cl3 minerals markets prices and the recent performance of the mineral and energy sector

INTRODUCTION

The two preceding chapters examined the diverse influences ondemand for mineral products and the various forces acting on thesupply side. In essence, prices are determined by the interactionof these opposing forces in the market place. The geographicallocation of demand, the end uses and the nature and sources ofsupply differ for each product, and these differences in marketstructure dictate precisely how demand and supply interact to setthe prices of individual products. The nature of the pricingmechanism is strongly influenced by the ease with which newsuppliers can enter the market (in other words by the barriers toentry). In the short to medium term price levels can be affected bypolitical, economic and social conditions in mineral-producing andconsuming countries, but the main factors are geological andtechnical. Where ore deposits are readily discovered and easilyexploitable with existing technology at prevailing price levels thebarriers to entry are low. Conversely, a scarcity of exploitabledeposits keeps the barriers high. Changes in exploration orextraction and processing technology can rapidly change theconditions of entry.

MARKET STRUCTURE – COMPETITIVE MARKETS

Where the barriers to market entry are low there is likely to bea relatively large number of suppliers. The more present andprospective suppliers there are, the more competitive they arelikely to be with each other. Price in such competitive markets isdetermined by the free interplay of supply and demand, and itwill fluctuate to the extent needed to clear the market. Thedemand curve facing each individual supplier is, to all intentsand purposes, flat rather than downward sloping to the right likethe industry’s demand curve. Producers are price takers andhave little or no influence over the prevailing price. They can,however, alter the amount they supply to the market, and eachsupplier will produce as much as possible as long as their cashcosts are fully covered.

Leaving aside the complications flowing from the existence ofinventories, other than normal working stocks, prices will settlein the near term where demand and supply intersect. Otherfactors being equal, a rise in demand or a fall in supply willprompt a rise in prices and a fall in demand, or a rise in supplywill prompt a fall in prices until equilibrium is restored. Inpractice, prices will tend to fluctuate around the equilibriumlevel, because conditions are continuously changing. Prices willgravitate towards the industry’s marginal cost of production: thecost of production of the last (or most expensive) unit of supplyfrom whatever source, which is required to balance the market.

The nature of the supply curve in competitive markets and itsinteraction with demand and price are illustrated in Figure 7.1.

Australian Mineral Economics 59

Mineral Markets, Prices and the Recent Performance ofthe Minerals and Energy Sector

Phillip Crowson

Introduction

Market Structure – Competitive Markets

Market Structure – Oligopolistic Markets

The Rise and Fall of Cartels

Producer Pricing

Terminal Markets

Recent Trends in Mineral Markets

CHAPTER 7

Price

QuantityCapacity

D

D1

D2

P

P1

P2

Q2 Q Q1

FIG 7.1 - Short-run supply and demand in competitive markets.

When prices are very low there is no supply, as costs exceedprices. Higher prices allow producers to cover their costs andenter the market until supply is constrained by the availablecapacity. Then no additional supplies can be immediatelyforthcoming, no matter how high prices rise. It takes time fornew capacity to be developed, whether that comes from theexpansion of existing operations or from new facilities. The priceand the quantity supplied settle at the point where the supply anddemand curves intersect (P and Q when the demand curve is D).If the demand curve rises to D1, higher cost producers will beable to supply and the price and quantity will rise to P1 and Q1.Conversely, when demand drops back to D2 (perhaps because ofeconomic recession or some technological change in end-usemarkets) higher cost producers will be unable to cover their costsand price and output will fall to P2 and Q2 respectively.

This assumes that suppliers merely have regard to near-termdemand and prices. In practice their reactions will be much morecomplex. If they believe that a price fall is temporary they maybe prepared to stockpile rather than reduce their output, or toincur losses for a period. The costs of closure, including therepayment of debt, environmental remediation and redundancypayments, may exceed the costs of continued operation. Also,many suppliers may have more complex objectives than short-term profit maximisation and may be prepared to produce at aloss. Over the longer term, when the constraint of existingcapacity is lifted, the supply curve will shift to the right, with itslevel dictated by technological change and shifts in the politicaland regulatory climate.

The non-ferrous metals, gold and silver, are the mineralproducts whose markets most closely approximate thecompetitive model. They are typical commodities, in the sensethat the products of different producers are reasonablyhomogeneous and any individual supplier’s product can readilysubstitute for that of another. There are many customers and avariety of end uses, each with common standards andspecifications. Producers can exert little or no influence over themarkets for their products, which are usually regional or global,and there is hardly any after-sales service, such as technicalsupport. Prices are uniform for the standard grades and theproducers concentrate on controlling their relative costs. Thereare many suppliers spread throughout the world and no singleproducer can influence the level of prices, except for very shortperiods. There are many ore deposits being exploited or underdevelopment, it appears relatively easy to discover new ones,secondary materials are readily available and transport costs aregenerally low relative to product prices. Information about recentand prospective trends in supply and demand is rapidly andwidely diffused and the markets are reasonably transparent.

That prices and volumes will settle at the unique point wherethe demand and supply curves intersect does not describe theactual process of price discovery, except in an auction market.There bids and offers are made in public until a price is derivedthat just clears the market. At that price all purchasers andsuppliers are satisfied. The method is similar for gold, silver andthe non-ferrous metals in that their prices are settled in terminalmarkets. The characteristics of such markets are explained in alater section of this chapter.

MARKET STRUCTURE – OLIGOPOLISTICMARKETS

The markets for most mineral products depart in varying degreesfrom the competitive model. The geological availability of manyproducts is much more limited than for the non-ferrous metals orthe technology needed for their extraction and processing is farmore complex. The accessibility of ore deposits for commercialmining may be restricted by a variety of political, environmentalor economic factors. For example, many developing countrieseither totally prohibited or severely circumscribed mineral

developments by privately owned companies through much ofthe 1960-1990 period, especially where such companies wereforeign-owned. Many countries prevent the mining of known oredeposits in national parks or wilderness areas. Unstable politicalconditions increase the risks of mineral exploration in manyregions, but particularly in Africa and parts of Asia, tounacceptable levels. These various influences, either alone or incombination, raise the barriers to entry and limit the number ofproducers.

As Table 7.1 illustrates, there are typically relatively fewsignificant suppliers to the market for a wide range of mineralsand their first stage products. The table shows the shares of thelargest firms in the global production of a range of mineralproducts, split between those that are traded in terminal marketsand those whose prices are fixed in other ways. Platinum appearsin both groups, as producers directly sell most production tousers at list prices that lag terminal market prices. The degree ofindustry concentration is a major influence on pricing, but notthe only one. Often there are also relatively few major users.

Where there are only a few major producers the suppliers donot have to take the demand curve as given and their actions canhave some influence on prices. Rather than a demand curve thatis flat, they face one sloping downwards to the right, just like theindustry. As there are usually few suppliers the supply curve islikely to be stepped. Producers can exert some control, even ifstrictly limited, over the prices they receive by differentiating thecharacteristics of their products from those of their competitors.In many instances there is considerable competition in thenon-price dimensions of the product, such as technical service or

60 Australian Mineral Economics

CHAPTER 7: MINERAL MARKETS, PRICES AND THE RECENT PERFORMANCE OF THE MINERALS AND ENERGY SECTOR

Leading Top 3 Top 5 Top 10

Metals traded on terminal markets

Silver 8 22 29 41

Gold 9 23 32 47

Platinum 42 76 89 98

Copper metal (2003) 10 24 34 49

Zinc metal 14 31 42 60

Aluminium 13 32 43 60

Nickel 16 39 49 68

Negotiated or list prices

Zinc mine 9 23 30 43

Lead mine 10 25 34 48

Copper mine 12 25 37 58

Iron ore (2003) 18 37 46 58

Manganese 9 26 36 52

Alumina 15 33 46 71

Bauxite 16 34 49 68

Chromite 21 49 64 83

Diamond value 29 64 76 82

Titanium minerals 24 53 70 85

Lithium 23 68 77 83*

Mercury (1997) 39 87 90†

Niobium 40 83 94 98‡

Platinum 42 76 89 98

Notes: † top 4, ‡ top 7, * top 9.

TABLE 7.1Concentration in mineral markets: percentage shares of largestfirms in world production 2002. (Source: Raw Materials Group,

2004.)

delivery schedules. The chemical and physical characteristics ofthe product are varied not just for particular end uses, but oftenalso for individual users. There is a wide variation in grades andspecifications, which is reflected in widely differing prices forapparently similar products. The costs of mining the raw ore areless important than its characteristics and the methods whereby itcan be modified to serve the end-uses that offer the highestprices. Even producers of commodity metals and minerals lookfor ways to upgrade and differentiate their products from those oftheir rivals in order to achieve a premium over the basic marketprices. Their objective, which is sometimes attained, is to createa market for their own output that is distinct in some way fromthe market as a whole.

Where prices settle will clearly still depend on how and wheredemand and supply intersect, no matter the precise structure of aproduct’s market. Since the costs of most suppliers are lowest ator near their maximum possible output they will tend to produceto capacity. Without the safety valve of terminal marketshowever, the costs of stockpiling excess supplies usually forcessuppliers to reduce their offerings in periods of weak marketconditions. The short run market conditions facing a‘representative’ producer are shown in Figure 7.2. The shapes ofthe demand and supply curves have been deliberatelyexaggerated.

As the producer faces a downward-sloping demand curve foroutput, the marginal revenue from additional sales will alsodecline with increasing output. Assuming that the producer aimsto maximise profits, they will produce to the level of output (Q)where marginal revenue equals marginal cost of production.The price (P) is rather higher than would be set in a completelycompetitive market and the producer would earn above-normalprofits. That is not a stable position because such profits wouldinduce a variety of competitive responses. Exploration and newmine development would be stimulated and technologicalresearch on lower-cost processes encouraged. On the demandside, the use of substitutes would be encouraged. In consequencethe demand curve facing the ‘representative’ producer would bepushed downwards, lowering the level of output associated witha given level of prices. Subject to the ease or difficulty withwhich the barriers to entry could be surmounted the excessprofits would eventually be eliminated by competition and thelong run equilibrium shown in Figure 7.3 would be attained.

The producer would still maximise profits at the point wheremarginal cost equalled marginal revenue, but with only a‘normal’ rate of profit. Also, the level of output would be ratherlower than would be reached in a perfectly competitive market,were that to exist in the real world. As markets develop, and thenumber and range of producers expand, prices drop towards the

marginal costs of production and any monopoly profits aregradually whittled away. The theoretically relevant marginalcosts are those likely to pertain over the long run. In other words,they will incorporate the opportunity costs of capital of thefacilities just needed to meet expanding demand over the longterm. In practice prices tend to gravitate, at least in thecompetitive markets, towards the cash break-even costs ofexisting marginal producers. New entrants will aim to have muchlower cash costs than these and to cover their full costs atexpected prices.

