be unleashed, at a time when it appears the market needs it the least. Inventories of nickel in LME warehouses at the end of August were about 47,000 tonnes, down only 1.9% year-to-date and still near their highest levels in eight years. And it could get worse.
Getting a new mining operation up and running takes years. Feasibility studies have to be conducted, capital raised and then there's all the construction work. Given the long lead-up time, it's guesswork as to when the market will actually be crying out for new production. When nickel shot up to $25/pound, miners were tantalized by the prospect of bringing new projects online in such a price environment. Some 16 months later, with several projects about to enter production, the timing has gone from opportune to pretty rotten.
Take BHP Billiton Ltd. (NYSE:BHP), for example. Its $2.2-billion Ravensthorpe nickel mine in Western Australia officially opened in May and production rates will be steadily increased until it reaches its 50,000-tonne-per-year capacity in a few years. Meanwhile, Brazilian miner Vale (NYSE:RIO) plans first commercial production at its Onça Puma project at the start of next year. It has a capacity of 58,000 tonnes per year of the nickel contained in iron-nickel, and is among several Brazilian operations that are targeted for future start-up.
Over in New Caledonia, two huge new projects are gearing up. Vale Inco's 60,000-tonne-per-year Goro mine will be the first, with production slated to start by December of this year. Xstrata Nickel's (OTC:XSRAF) Koniambo project is expected to follow in 2011, with a production target of 60,000 tonnes of nickel-in-ferronickel.
A similar-sized project, Ambatovy in Madagascar, operated by Canada's Sherritt International (OTCPK:SHERF), is expected to begin production in 2010.
And it appears Guatemala could soon be a major new source of nickel, after cash-rich Canadian mining company HudBay Minerals Inc. (HBMFF.PK) in June took over control of the country's Fenix project. Some estimate that project, slated to enter production in late-2010, could by itself feed world demand for nickel for two to three years.
So you get the picture. The irony is that while all this new production is in the pipeline, the industry is either making cutbacks at existing operations - or seriously considering them.
In early August, Australia's Minara Resources Ltd (OTC:MREJF) announced it had to defer its nickel expansion plan that would have increased annual output of nickel by as much as 10,000 tonnes. It blamed escalating costs.
Later in the month, Xstrata suspended operations at its Falcondo ferronickel mining operation in the Dominican Republic. It cited not only low nickel prices for the mothballing, but also the high cost of oil.
Energy Costs Become A Burden
Those energy costs are indeed a major problem for producers, especially those, like Falcondo, that are involved in mining laterite deposits. These are low-grade deposits and require intensive processing - and energy consumption - to produce a salable product.
In fact, much of the new production being planned and mentioned above is laterite. So the ballooning energy bills, combined with the pullback in nickel prices, make these projects economically questionable.
Many of these producers are betting things will turn around. In interviews with HardAssetsInvestor.com, officials at both Vale Inco and Xstrata Nickel say they are committed to their production schedules and believe the long-term fundamentals appear strong.
In the case of Xstrata's Koniambo, all that is needed to meet its cost of capital is a long-term nickel price of $4.60 per pound, so $10 nickel may not look all that bad on their books, especially if energy costs behave.
John Tumazos has been a metals analyst on Wall Street for many years and now runs his own consulting firm, John Tumazos Very Independent Research, LLC. He tells HAI there are eight projects in the world that use energy-intensive electric arc furnaces for ferronickel production. If the Fenix project comes to fruition, it would be the ninth.
These projects must not only contend with high energy costs, they are vulnerable to any electricity outages or shortages. Many are in parts of the world where power supplies aren't reliable.
Tumazos warns against complacency in thinking that these projects will stay in production, and offers a bit of fatherly advice: "You don't want to take your lover for granted, and you don't want to take your nickel mine for granted."
Tumazos also sees other supply risks. Vale Inco in Sudbury, facing tighter emission requirements from the Ontario government, plans to reduce its sulphur dioxide emissions by 63% by 2015. One possibility to meet those targets, Tumazos says, would be for the company to just produce less output from Sudbury, one of the world's richest nickel basins. Meanwhile, Norilsk (OTCPK:NILSY), a huge producer from Russia, could also see several supply disruptions, given it has invested far too little in keeping its operations up to date over past decades.
New supplies of nickel could be on the horizon, too, Tumazos said. For instance, the northern Minnesota and Michigan region appears ripe to become a major new nickel camp. More exploration work is required, but several companies have already staked land and it could become the next Sudbury, although the deposits would be of lower grade.
The Bottom Line: An Unpredictable Market
So where does this all leave the outlook for prices? That's hard to predict, especially given the potential for a lot of surprises on the supply side. Certainly, if the U.S. economy gets back on track and the rest of the world escapes a serious recession, demand should grow at a good pace. But there's so much new supply coming onto the market, consumption might not be able to keep pace. Production shutdowns at existing operations are another wild card.
A Reuters survey in July found that the median prediction among analysts for an average 2008 nickel price was $25,500 a tonne, or $11.56 a pound. In 2009, the forecast is for an average price of $10.43/pound. Tumazos sees prices averaging $10/pound in 2009 and 2010, and assumes $9/pound as a long-term price.
Sounds pretty steady, but don't be deceived: This is a market that has proven itself capable of wild swings. Keep your seatbelts fastened. Nickel appears poised for a volatile ride.