Markets with only a few suppliers are described as oligopolies,and those with only a few customers, are given the less commondescription of oligopsonies. In many such markets there may bea penumbra of smaller suppliers or users around the few largefirms. Small customers are liable to absorb an unduly largeamount of time and effort from the suppliers’ sales staff and theyare often serviced through distributors. Although small producersare unlikely to produce a full range of products, their persistencein selling their own grades can undermine established pricestructures. Major suppliers of many industrial minerals andminor metals therefore have to take full account of their activitiesand potential actions. The power of the major producers tocontrol their markets is accordingly circumscribed. In all caseseach producer has to take account of the possible impact anydecisions about pricing and production volume may have oncompetitors and of their likely policies. How those differ willpartly depend on each producer’s relative costs and availablecapacity.

In some instances the smaller producers may sell throughmerchants, who may also acquire supplies from other sources.These may include releases from redundant governmentstockpiles, scrap and secondary recovery and in previous timesimports from state trading countries that were on the fringes ofthe global market economy. Particularly when market conditionsare weak, merchants have been able to re-purchase excesssupplies from the customers of the major suppliers. Although theproducers naturally discourage resale of their products, theycannot always prevent it.

At the theoretical extreme of a market with just one supplier,or pure monopoly, the demand curves of the supplier and theindustry are the same. Monopolists can choose that combinationof price and volume that best suits their objectives. Assumingthat their objective is profit maximisation they will produce tothe point where the marginal revenue equals the marginal cost.The short run position shown in Figure 7.2 would hold for themonopolist over the long run. In practice there are no instancesof natural total monopoly in the mineral industries on a globalscale, although there have been cases of contrived monopoly



Price

Quantity

P

Q

Demand

Marginal

Revenue

Average

Cost

Marginal

Cost

Above-normal

profit

FIG 7.2 - Short run market equilibrium for a ‘representative’producer.

Price

Quantity

P1

Q1

Demand

Marginal

Revenue

Average

Cost

Marginal

Cost

FIG 7.3 - Long run market equilibrium for a ‘representative’producer.

through cartels and similar collusive actions in restraint of trade.The availability of secondary materials and of substitutes ofvarying degrees of effectiveness for most mineral productsmeans that any individual supplier’s power to raise prices byholding back supplies is strictly limited.

That substitutes exist and that there are usually competingsuppliers to global markets does not rule out the probability ofmore restricted monopolies. The key is the height of any barriersto entry. These can be artificially raised for domestic producersin a national market by protection against imports through tariffsor quotas. Over the post-war years there was a steady trend in allmajor economies towards dismantling quotas and otherquantitative restrictions and lowering tariff barriers on mostproducts. This gradually eroded local monopolies, often againstthe strong resistance of the previously favoured suppliers. Somedeveloping countries still have highly protective tariffs againstimports, although there are continuing pressures for theirreduction. The cost of transport provides a less penetrablebarrier, especially for bulk products with a low value to weightratio.

Accordingly, the markets for sand and gravel remain largelylocal, even in the US and Western Europe. For bulk products likecoal and iron ore, however, sharply declining costs of oceanshipping during the decades following the Second World Waropened up local and national markets to internationalcompetition, which had consequent repercussions on the marketstructure and pricing of such products.

As demand for a product develops and expands from its initialniche markets, new entrants are attracted over the prevailingbarriers to entry. The more suppliers there are, the more difficultit becomes for any one of them to control, or even influence,prices. In the initial stages of a product’s life cycle there may beonly a limited number of uses, or perhaps only one. Users will beprepared to pay high prices to satisfy their needs. The owners ofthe more accessible deposits are able to cream off monopolyprofits, especially where they also control innovative processingtechnology. These profits naturally attract the envious attentionsof other companies, stimulating both exploration and researchinto processes. Often both are successful and the initially highbarriers to entry are reduced.

New entrants can piggy-back off the marketing activities of theinitial pioneers. Capacity expands, probably at a faster rate thandemand, which remains dependent on specialist uses. Sooner orlater potential supply exceeds demand and prices come underpressure. The initial producers will have probably recouped theirinvestment several times over and be prepared to drop prices bothto stimulate demand and to choke off new entrants. Conversely,the latter may be forced into price cutting in order to gain marketshare. Often they may be able to withstand lowered pricesbecause their deposits or processes are superior to those of thepioneers. Normally production starts at those deposits that areknown or readily accessible, rather than at those with thepotentially lowest costs. Followers building completely newfacilities may be able to exploit process improvements moreeasily than the originators in their established plants.

Military needs in wartime have often forced large increases inthe capacity to produce many mineral products and metals, oftenirrespective of profitability. The physical need has beenparamount. When military demand has dropped, producers havebeen forced to develop new uses in order to keep their capacityrunning, often with price reductions. Changing technology hasalso been a driving force. In all cases rapidly expanding marketshave allowed producers to exploit economies of scale.

The ways in which market prices, other than those fixed interminal markets, are actually determined varies widely betweendifferent mineral products. Prices for some are posted byproducers, almost on a ‘take it or leave it’ basis. Such producerpricing, which is discussed later in this chapter, was once much

more widespread. In effect, the producer acts like a monopolist,offering to sell at a given price, with an implicit assumption thatoutput will be reduced to maintain that price when marketconditions are weak, and that some customers may be unsatisfiedwhen demand runs against the limits of capacity. Other producersmay voluntarily decide to follow the lead set by the price-settingproducer and accept satisfactory rather than maximised profits.In other instances producer pricing may be sustained throughcollusive behaviour, ranging from informal discussions to formalcartels. The recent history of cartels is also described later in thischapter.

Where there are only a few major participants on each side ofthe pricing equation (which is true for many mineral products)prices are largely determined by negotiation. Each participanthas to take account not only of the likely responses of thecustomer to their actions, but also of the possible reactions ofexisting and potential competitors. Such intelligence is usuallymore important for the producers than the purchasers. Eachmineral product effectively forms a small village where all themajor participants know each other. This village-like nature ofglobal mineral markets facilitates the rapid transmission ofgossip and information and the sense of prevailing marketconditions, even where there is no explicit market place.

How companies behave when negotiating prices largelydepends on the point reached in the business cycle and on thestrength of any barriers to entry. A tougher negotiating stance ismore appropriate when markets are tightening than when theyare in the recessionary phase of the cycle. Where there are few, ifany, viable undeveloped ore deposits, or where complexproprietary technology is required in the production process, theexisting producers’ bargaining position is strong. It weakensmarkedly where there is ample existing and prospective capacityand technology is readily available.

Thus the differing availability of ore deposits probably favoursmanganese producers over iron ore producers in their dealingswith the steel mills. Neither has a very strong position however,compared with the existing producers of titanium dioxidefeedstock during the 1980s and early 1990s. They benefited fromhigh barriers to entry in both ore reserves and technology. Theirmarket power was constrained by the comparative strengths of afew large purchasers. Mutual deterrence is as much a feature ofsome mineral markets as of international relations.

History suggests that price wars, once started, are difficult tostop and that they normally benefit only the customers. Even thatbenefit may be strictly short term if lower prices inhibitinvestment in additional capacity to meet growing demand.Much depends on whether the major producers concentrate theirattention on maximising prices and profitability, or on volume.The pursuit of market share is a common corporate objective,on the assumption that it can enhance a company’s marketpower. It does not usually appear to have been accompanied bylong-term profitability when it has been followed in the mineralsindustry. One possible argument in favour of maximisingvolume, even at the expense of weaker prices, is that it enables aproducer to achieve the designed economies of scale fromexisting capacity. The structure of costs may be such that theburden of fixed costs per unit of output rises sharply when themine and equipment are not fully utilised. The gains fromincreasing the volume of sales may more than outweigh any fallin prices.

Trade-offs like those are typical of the iron ore producingindustry. Producers of iron ore, like those of other minerals,never look solely at one dimension of their sales contracts but atthem all simultaneously. Concessions on price may be set againstincreased volume, but these are not the only dimensions of sales.Quality, including such features as the grade and the physical andchemical composition of the ore, is becoming increasinglyimportant. Quality involves far more than the ore itself. The



perceived reliability of a supplier and its susceptibility to strikesand other disruptions is another aspect of quality. The provisionof technical service to customers is not really important for theproducers of metallic ores, but it can be a valuable competitivetool for suppliers of industrial minerals. The terms on whichcredit is granted to purchasers and the extent to which prices mayvary with the prices of the customer’s products are also relevant,especially in the markets for base metals concentrates.

In iron ore and coal, as in many other products, pricing hasevolved over the past 30 years. When many exporting mineswere first established, trade was mainly based on long-termcontracts with prices fixed over long periods or indexed togeneral indicators according to agreed formulae. Such contractshave evolved into shorter term contracts covering severalyears, but with periodic price negotiations. The volumes can alsovary within predetermined limits, depending on marketconditions. Negotiations do not start from scratch every year, butfrom the prevailing prices, which roll over until a new agreementis reached. In some product markets, and especially in industrialminerals, prices are negotiated for the life of the contract, whichmay be for three to five years. Provision may be made for pricesto move over the life of the contract in step with agreed indices,such as US wholesale prices. When the contracts expire, the twoparties will negotiate a new agreement taking into accountchanges in the balance between supply and demand and theextent to which the expiring contract favoured one side or theother. Very often one party will be keen to offset anydisadvantages it suffered during the previous contract term.Usually agreement is eventually reached because there is amutual interest in a continued relationship, but discussionsoccasionally break up in acrimony, with the parties resorting toarbitration.

More frequent negotiation of prices tends to prevent suchdisruptions since contract prices then move more closely withmarket conditions. Sometimes prices are changed half-yearly oreven quarterly, as in sulfur and some fertiliser materials. Annualprice negotiation is now the general rule in iron ore, coal andbase metals concentrates. Large producers may divide theircontractual volumes, even with one customer, into blocks whoseprices are negotiated at different times. That softens the impactof any large price movements resulting from the annualnegotiating round. The outcome of the annual bargainingnaturally depends on the relative strengths of the buyers andsellers, but also on the changing objectives of individualproducers. The first major price settlement reached in the annualbargaining round usually sets the tone for the entire market andother suppliers quickly follow. The same supplier and customermay lead the market for several years running, but the leadershipoften changes. Published prices are normally only one facet of asettlement that also includes arrangements on tonnage. Theproducer that settles first in a weak market may havecounterbalanced concessions on price with increased salesvolumes, but the followers seldom derive those benefits.Participants in the market have to weigh up all the alternatives intheir negotiating strategies. Obviously they will need to takeaccount of the size of their own and their competitors’inventories and of the balance between the capacity and output ofeach producer. Eventually a global consensus about prices isreached and prices in the main regional markets are closelylinked. Sometimes such a consensus is reached quickly, whereasin other years the negotiations can drag on for months.

THE RISE AND FALL OF CARTELS

Even where prices are negotiated between major producers andusers of a product, there may be scope for collusive actionbetween producers. Adam Smith (1976) [1776] remarked on thistendency over 200 years ago:

People of the same trade seldom meet together,even for merriment and diversion, but theconversation ends in a conspiracy against thepublic, or in some contrivance to raise prices.

The same factors that facilitate producer pricing – namely arelatively limited number of producers – tend to encouragerestrictive agreements to limit output or raise prices. The historyof the minerals and metals industry is littered with attempts to fixprices through cooperative actions. These have met with varyingdegrees of success, but most have ultimately failed. Some haveworked through producer pricing whilst others have operatedthrough terminal markets. Many, but by no means all, werestarted in periods of over-supply as defensive reactions toself-defeating price cutting. Those were often introduced withthe active support of or at least implicit connivance of,governments.

Attitudes to cartels between producers are much affected byprevailing political philosophies. During the period between theFirst and Second World Wars, many governments accepted theneed for concerted action to restrict output in conditions of acuteexcess capacity and weak demand in order to sustain prices.In the decades following the Second World War such attitudespersisted and they were reinforced by the widespread acceptanceof government intervention and regulation of economic activity.

The Organisation of Petroleum Exporting Countries(OPEC) was one of many producer-based organisationsestablished during this period. It was founded in 1960 by fivecountries, Iran, Iraq, Kuwait, Saudi Arabia and Venezuela and afurther eight oil producing countries had joined by 1973. For thefirst decade of its existence OPEC achieved very little, but itsmembers chipped away at the power of the international oilcompanies that effectively controlled their production. Stronglyrising international demand for crude oil, partly driven by the USmoving from a production surplus to a deficit, enabled theproducers to achieve moderate price increases in 1971. TheArab-Israeli war of October 1973 and its aftermath encouragedOPEC to go much further in gaining control of pricing andproduction. The move was driven by political rather thaneconomic considerations, as a means of putting pressure on theindustrial countries. The price of oil quadrupled, transformingthe international oil market and prompting serious economicdislocation in the global economy. The Iranian revolution in1979, coupled with political upsets elsewhere, led to a furtherround of sharp price rises in 1979-80.

The initial price increases held because the short run demandfor oil was highly price inelastic, but by the early 1980salternative sources of oil were being developed, partly under thestimulus of the higher prices then ruling. There had also beenwholesale substitution away from oil to alternative fuels andenergy-saving measures of all types. By the late 1990s OPECsupplied about two-fifths of the global production of crude oilcompared with well over half in the early 1970s. Although OPECintroduced formal quotas on production in 1982 in order tosustain prices, there was widespread cheating and crude oilprices drifted downwards from the mid 1980s. The first Gulf Warin 1991 had but a temporary impact on oil prices.

By the late 1990s global demand was again starting to outstripthe available capacity to produce and OPEC’s production quotasbecame more effective. The collapse of Iraqi production in 2003helped OPEC to sustain crude oil prices. Most of the survivingmembers of OPEC (Ecuador left in 1992 and Gabon in 1995) areIslamic states with a similar political outlook, although thesimilarities between theocratic Iran, a feudal monarchy likeSaudi Arabia and Nigeria or Indonesia should not be overstated.OPEC’s successes have sprung not so much from its own policiesand actions as from the global market conditions it faces.OPEC’s share of world oil production between 1965 and 2004 isshown in Figure 7.4.



OPEC’s apparent success in raising crude oil prices in theearly 1970s prompted the formation of similar internationalproducer groups for a variety of mineral products, such asphosphates, bauxite, iron ore, mercury and tungsten. Less formalarrangements covered manganese, lead and zinc. Many groups,nominally at least, excluded any discussion of prices from theiragenda. The articles of the World Phosphate Institute, forexample, were framed in such a way as to leave the three UScompany members free of any anti-trust action. Australia onlyjoined the bauxite and iron ore associations on the understandingthat they would not attempt to increase prices unilaterally.Nonetheless, the smoothing of price fluctuations was always animportant objective of most members of all these producergroups and of the copper producers’ group, CIPEC, which wasformed in 1967. Most were inter-governmental bodies, althoughthe phosphate, mercury and tungsten organisations hadindividual company members. Most lacked the wider commoninterests that created the strong cohesiveness of the Arabmembers of OPEC. Weak market conditions from 1974 onwardsprevented most producer associations from exploiting any powerthey might have had. In any case, the basic economic conditionsthat allowed OPEC to boost oil prices do not exist in mostcommodities.

There are several preconditions for successful cartel action:

• members should share some common interests and objectives;

• there should not be a wide range of grades or qualities of theproduct involved, but different producers’ output should beclosely substitutable (the scope for cheating tends to varyinversely with the homogeneity of the product);

• a high level of concentration of production and reserves isrequired; and

• the cost structures of each producer should be broadlycomparable.

Where costs of production diverge widely there is littlecommunity of interest between the lower and higher costproducers. Similarly, a wide diversity of sources of productionand undeveloped reserves raises the prospect of new entrantsundermining the cartel. In essence, the barriers to entry need tobe fairly high and not just in the short run. There should be fewviable substitutes in the product’s major uses and theprice-elasticity of demand should be very low.

Even during their heyday in the late 1970s, producerassociations formed merely to increase or stabilise prices wereunlikely to succeed, because some or all of the necessarypre-conditions for success were lacking. Table 7.2 outlines thefate of several international producer groups that were formed orgained prominence during the 1970s.

Bauxite was perhaps the nearest parallel to petroleum in theearly 1970s and producing countries such as Jamaica raised theirreturns from local bauxite production. That was a temporarysuccess however, because there were ample alternative resourcesand the barriers to entry were relatively low. The raising of pricesprovided leeway for potential producers in other countries suchas Brazil to develop new mines. Jamaica’s share of globalbauxite output fell from around 18 per cent in 1973-74 to eightper cent by the mid-1980s.

Morocco and the other members of the putative phosphatecartel were unsuccessful in sustaining their price increasesbecause farmers effectively went on strike and delayed theapplication of phosphatic fertilisers. Many of theinter-governmental producer groups that were formed during the1970s did not survive changes in market conditions andprevailing political philosophies. The International BauxiteAssociation, for example, saw a gradual loss of members beforecollapsing in 1995. In copper, CIPEC saw many memberswithdraw and contracted, leaving its residual coordinatingfunctions carried out in Chile.

Even if the necessary preconditions for cartels had been inplace, the marked change in global political conditions thatgathered force during the 1980s would have made their livesdifficult. The emphasis moved from collective to individualaction and to the primacy of market forces. Governmentintervention became unfashionable with the view that pricesshould be allowed to find their own levels in response tocompetitive forces, which should be facilitated by effectivecompetition policies.

A major defect of producer cartels is that they do not explicitlytake account of the interests of consumers. Governments ofcommodity-consuming countries are, therefore, wary of theircreation, especially where companies rather than governmentsare involved. Both the US and the European Union came outstrongly against any effective cartels, whether these wereorganised by individual producing companies (private or stateowned) or by governments. This opposition was less than total,however, as the United States has explicitly allowed cartels thatenable US exporters to compete internationally. Thus USexporters of phosphates and soda ash combine to sell in overseasmarkets. Similarly, joint purchasing arrangements amongstconsuming companies are also acceptable. Examples include theJapanese smelter pool, which arranges imports of copperconcentrates and joint purchasing by both the Japanese and theGerman steel mills. One company may take the lead in dealingswith producers, with the ensuing agreement shared by all. Jointpurchasing can tip the scales in the purchasers’ favour, evenwhere they have an apparently weak initial bargaining position.

Until the mid-1970s only the US had strong anti-trustlegislation and non-US companies were prepared to collude tomaintain prices. The important proviso was that such collusiondid not affect US commerce, otherwise it would have broughtthose involved under the reach of the extra-territorial provisions



0

10

20

30

40

50

60

1965 1970 1975 1980 1985 1990 1995 2000

%s

ha

reo

fw

orl

dto

tal

0

20

40

60

80

100

1965 1970 1975 1980 1985 1990 1995 2000

millio

nb

arr

els

/day

OPEC Non-OPEC

A

B

FIG 7.4 - (A) World crude oil production and OPEC’s share ofworld production. (Source: British Petroleum, 2004 – the datacover crude oil, shale oil, oil sands and natural gas liquids).

(B) OPEC’s percentage share of world oil production.

of the US anti-trust laws. It was reasonable to assume thatproducer pricing outside the US was beyond reach as long as theUS was self-sufficient in the affected products. Imports into theUS of many minerals and metals began rising strongly in theearly 1970s however, for a variety of different (usually specific)reasons. That led the US Department of Justice to examinepossible breaches of anti-trust laws by foreign companies.Simultaneously, the European Union’s competition policy wasbeing developed and enforced through case law.

International zinc producers were amongst the first toexperience the changed climate. Companies who had establishedand maintained the well-publicised European Producer Pricesystem for zinc from 1964 onwards with the tacit approval oftheir host governments were questioned by the US anti-trustauthorities in 1976 and a case was brought against them by theEuropean Competition Directorate. That eventually resulted infines and the effective collapse of the system of zinc producerprices, which had been enforced through an agreement tostockpile, intervene on the London Metal Exchange and reduceoutput when necessary. The vestiges of the system lingered onfor some years, but without the previous effectiveness. Evenwhen it was fully operational those involved in the system hadbeen quite prepared to cheat their colleagues if they could. Alsoduring the late 1970s the European Competition Directoratesuccessfully prosecuted a group of companies who hadcollectively purchased all exports of aluminium from Easterncountries in order to keep them off the London Metal Exchangeand damage the prevailing producer price structure.

These actions, and others in different industries, madesuppliers of minerals and metals into North America and theEuropean Union much more careful about the anti-trust rules.For example, the major aluminium producers took great pains to

involve governments in ways of tackling the problems raised bythe sudden and unexpected outflow of aluminium metal from theformer Soviet Union in the late 1980s and early 1990s. TheMemorandum of Understanding signed between Russia andcertain major aluminium-producing countries in early 1994 wasan inter-governmental agreement. It provided a fig leaf behindwhich the companies could shelter when they cut their output inorder to restore market balance. Those cuts coincided with aninflux of speculative funds into purchasing non-ferrous metals,especially aluminium. During 1994 prices rose sharply, by farmore than anyone had forecast, and some aggrieved users ofaluminium attempted to sue the US producers for anti-trustviolations.

The diamond market provides the longest running example ofa price setting cartel that has been treated as unlawful in the US.For many years De Beers operated an effective cartel amongstthe mining countries and controlled market prices through itssales policies and by stockpiling. The US anti-trust authoritieswere strongly antagonistic and would have prosecuted both thecompany and its officers had they ever been within USjurisdiction. That was not however, a sufficient impediment,notwithstanding the considerable funds that had to be raised tofinance stocks during periods of weak demand such as the early1980s and early 1990s. The collapse of the Soviet Union in 1991and the development of new mines outside De Beers’ controlweakened its influence. Australian production, mainly ofindustrial diamonds, began in the early 1980s and the Australianproducers became increasingly assertive towards the De BeersCentral Selling Organisation. Gradually De Beers’ tight grip onglobal diamond marketing weakened, especially with the start-upof Canadian production in 2001. A considerable degree ofmarket discipline remains however, largely because of the nature



Bauxite International Bauxite Association (IBA)Formed March 1974 and by 1975 members controlled 85 per cent of non-socialist world output. Jamaica, Surinam, DominicanRepublic and Guinea successfully raised bauxite mining taxes, but Australia did not. The countries that did lost market share and theIBA became increasingly ineffective. Jamaica withdrew in mid-1994 and the IBA collapsed in 1995.

Copper Conseil Intergouvernmental des Pays Exportateurs de Cuivre (CIPEC)Formed in June 1967 by Chile, Peru, Zaire and Zambia. Yugoslavia and Indonesia joined later and Australia and Papua New Guineabecame associates. In 1974-76 CIPEC unsuccessfully tried to stabilise copper prices through production cuts, but its memberscontrolled too small a share of the global market. CIPEC dwindled in importance with the collapse of Central African copperproduction, the withdrawal of several members and the establishment of an International Copper Study Group in 1993. Its residualcoordinating functions moved to Chile’s Copper Commission.

Iron ore Association of Iron Ore Exporting Countries (APEF)Developing country members pressed for attempts to set export prices in 1975, but Australia and Sweden refused. Neither Brazil norCanada joined. APEF collected statistics on market trends until its suspension in 1989. Its statistics gathering role was taken over fora period by an UNCTAD Trust Fund.

Phosphate rock World Phosphate Rock InstituteMorocco, the leading producer outside the USA, joined with Algeria, Brazil, Jordan, Senegal, Syria, Togo and Tunisia in 1973.Morocco sharply raised export prices in 1974 and several other members followed suit. The United States’ export cartel, Phosrock,also raised its prices. The global market collapsed in 1975 when the effects of recession were exacerbated by farmers ceasing toapply phosphatic fertilisers.

Mercury Mercury Producers’ Association (Assimer)Formed in 1975 by Algeria, Turkey, Mexico, Italy, Spain and Yugoslavia. Most production was state-owned. In late 1977 Assimerannounced attempts to control the market with sales restrictions, followed by price increases. Its control was undermined in 1982 byfalling consumption, increased secondary supplies and sales from US stockpiles, but was reasserted for a brief period in the late1980s. Growing concerns about the adverse impact of mercury on human health and the environment have led to even tighterregulations on consumption. These have also boosted recycling and greatly reduced any pricing power of the primary producers.

Tungsten UNCTAD Committee on Tungsten, Primary Tungsten AssociationInternational Tungsten Industry AssociationAn Ad Hoc Committee on Tungsten, an inter-governmental body, was established under the auspices of the United Nations in 1963.One of its tasks was to examine ways of stabilising prices. In due course, the Committee and its various offshoots moved under theUNCTAD umbrella. Its main role was the collection of statistics but it also attempted to reach agreement on means of stabilising themarket, especially during the late 1970s. It was complemented by a producer organisation, the Primary Tungsten Association (PTA),established by major producing companies in 1976. With changing attitudes to market intervention, the UNCTAD Committee wasreplaced in October 1992 by an Inter-governmental Group of Experts on Tungsten, whose remit was solely statistical. The PTA wasreplaced by the International Tungsten Industry Association in early 1988. This brought together mining companies, processors,consumers and traders in a research organisation under Belgian law.

TABLE 7.2International producer associations in the minerals industry.

of the market for diamond gems. Consumers, perhaps even morethan producers, have an interest in maintaining high prices for aproduct whose value is as a status object rather than for itsintrinsic properties in use. If the global diamond market iscartelised, it is a cartel in which consumers are as guilty ofconspiring as producers. That makes diamonds very much aspecial case. Even in diamonds, a form of producer pricing doesnot eliminate the need for careful analysis of market trends, for awillingness to stockpile, or for a need for production cutbacks inperiods of weak demand.

Notwithstanding strong anti-trust legislation in majorminerals-consuming countries, collusive actions to restrictcompetition persist. In 2003 for example, the European Unionfined European producers of copper tube for price fixing. It alsobegan an investigation into the copper concentrate market jointlywith the relevant Canadian and US agencies. There weresuggestions that meetings to discuss market conditions andindustry statistics provided a front for price fixing. Theinvestigations were eventually dropped without any actions beingtaken. The nature of the markets for minerals and their first-stageproducts means that producers will always seek ways ofrestricting competition. The search inevitably intensifies duringprolonged periods of weak market conditions. Most collusiveagreements are likely to prove temporary because demand is notsufficiently price inelastic over the medium to long term andbecause the barriers to entry are not high enough.

PRODUCER PRICING

Collusive action of any type is not a pre-requisite of producerpricing. Where there are only a few suppliers to a market butmany end-uses and customers, producers may quote list prices.Such producer prices may be set by a dominant producer orprice leader and followed fairly closely by the other suppliers.They may have similar cost structures and have learned frombitter experience that vigorous price competition brings onlytemporary gains in market share that are usually whittled away inthe next round of price cuts, to the benefit of users rather thanproducers. Concentration on the other competitive dimensions,such as product quality, marketing or technical service, may bemore effective means of attracting and retaining customers.

Where producers set prices they tend to keep them fixed forlong periods. They often set them not by reference to marginalcosts, whether their own or those of the industry, but to some formof average cost. Prices change in response to clear externalstimuli, like movements in the costs of major raw materials suchas crude oil. They are also responsive to their setter’s financialneeds and changes in productive capacity, which often go together.

Customers claim to like producer prices because of theirapparent stability and their air of predictability. The infrequentchanges enable consumers to plan ahead with confidence,especially where their purchasing is subject to annual cashbudgeting. That has been the typical pattern not just forstate-owned companies and government departments but also formajor purchasers such as automobile producers. In theimmediate post-war decades, producers set prices for mostminerals and metals and true market-related pricing wasrelatively rare.

The stability of producer pricing was (and is) more apparentthan real. It is impossible to maintain complete control over bothprices and the volume purchased, except under total monopoly.No matter how clever the forecasters, there are alwaysunexpected changes in the balance between supply and demand.Stable prices are only realisable where suppliers are prepared toreduce their offerings when markets are over-supplied and toexpand their offerings rapidly in times of shortage. That in turnmeans a willingness to stockpile and even reduce production inweak markets and to raise output rapidly in the boom. Thisimplies that there will be a degree of over-capacity throughout

most phases of the business cycle, which in turn means thatreally effective producer pricing is only achievable in thosemarkets where there are only a few strong companies. Highbarriers to entry into the market and a perceived community ofinterest in price stability between the suppliers are usuallypreconditions for success.

Producer pricing has been strongest and most tenacious innational or regional markets that are protected in some mannerfrom imports. The basic cost structures of producers within onecountry may differ, but they are subject to similar variations incosts and demand and to a common regulatory framework. Oftenthe producers of the primary materials may be integrated withdownstream users of their products. That means that the actualprice of the raw materials is not of great importance, but itmerely indicates where profits are recorded for accountingpurposes. The tax authorities will have some interest in ensuringthat transfer prices between the various stages are not beingused to evade taxes, but that need not impinge on market prices.The list prices for the raw materials may only be paid on themodest portion of sales, often to small users, made outside theintegrated network. That was the case in the US primaryaluminium industry and largely still is. The prices ofsemi-fabricated products are infinitely more important to themajor US aluminium producers than the price of ingot. Theprogressive reductions in tariffs and other barriers to tradebetween major metal producing and consuming countries in the1960s and 1970s lowered barriers to foreign competition andmade the defence of domestic producer prices much harder:prices could be more easily undercut by imports.

Even where producers are able to tailor their production tofluctuating demand, the fit will rarely be perfect. Individualproducers may be unable to bear the burden of financing largeinventories, even with accommodating financial institutions.When markets are weak for extended periods the patience ofsuch institutions soon becomes strained and their willingness togrant additional credit distinctly limited. Hence, recourse has tobe made to production cutbacks, which are seldom easy toengineer unless one supplier is prepared to shoulder the entireburden. Individual producers may believe that they have aninherent cost advantage that enables them to carry on producingat a profit when others make losses. They may expect animminent improvement in market conditions, or they may beloath to countenance any drop in market share that might flowfrom their cutbacks. This all means that collusion between thesuppliers has often been necessary to ensure the appropriatecutbacks. This might be no more than following the example setby a dominant market leader, such as International Nickel innickel, or the former Amax in molybdenum. More than thatinvites a legal riposte. The US has long had legislationprohibiting collusive action in restraint of trade, but the diligencewith which it has been enforced has varied. The legal sanctionsinclude possible imprisonment of those individuals found guiltyand the threat of triple damages for any aggrieved parties.

Even where producers’ published list prices have beenapparently stable for long periods, the prices at which business isactually transacted can diverge markedly. Large customers mayenjoy volume discounts that rise when market conditionsdeteriorate and other forms of incentive then creep in. Whendemand presses against the limits of capacity and redundantplant has been brought into service premiums may be imposedon groups of customers, or even on all. Moreover, rationing willsometimes be introduced, with long-established customersfavoured over casual trade. That naturally creates a constituencyamongst the aggrieved parties in support of potential newentrants. It was International Nickel’s inability to supply nickelduring a strike in 1969, and the ensuing acute shortages, thattriggered a massive exploration boom and the subsequentdevelopment of new mines elsewhere. That in turn underminedInternational Nickel’s hold on the nickel market.



Typically producers’ list prices have tended to rise over time,at least in money terms, with cost-justified, or market-driven,increases much more common than price cuts introduced whenconditions are bad. The burden of those is taken more onvolumes supplied. The benefits of productivity improvements ofall types are not fully passed on to customers, except when newentrants threaten to undermine the established order. Indeed,effective producer pricing may discourage suppliers frompursuing productivity as aggressively as those who are forcedcontinuously to lower their costs to survive in periods of fallingmarket prices. The inherent discipline of market pricing is onereason why producers always nostalgically incline towardsproducer pricing.

The ability of producers to set prices has been graduallyweakened not just by trade liberalisation but also by the spreadof demand away from its traditional locations, and by thedevelopment of new facilities to meet that rising demand. In theimmediate post-war decade the US was the dominant producerand user of minerals and metals, and prices were heavilyinfluenced by the actions of US companies. Gradually, firstWestern Europe, then Japan and more recently other countries,emerged to challenge the US hegemony. Simultaneously, thenationalisation of foreign-owned mines and processing plants bymany countries, particularly (but not exclusively) in thedeveloping world, weakened the ability of US companies tocontrol supply. The newly state-owned companies were oftenmainly concerned with maximising their throughput and revenues.Also, new mines and plants were established in developingcountries, often by state enterprises. These lacked any establishedmarketing experience and they were initially content to sellthrough merchants, who could grant credit as well as obtain accessto markets. Aluminium was far from alone in this regard, althoughinvestment in new aluminium smelters was stimulated by the oilprice rises and changing energy costs of the 1970s.

Another nail in the coffin of producer prices for products thatare produced and sold in a range of countries was the collapse ofthe post-war system of fixed exchange rates that culminated inthe devaluation of the US dollar in 1971. This ushered in aregime of floating exchange rates that was initiallyaccompanied by rampant cost and price inflation. Althoughcurrencies could (and did) change their parities under the regimeof fixed rates, such changes were infrequent. The prevailingassumption, broadly justified by experience, was of stability.Nearly all producer prices were denominated in US dollars,which had been regarded as a completely stable yardstick.Floating exchange rates soon undermined that faith andcontributed to diverging interests between producers withdifferent currencies, let alone between them and consumers.What was a stable price in one currency was not necessarilystable in another, which meant that fixed dollar prices no longerprovided unequivocal signals about the changing balancebetween supply and demand. Producers with appreciatingcurrencies saw their receipts shrink in their own currencies,sometimes even when dollar prices rose. Conversely, those withdevaluing currencies saw their domestic revenues rise even whenmarkets were oversupplied and dollar prices eased. The stabilityof producer pricing, and hence one of its basic rationales, wasundermined. Domestic prices still diverge even when globalprices are market-determined and currencies fluctuate, but noone has ever claimed that market-driven prices are stable.

A summary of the history of producer pricing in non-ferrousmetals appears in Table 7.3.

Collusive action to fix prices has long been illegal in the US,but overseas markets had not been subject to similar anti-trustlegislation. That changed during the early 1970s, with thedevelopment of the European Union’s competition policy. Asdiscussed in the previous section, anti-trust actions forced the

demise of the European producer pricing system for zinc duringthe late 1970s. It was, however, already suffering fromdifferences of interest between the different suppliers. Given itsfungible nature, there is nothing to distinguish between metal ofa given quality from different producers. Some are fullyintegrated from mine to refinery, whereas others are not. Customsmelters face a fluctuating market for their raw materials as wellas for their products. Costs of production, responsiveness tofluctuating exchange rates and ability to vary output variedwidely between producers. There was no long-term communityof interest between the different producers that would persuadethem to tailor their supply to demand for long periods, or to buildup their own stocks rather than sell into the market, and cheatingwas rife. There was a tendency to set producer prices at a highenough level to placate the least efficient producer. Thatdiscouraged consumption and provided scope for the moreefficient to expand. It also eased the path for new entrants whomay have been outside the system. Excess capacity inevitablyresulted. The aftershocks of the collapse of producer pricingreverberated around the zinc industry for years.

There was always a tendency for all producer prices to be tooinflexible in response to changing market conditions and over thelong term to be set too high. The world copper producer price ofthe late 1950s and early 1960s probably accentuated theover-supply of the early 1960s. The European zinc producerprice and the stable nickel producer prices of the 1970s alsotended to create excess capacity during the 1970s. Inevitablysome countries or companies will not actively participate inproducer price schemes but will exploit them to full advantage.These, rather than the active participants, gain the most. Over thelonger term there is a tendency to cheat and to discount inperiods of weak demand.

Aside from any tendency for over-rigid producer prices toencourage excess capacity, there is a need to fund large stocks inperiods of weak demand. If producer prices are to be crediblecompared with free market quotations, the latter must besupported, however thin the market. In a severe recession almostlimitless funds and nerves of steel are needed to support a givenprice. Unless the support level is carefully chosen, the availablefunds will run out, market prices will plunge and the participantswill be faced with large book losses.



Aluminium: The US Producer Price (Alcoa) was dropped in 1986.Alcan’s World Price was the yardstick for pricing outside the US to theend of 1988. It co-existed with various free-market quotations. LMEpricing began in 1979 and progressively superseded producer pricing.

Copper: Central African and Chilean producers set a producer pricebetween 1961 and 1966, when it collapsed. Most sales outside the UShave subsequently been based on LME prices. Within the US producerpricing continued until well into the 1980s.

Lead: Within the US posted producer prices persist, but the vastmajority of the lead industry has long used LME prices as their pricingbasis.

Nickel: International Nickel posted its world producer price untilDecember 1987. LME quotations began in late 1978. For much of the1970s there was heavy discounting from posted producer prices, andfree market prices were more reliable guides to transaction prices. LMEquotations now dominate.

Tin: Prices in the London and Penang markets, which were the basis ofmost trade in tin, were effectively controlled by the operations of theInternational Tin Council (ITC) between 1956 and October 1985. Withthe collapse of the ITC, prices became entirely market-determined.

Zinc: Most global business is now based on LME prices. Within theUS producers posted prices until 1993. Elsewhere most producersnominally used the International Producer Price from its inception inJuly 1964 until its final demise in 1988. Its hold weakened from themid 1970s, as described in the main text.

TABLE 7.3The history of producer pricing in major non-ferrous metals.

That collusive action amongst suppliers to enforce list pricesis illegal in the major industrial economies by no means rules outproducer pricing. Some other countries lack effective anti-trustrules, or may accept that the resultant price stability is beneficialto their export earnings. The publication of list prices, evenwithout collusive action, is still common in the minor metalsand some industrial minerals. It often co-exists with a dealer(or merchant) market in which prices are far more volatile. Thisis not just because the latter quickly reflects changes in thebalance between the global supply and demand, but also becausemerchants will gain access to varying proportions of the totalsupply over the course of the business cycle. In good timesproducers will control a much greater share of the total supplythan when conditions are depressed. Customers may have morethan they need and offload the excess onto merchants.

When merchant prices diverge from list prices in eitherdirection for extended periods, the producers’ list prices becomemerely nominal and of little practical relevance. In time they maybe completely withdrawn and all pricing then becomes based onthe merchant market. Prices are usually indicated through regularcompilations in the technical press of the averages or ranges ofthe quotations of individual merchants for specified grades andvolumes. No matter how assiduous and careful the compilers ofsuch prices, there is no guarantee that much trade actually takesplace at them. They are indicative at best. On occasion, marketparticipants have raised strong concerns about the validity ofsome published prices.

For many market participants, price transparency is a mixedblessing. There is often dispute about the relevance of publishedprices to particular trades. Those purchasers who have managedto obtain special deals and their suppliers, often prefer secrecyrather than publicity. Prices are something agreed betweenconsenting adults in private, rather than blazoned over the pagesof the technical press. Traders also thrive where they can exploittheir unique knowledge of market conditions. Even so, the nextlogical step from a large merchant-based market with opaqueprice formation is the transfer of the process of price discovery tosome form of terminal market. That not only enhancestransparency, but offers opportunities for hedging price risk.

TERMINAL MARKETS

The essence of terminal markets is that prices are set at least on adaily basis to balance that day’s marginal offerings and demand.Directly or indirectly, those prices govern all that day’stransactions, whether or not they are actually made through theexchanges. The offerings and demand may come not only fromindustrial companies, whether producers or users, but also frommerchants and investors of all types. Thus supply and demand inthese markets are much broader than production (whether ofprimary or secondary material) and industrial usage.

Terminal markets may have four main interlocking functions,which they fulfil in varying degrees. These are:

• the determination of daily reference prices for the productstraded;

• the provision of facilities for hedging against price risk;

• acting as a market of last resort through a dedicatedwarehouse network; and

• giving opportunities for investment in metals as assets.

Each exchange has its different methods and traditions. Theleading terminal market for trading non-ferrous metals is theLondon Metal Exchange (LME), which accounts for over 90per cent of global exchange business for those metals it trades.These are aluminium, aluminium alloy or secondary aluminium,copper, lead, nickel, tin and zinc. The New York MercantileExchange (Nymex) trades copper and aluminium through its

Comex Division, the Tokyo Commodity Exchange started analuminium contract in 1997, Kuala Lumpur trades tin andShanghai deals in several metals. New York, Tokyo, Hong Kong,São Paulo and the London Bullion Market trade precious metals.Crude oil and natural gas are quoted by Nymex and theInternational Petroleum Exchange in London.

The London Metal Exchange

The London Metal Exchange was first established in 1877. It wasextensively re-organised in 1987 following the default of theInternational Tin Council and the passage of the UnitedKingdom’s Financial Services Act, and became a limitedcompany owned by its shareholders in 2001. Its activities areclosely related to the physical metals trade, but it had to be fittedinto the framework established under the Financial Services Act.It is a Recognised Investment Exchange regulated directly by theFinancial Services Authority, which closely defines theconditions under which the Exchange operates, and above allrequires that it maintains orderly markets in all its contracts. Inits activities in the US, such as the listing of approvedwarehouses, the Exchange is governed by the relevant USlegislation and by the Commodities and Futures TradeCommission (the CFTC). It is also subject to any relevantDirectives of the European Union. The Exchange is responsiblefor maintaining and policing its trading rules and regulations.A branch of the Financial Services Authority regulates thecommercial and ethical conduct of its members. Although theExchange is based in London, foreign companies ultimately ownmost of its members and it is a truly global market.

A historical summary of LME contracts appears in Table 7.4.The copper, lead and zinc contracts have a long history, as dothose for tin. Trading in the latter, however, was halted after thecollapse of the International Tin Council in October 1985 andonly resumed in 1989. The zinc contract was given new leases oflife by the final demise of European producer pricing in the1980s and by the adoption of an LME pricing base by the US in1993. Trading in aluminium started in 1978 and nickel followedin 1979. Their respective industries initially shunned bothcontracts and it was some years before they were fully accepted



Copper: 1877, with specification periodically changed. First officialLME contract 1883. Present Grade A contract June 1986.

Tin: 1877, with specifications periodically changed. Contractsuspended 25 October 1985 and re-introduced June 1989. First officialLME contract 1883.

Pig iron: 1877 until 1920s.

Lead: 1920, but traded unofficially before then. The specificationshave been periodically changed.

Zinc: 1920, but traded unofficially before then. The specifications havebeen periodically changed. Present Special High Grade 99.995%contract introduced June 1986.

Aluminium: December 1978, with the contract changed to High Gradein August 1987.

Nickel: April 1979, with specifications periodically changed.

Silver: 1969 until mid 1989. New contract in May 1999 suspended inMarch 2002.

Aluminium alloy: October 1992.

North American Special Aluminium Alloy Contract (NAASC):March 2002.

Index: April 2000. Based on the six major metals.

Polypropylene and linear low density polyethylene: 27 May 2005.

TABLE 7.4London Metal Exchange contracts.

as being representative. The contract for aluminium alloy begantrading in early 1992 and was also slow to gain acceptance. Itwas joined by a North American aluminium alloy contract(NASAAC) in March 2002. Pig iron was traded for a period untilthe 1920s and trading in silver began in 1969, ceased in mid1989, resumed on a new basis in May 1999 and was suspendedonce more in March 2002. The relative importance of eachcontract varies annually depending on the market conditions foreach metal. In 2003 aluminium accounted for almost 39 per centof the total number of lots traded, copper for nearly 28 per centand zinc for 15 per cent. Lead and nickel each provided aroundsix per cent of the lots traded, and the two aluminium alloycontracts for roughly two per cent. Trading in two plasticscontracts started in May 2005.

Only a very small percentage of the volume of non-ferrousmetal produced and traded is physically delivered into LMEregistered warehouses, but the bulk of the world’s non-ferrousmetals are traded by reference to LME prices, and the LMEcaptures by far the greater share of hedging business. Trading isby open outcry across a ring, in which the dealers sit and shouttheir bids or offers. This is backed up by a telephone-basedinter-dealer market outside ring trading sessions and by a screentrading system, LME Select, which system was first introducedin early 2001 and has been gradually refined. Like the telephonemarket, it is only open to trading between LME member brokers.The share of total LME business transacted through the Ringitself has gradually declined to under two-fifths.

The basic contract for each metal is for three months forward,with each working day being good for delivery against theprompt, or delivery dates. Daily cash prices are also fixed, withadditional prices for 15 months ahead for lead and tin, going to27 months for nickel, zinc and aluminium alloys and to63 months for aluminium and copper. The period for those twowas extended from 27 months in September 2002. The prices arestrictly forward prices for future delivery on specified datesrather than the futures prices traded in most other markets suchas Nymex. This is one of the LME’s distinguishing features. Allprices are fixed in US dollars, the prime currency of thenon-ferrous metals industry, but with facilities for also clearingin sterling, Japanese yen and euros.

The prices established by open outcry at the close of thesecond or official rings become the official settlement prices foreach day’s trading. These rings concentrate bids and offers fromthe whole world into one brief and orgasmic trading session,which reaches its climax at the closing bell. The prices reflect themarginal tonnage offered and demanded that day, no matter thesource or the destination. They inevitably fluctuate daily, butbroadly reflect, under normal circumstances, the global markets’balance of supply and demand.

Trade is conducted in lots rather than tonnes, with each lot ofaluminium, copper, lead and zinc amounting to 25 tonnes. Nickelis traded in six tonne lots, tin in five tonnes and aluminium alloysin 20 tonnes. Prices are set for metal that meets the prevailingcontract specifications, which are established with reference tothe needs of the producing and using industries. Individualproducers’ brands that meet the contract specifications can beregistered and are good for delivery once they have been testedand accepted. The contract for each metal sets out the shapes,weights and methods of strapping. The contract specificationsare not for the lowest common denominator of industry’s needs,but for that quality and shape which is most widely traded anddemanded. Specifications have tended to rise over the years. Inthe 1980s, for example, the aluminium specification was raisedfrom a minimum of 99.5 per cent aluminium to 99.7 per cent,and the copper contract moved from wirebars to Grade Acathode. The quality of zinc has been progressively raised,initially from good ordinary brand to high grade, and then thespecial high grade with minimum 99.995 per cent zinc that is

traded today. The contracts specify minimum standards, whichmany producers easily exceed. The daily prices do notdistinguish between the individual registered brands, but brokersand traders may pay premiums for particular brands that areespecially in demand. Similarly, the price is for delivery into orout of any registered warehouse, no matter where it is located,and premiums may be established for specific locations.

Whether they are concluded on or off the ring, all LMEcontracts are cleared through the London Clearing House.Before the clearing arrangements were introduced in 1987,brokers acted as principals, which meant that the market’s usersfaced a risk of their broker defaulting. The clearing mechanismoffers security to all users of the market that their contracts willbe honoured, even if the initiating broker were to go bankrupt.The prime distinguishing feature of LME contracts is that theyare not cash cleared. In other words, users of the market do nothave to contribute additional cash when their contracts aremaking losses, nor can they take out profits ahead of the promptdate; rather the contracts are cleared against bank guarantees,with brokers granting credit to their clients. Most trade users alsodo not insist that their business is segregated. These featuresmake the Exchange particularly useful for trade users, who donot have to commit variable and uncertain amounts of workingcapital to use the market.

Other exchanges that trade in metal futures or in energyproducts, like the New York Mercantile Exchange, are cashcleared. It was the ability to take out paper profits when priceswere rising that enabled the Hunt Brothers to drive up silverprices so dramatically in 1979-80, when they were attempting tocorner the silver market. They could reinvest their paper profitsin margins on yet more futures contracts. When the bubble burstand prices started falling, repeated calls for additional cashmargin accelerated and accentuated the decline of genuinehedging as well as speculative business.

Credit clearing makes it easier for the metals industry to usethe market to hedge against price risks. Hedging is theelimination of uncertainty at a known cost. Users of the marketwith future commitments for purchase or delivery of physicalmetal can buy or sell an equivalent and offsetting forwardcontract that matures at the same time. The prices are knowntoday. When the time comes to deliver or buy, the user can closeout the forward contract and take either a loss or a profit to setagainst the offsetting profit or loss on the physical contract. Theliquidity of each contract tends to diminish rapidly the furtherforward they go beyond three months.

In addition to conventional forward contracts, the LME alsotrades options. These give the purchaser or the seller the right, butnot the obligation, to buy or sell at the strike price. The premiumpaid for this right varies inversely with the amount by which thestrike price varies from prevailing price levels. It is like aninsurance premium to protect against a known event. The LME’straded options are mainly so-called European options, whichrefer to prices on specified future dates, the third Wednesday ofeach month. Most users are much more interested in achievingaverage prices over a period, such as a month or a year. Until 1997the substantial and fast growing business in Asian options of thistype was conducted ‘over the counter’ (OTC) in deals specificallytailored for the individual users. The LME introduced tradedaverage price options (TAPOs) in early 1997, initially foraluminium and copper but now for all the metals, to provide theprotection of the clearing mechanism to such widely usedcontracts, and to increase market transparency by bringing theminto the open. Most OTC options deals are denominated in UScents per pound of metal, whereas LME contracts are expressed inUS dollars per tonne. The LME strike prices have, therefore, beentoo coarse and inconvenient for it to attract as much business to itscontracts as it initially expected.



Metal brokers can provide an infinite variety of combinations offorward prices and options to cover virtually any eventuality. Theunderlying mathematics and the jargon of these price derivativescan be complex, but their basic function is to enable producers andusers of metals to eliminate the risk of uncertain volatile prices ata known cost. The use of options overcomes one of the basicproblems of forward contracts, which lock in specified prices. Useof those denies the seller the benefit of any upside if prices at thetime of delivery greatly exceed the contract’s forward price, andthe purchaser the benefit of any fall below the forward price. Thelatter is particularly important for fabricators who are activelycompeting for business and operating on tight margins. One oftheir major concerns is that their competitors do not buy their rawmaterials on more favourable terms. No matter what combinationof hedging mechanisms is used, it is always the responsibility ofthe user’s management to ensure that it is aware of exactly what isbeing done and of the potential risks involved. The well-publicisedincidents in which companies have lost heavily in metals tradinghave all been ultimately traceable back to lax management in theaffected companies.

The growth of options trading has been of especial value toinvestors in metals, who are known pejoratively as speculators.There always have to be individuals or firms who are prepared toinvest in metals in order to provide adequate liquidity to themarket. Without such liquidity, the costs of hedging couldbecome prohibitive. Moreover, prices could periodically swinguncontrollably in one direction or another unless there werealways people who were willing and able to take contrary viewsto the market as a whole. Trade use of the LME still accounts, onaverage, for around 80 per cent of its total business, but theExchange’s turnover greatly exceeds the global production anduse of each metal. In 2003 the multiples of LME turnover toglobal output varied from 17 for lead, up to 34 for copper, withnickel at 22, aluminium at 26 and zinc at 28. The multiples weremuch lower (three to six) for the aluminium alloy contracts.These large multiples by no means reflect the amount ofspeculative activity. A proportion of LME turnover comes frombrokers adjusting contract dates and volumes to meet the preciseneeds of their customers.

We always have to be cautious in attributing sharp andunexpected shifts in prices to the speculators. However good thestatistics about consumption and production in the recent past,prices also reflect expected trends. We do not always havesufficient knowledge about the present and the future. Forecastsusually cluster together and they are often wrong, perhapsbecause of random shocks. Sometimes market sentiment canchange dramatically, almost overnight, and prices have to catchup. Sharp and apparently inexplicable price movements can oftenbe explained retrospectively by fundamental forces. Speculativeinvestment tends to even out over time and prices do broadlyreflect relative shifts in supply and demand. At times, however,‘investment’ in metals as such can become substantial and pricescan then be driven up or down more than might seemingly bewarranted by underlying trends in supply and demand.

Much of the LME’s turnover arises from its use as a market oflast resort. LME contracts provide for physical delivery, and insupport there is a network of registered warehouses throughoutthe world (see Figure 7.5). The Exchange itself does not own oroperate the warehouses nor does it own the metal they contain. Itapproves warehouse locations, with the objective of having awidespread network throughout the world in all important areasof net consumption. Warehouse locations must have appropriatefiscal and regulatory systems, be served by a good transportnetwork, have the facility to store goods without payment of dutyand enjoy political and economic stability. These requirementsrule out some apparently desirable locations. Once locationshave been decided, warehouse companies may apply to openfacilities. The contract between the Exchange and thosecompanies that satisfy its criteria sets out the warehousecompany’s rights and obligations and provides for a disciplinaryprocedure. Metal of approved brands may be delivered into awarehouse to satisfy delivery commitments in exchange for LMEwarrants. These are bearer documents giving title to a specificparcel of metal in a specified warehouse. The terms on whichmetal is delivered and stored are agreed between the warehousecompanies and the companies who deliver it.



5 locations in the UK; all metals. 19th century to 1994

12 locations, 6 countries in Europe: all metals 1962 to 1995

2 locations in Korea; not zinc 2001

7 locations in USA; all metals 1991 -984 locations in Japan; aluminium 1989

2 locations in Malaysia; all metals 2004

Singapore; all metals 1987

Dubai; not aluminium 1999 -2001

FIG 7.5 - LME registered warehouse locations in 2004. Note: the number of locations was increased during the 1990s to cope with an inflow ofmetal associated with the collapse of the former Soviet Union and a global recession, and several little-used locations were recently de-listed.

When markets are over-supplied, metal flows into warehousesand moves out again when markets tighten. Movements in thestocks held in LME-registered warehouses are thus usefulbellwethers of market conditions. Over the years there has been aprogressive move towards placing a greater proportion of surplusmetal in LME warehouses. This partly reflects the growing useof the Exchange for hedging and as a price reference and theextension of the warehouse network. Warehouses were originallyconfined to the UK, with locations first authorised in mainlandEurope during the 1960s. Singapore and Japan followed in thelate 1980s and the US in 1991. Dubai and Korea were added in2001, although Dubai was good for silver delivery from 1999 to2002, and Malaysia was being registered in 2004. Some locationsmay not store particular metals, either because they are close tomajor producing areas such as Singapore was historically withtin (until the LME lifted this limitation in 2002), or because oflocal restrictions on trade. Thus Japanese warehouses only storealuminium, Dubai does not take aluminium and Korea may notaccept zinc. LME copper trading only commenced in the US in1995.

The growth of LME stocks relative to total reportedinventories is also part of, and primarily mirrors, a global trendtowards reducing the amount of working capital tied up. If metalis held in LME registered warehouses, there is much less need tohold stocks in producers’ or consumers’ yards, and no need forthe metals industry itself to arrange their financing. LMEwarehouses became magnets for surplus metal during therecessions of the early 1990s. Excess western supplies weregreatly augmented by outflows from eastern countries. Althoughmuch of the latter was not registered for LME delivery, it partlydisplaced metal that was, allowing the latter to be delivered intowarehouses. Had the surplus metal not gone into LMEwarehouses, most of it would have been absorbed elsewhere andthere would have been little, if any, cutback in production beyondwhat actually occurred. From 1994 onwards the tonnage of metalheld in warehouses contracted, but the withdrawals did notnecessarily flow into final consumption. Much was taken out ofLME-registered facilities, partly to reduce its visibility andinfluence prices. The expectation was that final demand wouldsoon rise sufficiently to absorb excess stocks. In actualitydemand rose less than expected and LME stocks levelled out.

The spread of the LME’s warehouse network from itspredominantly European focus changed LME prices from mainlyreflecting European balances between supply and demand intoglobal indicators. That in turn altered the structure of premiumsover and above LME prices for delivery in particular locations.The LME’s settlement prices will inevitably reflect the balancebetween deliveries of metal into warehouses and shipments out.There may be net inflows in some locations at the same time asmetal is flowing out elsewhere. Not all locations and warehousesare equally accessible or convenient and the charges forremoving metal vary. The warehouse companies in the lessfavoured locations have sometimes offered inducements totraders to place metal in their warehouses, and once it is there ittends to stick.

The wider the warehouse network, the easier it becomes todeliver metal onto warrant when markets are tight. When marketsare well supplied they are usually in contango. In other words,prices for future delivery exceed cash prices by a margin thatrepresents the costs of storage and insurance and the rate ofinterest, or the time value of money. To the extent that warehousecompanies offer any special deals on rents, the normal contangowill be reduced. Other things being equal, a rise in warehouserents or interest rates would be accompanied by a widening ofthe contango. Often, however, such an adjustment would beswamped by other influences on prices. The further forward thequoted price, the greater the margin above cash prices, althougha lack of liquidity for the far forward dates could influence therelationship. Without any extraneous shocks, the relationshipbetween prices for the different delivery dates is stable.

When, for one reason or another, there is a shortage of metalfor immediate delivery, prices move into a backwardation. Thatmeans that cash prices for immediate delivery rise above theforward prices. There may be sound fundamental reasons for abackwardation, like a prolonged shortage of supply relative tobuoyant demand, perhaps caused by transport disruptions or astrike at a major producer. The only cure is an influx of metalinto LME warehouses that is sufficient to restore balance. Abackwardation often makes it worthwhile for those who haveexcess tonnage, however temporarily, to deliver into warehousesin order to earn a rate of return that may greatly exceed the costof finance. The emergence of bubbles in the pattern of prices is,however, often a sign that someone is attempting to squeeze themarket. In other words, they may have gained control of thegreater part of the available LME inventory and also have largelong positions which give them potential access to far moremetal than they need to meet their future commitments. Thosewho are short will have to pay the backwardation or borrowmetal at a cost in order to meet their commitments. Occasionallya merchant may inadvertently ‘squeeze’ the market, but moreusually there will be deliberate manipulation, which offendsagainst the preservation of orderly markets, one of the LME’sprime functions as a Recognised Investment Exchange.

Backwardations raise the costs of hedging for physical users ofthe market, sometimes prohibitively. They can also distort thevalidity of LME quotations as reference prices for the globalmetals industry. The LME’s Rules and Regulations give itconsiderable powers to prevent manipulation and punish anymembers who break those rules. Unfortunately, although it isrelatively easy for market participants to suspect when a price isbeing manipulated, proof is usually difficult. Also, the Exchangehas no jurisdiction over either the parallel physical market ornon-LME business. Squeezes may often be engineered in theover-the-counter market rather than in LME contracts, althoughthey find their full flowering in the behaviour of LMEquotations. The best defence against market manipulation is thegreatest possible transparency in all types of trade. Sincemid-1996 the LME has greatly increased the amount ofinformation that it publishes, but it always faces a difficultbalancing act. An excessive insistence on transparency couldlead to trade drying up or being driven offshore, or toover-the-counter markets that are outside the scope of anyregulation. That would not necessarily be in the users’ best long-term interests.

The LME’s main competitor, the New York MercantileExchange, has claimed that it has lost trade to the LME becausethe latter has been less tightly regulated. Close inspectionindicates that the methods of regulation in London and New Yorkare certainly very different, but that the LME is no less tightlycontrolled and policed than its US counterpart. The main reasonthat the LME captured most of the global business in non-ferrousmetals is that its contracts and methods of trading have beenmore suited to the needs of trade users than those operated inNew York. The LME’s main attractions include its system ofprompt dates, its extensive warehouse network and its creditrather than cash clearing. It also straddles the three main globaltime zones, picking up the close of business in Asian marketsearly in the day and overlapping with New York in the afternoon.Finally, the UK does not have a large domestic mining andsmelting industry with vested interests, but it has a long traditionof open markets and liberal trading. The Comex Division of theNew York Mercantile Exchange has much lower liquidity, withtrade concentrated on hedging by domestic US companies and onspeculative investment business. A considerable amount of itstrading is conducted on their own account by ‘locals’, rather thanfor trade clients. Arbitrage between the London and New Yorkmarkets has ensured that their respective prices rarely step too farout of line with each other.



The present systems will only survive, however, as long as themarkets’ users are content that they give prices that are properlyrepresentative of market conditions. The prices set are far morechaotic and seemingly more haphazard than producer pricingsystems, but more transparent and reflective of changing marketconditions.

Some criticise LME prices as being excessively volatile, underthe influence of investment in metals by financial institutions ofall types, often grouped under the general description of‘speculators’. Certainly, prices can move markedly even withinthe course of a day, let alone from one day to the next. Theexplosive growth of options-related business also appears to haveintroduced extra volatility. Much of that business, however, isconducted on the behalf of producers and fabricators insuringagainst adverse future price trends. To the extent that asignificant proportion of annual production is protected formonths (or even years) ahead, that much will be less responsivethan it might previously have been to weakening prices. Theprotected producers will have no immediate need to cut theiroutput because they are incurring cash losses. That in turn meansthat the burden of any excess supplies in recessions is thrownmore heavily than in the past on prices rather than volumes. Thatalone will give the appearance of increased price volatility, but itowes nothing to speculative activity. Any genuine evidence thatprices of non-ferrous metals have become more volatile in recentyears because of speculative activity is rather tenuous. Thosewho assert that prices have become more volatile have usuallylooked at trends over relatively short periods and have failed toallow fully for the many factors influencing prices.

RECENT TRENDS IN MINERAL MARKETS

At the start of the new millennium most sectors of the mineralsindustry seemed set for a prosperous decade. The majorinternational political tensions that had persisted since theSecond World War were largely resolved, market capitalism hadseemingly triumphed over more dirigiste systems and the globaleconomy was becoming increasingly unified. It had quicklyshrugged off the Asian crises of 1997-98 and had resumedapparently healthy expansion, inflation had been tamed, currencymarkets were relatively stable and oil prices remained subdued.Subsequent events showed that any complacency was sadlymisplaced and that turbulence was developing beneath anapparently smooth surface. Led by the US, the major industrialeconomies were on the brink of recession and new politicaltensions and uncertainties were developing in the world at large.

Demand for mineral products is driven by economic activity,which faltered in 2001 after a strong start to the decade.Figure 7.6 shows the annual rates of change of output, bothglobally and in the major advanced economies (Canada, USA,Japan, France, Germany, Italy and the UK) from 1998 onwards.

From 1999 onwards global growth was much greater than that ofthe advanced economies, but the world economy was knocked bythe latter’s recession in 2001-02. The upswing in 2003-04 wasunexpectedly strong, with overall activity rising rapidly in 2004.Growth continued in 2005 at a slower rate (InternationalMonetary Fund, 2005). The strength of global activity over theperiod owed much to the strength of the Asian economies,especially of China. The buoyant Chinese economy has been oneof the main forces driving demand for mineral products over thepast decade. Its share of world output (measured on a purchasingpower parity basis) rose from 10.2 per cent in 1988 to 13.2 percent in 2004. This has been partly at the expense of growthelsewhere, with Chinese exporters benefiting from a low cost baseand an undervalued currency, but it mainly reflects stronglygrowing internal demand, led by heavy investment in plant,equipment and infrastructure.

The relationship between overall economic activity and themineral and metals industry is brought out in Figure 7.7, whichcompares annual percentage changes in global GDP, the usage ofrefined copper and the output of crude steel. Although demandfor each mineral and metal product is driven by different end-usemarkets, all follow broadly similar trends. Many depend directlyon the performance of the steel industry. Copper usage grewparticularly strongly in 1999-2000 when the US economy wasbooming, but it fell in 2001 and grew more slowly than globalactivity in 2002-03. By contrast steel production was relativelyweak in 1998-99, but has grown much more strongly than globalGDP since 2001. Its strength derives from China’s burgeoningoutput, which increased by 23 per cent in 2004 alone. China’sproduction of crude steel rose from 115 Mt in 1998, under 15 percent of the total, to 272 Mt (26 per cent of global production) in2004. It accounted for 57 per cent of the growth in global steeloutput over the six year period. Inevitably this rapid growth hasspilled over into strongly increased demand for raw materialsfrom overseas and in that regard steel has been typical of mostminerals, including fuels.

A strong global economy not only boosted demand fornon-fuel minerals, but also for fuels including petroleum. Worlddemand for crude oil, shown in Table 7.5, rose by 3.4 per cent in2004 (the largest percentage increase for many years) forcingdemand against the constraints of effective capacity. Iraq’s outputhad not recovered from the ravages of war and some members ofOPEC held back production. The OECD countries, led by theUS, raised their consumption in 2003 and 2004 after severalyears of stagnation. The US accounts for 25 per cent of globaloff-take, OECD Europe for 19 per cent and Japan for seven percent. China (eight per cent) and India (three per cent) were majorcontributors to the 6.7 per cent rise in non-OECD demand.



0

1

2

3

4

5

6

1998 1999 2000 2001 2002 2003 2004 2005

World

Major advanced economies

%p

er

an

nu

mch

an

ge

FIG 7.6 - The growth of economic activity (gross domestic product),1998-2005. (Source: International Monetary Fund, 2005.)

-4

-2

0

2

4

6

8

10

1999 2000 2002 2003 2004

World GDP Refined copper usage Crude steel output

%ch

an

ge

on

pre

vio

us

ye

ar

20011998

FIG 7.7 - Global GDP, copper usage and steel output, percentageper annum changes 1998-2004. (Sources: International MonetaryFund, 2005; International Copper Study Group, 2005; International

Iron and Steel Institute, 2005.)

The effects of this strong growth of demand on prices wereaccentuated by existing political tensions in the Middle East andby fears that unrest is spreading to major producers like SaudiArabia. Speculative pressures were further influences in drivingcrude oil prices up to their highest levels in real terms since the1970s. In money terms, prices have never been higher. Theirbehaviour from 1999 onwards, as expressed in the spot price ofBrent crude on the International Petroleum Exchange in London,is illustrated in Figure 7.8.

Prices had weakened in 2001-02 in response to recession, withthe attack on the World Trade Centre in September 2001 havingno real impact. The Iraq war caused a minor blip in 2003, butprices really only started to rise strongly during 2004. Whereasprices around the $30/barrel level had been regarded asacceptable, their rise to over $50/barrel has raised concerns aboutpossible adverse effects on global inflation and levels ofeconomic activity. Forecasts of economic growth wereconsequently being shaved down in early 2005. Not only do highoil prices have potentially adverse effects on demand for mineralproducts but they also directly raise production costs.

In part, the rise in oil prices was initially justified by anaccompanying weakening of the US dollar in currency markets.Some oil producing countries tailored their supply in order toraise prices sufficiently to offset the dollar’s decline, but suchfine-tuning is seldom possible. The performance of the US dollarhas been a major influence on the prices of all internationallytraded mineral commodities. Figure 7.9 plots two measures ofthe real effective exchange rate since January 1998. Itstrengthened by 21 per cent against a weighted average basket ofmajor currencies (those of Australia, Canada, ‘Euroland’, Japan,Sweden, Switzerland and the UK) between October 1999 andFebruary 2002. It followed a similar trend, but to a less markedextent against the currencies of a much larger group of its tradingpartners, partly because some of those currencies are pegged tothe dollar itself.

Prices of most minerals and metals are denominated in USdollars and the US exchange rate is a strong influence on thoseprices. Other things being equal, a strengthening of the US dollarleads to falling dollar prices, and a weakening dollar to risingdollar prices. Many producers whose currencies strengthenedagainst the dollar also saw rising costs and falling margins in2000-02 to the point where they were forced to suspend or curtailoperations. The adverse impact of the currency squeeze wasaccentuated by the simultaneous weakening of demand becauseof recession. Capital spending of all types, but especially onexploration and grassroots projects, was pared back as theindustry strove to minimise costs. These years witnessed a surgein mergers and consolidations in many sectors of the industry,with a pronounced peak in 2001 (Raw Materials Group, 2004).

The gold industry was especially hard hit by weak prices in thelate 1990s and early 2000s. Exploration spending of all types, butespecially on gold, had peaked in 1997, and it subsequentlyplummeted, not just in response to weak markets, but alsobecause of the adverse effects of the Bre-X fraud (where a goldproject in Indonesia had been hyped on the basis of non-existentore reserves) and the competing lure for speculative investors ofdot com projects. The trough in exploration spending wasreached in 2002, with that on gold down from 1997’s US$ 2.6billion to under US$ 0.8 billion. Exploration for other productsdropped from US$ 2.5 billion to US$ 1.1 billion over the sameperiod. The recovery in prices from their recessionary troughbrought a corresponding revival of exploration, with spending ongold rising to US$ 1.9 billion in 2004, and that on other productsup to US$ 3.8 billion (Metals Economics Group, 2005).

The inverse relationship between real US dollar exchange ratesand gold prices is illustrated in Figure 7.10. Gold prices averagedbelow US$ 400 per ounce throughout the 1990s and had fallensharply from 1996. The recovery began in late 2001, after theattacks on the World Trade Center, and it was fostered not just bythe weakening US dollar, but also by rising internationaltensions. Rising oil prices and fears of resurgent inflation gave anadded boost from late 2004.

Prices of non-ferrous metals lagged behind gold prices in2002-03. In some cases capacity had outstripped demand,notwithstanding mine and plant closures and cutbacks. Therewere also large inventory overhangs, particularly in the mostvisible form of Exchange stocks. Their existence initiallymoderated the impact of improving supply/demand balances onprice levels. Table 7.6 shows the end-year levels of LMEwarehouse inventories from 1998 onwards.

LME warehouses are not the only sources of readily availablemetal and stocks have moved substantially within each year.Nonetheless, Table 7.6 gives a broad indication of the changingpressures of demand for the various metals. They all danced tothe beat of economic activity, but with different timings andvariations. Speculative activity by financial institutions of alltypes, including hedge funds, may have hastened (and evenenhanced) some price rises, but the basic determinants were



Year World OECD Non-OECD

1998 74.7 46.6 28

1999 76.1 47.4 28.8

2000 76.9 47.6 29.3

2001 77.4 47.5 29.9

2002 78.2 47.6 30.6

2003 79.6 48.1 31.5

2004 82.3 48.8 33.6

TABLE 7.5World oil demand (million barrels per day).

(Source: International Monetary Fund, 2005.)

0

10

20

30

40

50

60

1999 2000 2001 2002 2003 2004 2005

US

$/b

arr

el

FIG 7.8 - Monthly average prices of crude oil (US$/barrel forBrent crude). (Source: International Petroleum Exchange, 2005.)

80

90

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130

1998 1999 2000 2001 2002 2003 2004 2005

Ind

ex

nu

mb

ers

.Jan

ua

ry1

99

8=

10

0

Major currencies

US trading partners

FIG 7.9 - Effective monthly average real exchange rates of theUS dollar. (Source: US Federal Reserve Board, 2005.)

improving demand and a weakening US dollar. Figure 7.11shows the behaviour of a weighted average index of non-ferrousmetal prices from the start of 1999. Prices rose during 1999, butlevelled out in 2000 and fell back between September 2000 andlate 2001. The recovery did not really get into its proper strideuntil after May 2003.

That the rise in prices sprang from much more than speculativeactivity in a terminal market was shown by the simultaneousimprovement of the prices of many minor metals, of industrialminerals and of bulk minerals, including coal and iron ore. Thelatter two have greatly benefited from China’s burgeoningdemand, but their latest price increases should be judged againsttheir lacklustre performance for much of the preceding decade.Whereas the non-ferrous metals are priced on terminal markets,which provide both opportunities for hedging price risk and amarket of last resort, producers of bulk minerals have neither.

Until recent years, demand grew relatively slowly and producerswere fairly reluctant to invest in capacity in anticipation of futuresales. In consequence the 2003-04 spurt in demand createdsupply bottlenecks and suppliers seized their advantage withsharp price rises. Mine expansions and new capacity are underconstruction that will improve the market balance within a fewyears, but markets will remain tight in the interim. ContractualUS dollar prices of internationally traded thermal coal rose bynearly 70 per cent in 2004, whilst those of coking coal rose byabout 26 per cent in 2004 and by roughly 116 per cent for 2005deliveries. Prices of iron ore also jumped for 2005 deliveries, butby a more modest 71.5 per cent. Even allowing for theweakening of the US dollar, producers are earning handsomeprofits at these prices and potential new entrants are jostling forposition. Figure 7.12 compares yearly index numbers of prices ofiron ore and of base metals. Iron ore had lagged until the 2005price settlements.

Many commentators in late 2004 and early 2005 wereheralding a lengthy period of strong prosperity for the metals andminerals industry. Few had properly observed the lessons ofhistory that barriers to entry are fairly low and that demand isdependent not just on the performance of a single country(however bright its prospects might seem) but on a complexinterplay of global forces. Profitability depends on the ratiobetween prices and costs and many of the factors that loweredcosts in the preceding decade or so have worked themselves out,or have even reversed.

REFERENCESBritish Petroleum, 2004. BP statistical review of world energy [online].

Available from: <http://www.bp.com>.International Copper Study Group, 2005. [Online] <http://www.icsg.org>.International Iron and Steel Institute, 2005. [Online]

<http://www.worldsteel.org>.International Monetary Fund, 2005. World economic outlook database,

April [online]. Available from: <http://www.imf.org>.International Petroleum Exchange, 2005. [Online] <http://www.ipe.com>

now listed under Intercontinental Exchange: <http://www.theice.com>.London Bullion Market Association, 2005. [Online]

<http://www.lbma.org.uk>.London Metal Exchange, 2005. [Online] <http://www.lme.co.uk>.Metal Bulletin, 2005. [Online] <http://www.metalbulletin.com>.Metals Economics Group, 2005. [Online]

<http://www.metalseconomics.com>.Mining Journal, 2005. [Online] <http://www.mining-journal.com>.Raw Materials Group, 2004. Database, May, Stockholm, Sweden.Smith, A, 1976 [1776]. An Enquiry into the Nature and Causes of the

Wealth of Nations (eds: R H Campbell, A S Skinner and W B Todd)(Oxford University Press: Oxford).

The Economist, 2005. [Online] <http://www.economist.com>.US Federal Reserve Board, 2005. [Online] <http://www.federalreserve.gov>.



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35796 35977 36161 36342 36526 36708 36892 37073 37257 37438 37622 37803 37987 38169 38353

Gold price

Ind

ex

nu

mb

ers

Ja

nu

ary

19

98

=1

00

FIG 7.10 - Index numbers of monthly average gold prices and realeffective exchange rates of the US dollar against major currencies.(Source: US Federal Reserve Board, 2005; London Bullion Market

Association, 2005.)

Year Aluminium Copper Lead Nickel Tin Zinc

1998 635 592 108 66 8 317

1999 774 790 176 47 9 279

2000 322 357 131 10 13 195

2001 821 799 98 19 31 433

2002 1241 856 184 22 26 651

2003 1423 460 109 24 14 740

2004 695 49 40 21 8 629

TABLE 7.6Inventories in LME warehouses at year-end, 1998-2004

(thousands of tonnes). (Source: London Metal Exchange, 2005.)

70

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Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05

Ind

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FIG 7.11 - The Economist index of non-ferrous metal prices.Monthly averages, 2000 = 100. (Source: The Economist, 2005.)

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Iron ore(Hamersley fines to Japan f.o.b.)

Non-ferrous metals

(The Economist index)

Ind

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=1

00

FIG 7.12 - Index numbers of prices of iron ore and non-ferrousmetals, re-based on 1999 = 100. (Sources: The Economist, 2005;

Metal Bulletin, 2005; Mining Journal, 2005.)

http://www.bp.com

http://www.icsg.org

http://www.worldsteel.org

http://www.imf.org

http://www.theipe.com/

http://www.theice.com

http://www.lbma.org.uk

http://www.lme.co.uk

http://www.metalbulletin.com

http://www.metalseconomics.com

http://www.mining-journal.com

http://www.economist.com

http://www.federalreserve.gov

cl3 minerals markets prices and the recent performance of the mineral and energy sector

Documents

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