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WORKING DRAFT Last Modified 18/09/2017 17:50 Romance Standard Time Printed This report is solely for the use of client personnel. No part of it may be circulated, quoted, or reproduced for distribution outside the client organization without prior written approval from McKinsey & Company. This material was used by McKinsey & Company during an oral presentation; it is not a complete record of the discussion. Where do we go from here? The Market Forces Changing Mining Outlook for Key Commodities EXPOSIBRAM Belo Horizonte September 2017

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Page 1: Where do we go from here?portaldamineracao.com.br/wp-content/uploads/2018/... · This report is solely for the use of client personnel. No part of it may be circulated, quoted, or

WORKING DRAFT

Last Modified 18/09/2017 17:50 Romance Standard Time

Printed

This report is solely for the use of client personnel. No part of it may be circulated, quoted, or reproduced for distribution outside

the client organization without prior written approval from McKinsey & Company. This material was used by McKinsey &

Company during an oral presentation; it is not a complete record of the discussion.

Where do we go from here? The Market Forces Changing Mining

Outlook for Key Commodities

EXPOSIBRAM

Belo Horizonte September 2017

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2McKinsey & Company

The Boom & Bust cycle is here to stay

Since 2005, the mining sector went through 5 massive price swings (boom & bust)

▪ Conventional wisdom often tries to describes these events as “demand driven”

▪ Real commodity demand however is robust, and X-rates, oil prices,.. have far bigger impact on prices

as they create swings in marginal cost structures of +/- 25%. These price swings induce supply shifts,

(sometimes also demand shifts), which will feed the next price correction

▪ Price bands are very wide. The 85% confidence interval (for historic prices over a 15 yr cycle), goes

from X to 2X for primary commodities, and from X to 4X for by-product commodities. In other words, a

gold price outlook could be 1100 to 2200 USD/oz, silver could be 10 to 40 USD/oz.

▪ Average prices over a cycle do not respond to a price regime or archetype. They are neither

cash cost, nor incentive prices. They are typically 30% (20%-40%) above cash cost (e.g., floor prices).

Floor prices (and hence the price bands) inflate with average productivity declines in the industry

when measured over longer periods in time (10 years). Until 1995, the opposite was true, prices

declined in line with historic productivity gains.

▪ Pricing regimes for most commodities are now improving. In absence of demand catalysts, price

recoveries are supported by differentiated supply stories (China cuts and/or depletion and grade

erosion). We favor “exploration” dependent commodities, but beware of the next hype (Lithium, Co,..)

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3McKinsey & Company

The mining sector has been fundamentally reshaped,

but has also become more volatile, and more vulnerable

600

400

200

1,200

1,600

1,400

1,000

800

0

1990 92 94 12

21% p.a.

10060402 0896 98 00

-6% p.a.

0% p.a.

SOURCE: McKinsey Mining Model

14 16

REVENUES AND EBITDA OF THE GLOBAL MINING INDUSTRY

USD billions (nominal)

“Supercycle up”Steady State “Supercycle down” SUPERCYCLE UP

50% volume

growth (75%

of this from

China demand)

50% drop in

mining

productivity

Mega-swings in

Forex/oil prices

Revenue

EBITDA

Volumes: +4% p.a.

Prices: +16% p.a.

Volumes:

+10%

Prices:

-35%

5McKinsey & Company

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4McKinsey & Company

High volatility

▪ Since 2011, drop of 71

MPI points, versus 50

in 2008/09

▪ Stagnating demand in

2015 and strengthening

USD in 2014/15 leading

to 2009 pricing

or worse

▪ Commodities priced

below cash cost

in 2015

▪ MPI of 55 (absolute

bottom; “zero EBITDA”)

reached

in Dec ‘15/Jan ‘16

▪ Low price levels start

triggering production

cutbacks (1H’16)

▪ Back to normal

in ’17?

Extreme volatility is here to stay

SOURCE: McKinsey Mining Model

8588

126

109

40

130

20

90

50

10

100

120

80

110

70

60

30

0

2017

55

2015 2016

65

201420132008

59

201220112009

MONTHLY PRICE-INDEX FOR THE GLOBAL MINING INDUSTRY

1 MPI = 1 USD billion/month revenue

Price Bust in ’15/16 despite

volume Boom

Greenfield

expansions

Production

cutbacks

Fly-up zone with

price pull-back

Index

6McKinsey & Company

2010

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5McKinsey & Company

Mining productivity (total factor

productivity and geological factors)

is a key driver of price performance

and revenue development

SOURCE: McKinsey Basic Materials Institute (BMI Mining Model); MPI study 2015

0

120

140

80

100

160

-4.0% p.a.

+1.0% p.a.

08 12

-7.2% p.a.

201410200405 06 09 11 1307

07 20141009 1205 131108

-2,6% p.a.

062004

100

150

200

11 13

-0.8% p.a.

-10.1% p.a.

2014122004 06 10080705 09

Global Mine Productivity (Calculated)

Grade Erosion

Typical productivity growth in

manufacturing sector of 2-3% p.a.

Total Factor Productivity (MPI)

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6McKinsey & Company

1 Includes copper, aluminum, iron ore, tin, nickel, zinc, lead, and uranium price indices

Volumes

Oil price

(WTI)

-5-23

-10-4-17

14

48

-19-8

17

56

223512

-3-10

0-16

03

-8

5

-5-5

7910

1020

5

-3

0604 05 09 10 13072001 0302 08 11 12 20161514

-12

-48

-5

4

-1

2029

-38

38917

363319

1

-15

1

00

5569

-2

154565

22

Comparison of price drivers

Year on year change, percentage

Contrary to common belief, the boom/bust cycle was not shaped by demand —

forex, oil prices and growing (over) supply contributed significantly

SOURCE: IMF, McKinsey Global Institute, McKinsey Basic Materials Institute

US$/Euro

IMF Metals

Price Index1

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7McKinsey & Company

Global Mining RevenueNominal Currency (USD)

SOURCE: McKinsey Mining Model

321

1,200

600

800

1,400

400

1,600

200

0

1,000

1,170

2003 07 0804 0605

1,309

11 1612 20171513 14

1,090

1,593

1009

863

US Dollar

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8McKinsey & Company

Global Mining RevenueNominal Currency (USD)

SOURCE: McKinsey Mining Model

321

1,200

600

800

1,400

400

1,600

200

0

1,000

1,170

2003 07 0804 0605

1,309

11 1612 20171513 14

1,090

1,593

1009

863

US Dollar

• Demand boom (4% pa)

• Productivity decline

(-10% pa)

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9McKinsey & Company

Global Mining RevenueNominal Currency (USD)

SOURCE: McKinsey Mining Model

321

1,200

600

800

1,400

400

1,600

200

0

1,000

1,170

2003 07 0804 0605

1,309

11 1612 20171513 14

1,090

1,593

1009

863

US Dollar

• Week USD

• Peak oil

• Demand boom (4% pa)

• Productivity decline

(-10% pa)

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10McKinsey & Company

Global Mining RevenueNominal Currency (USD)

SOURCE: McKinsey Mining Model

321

1,200

600

800

1,400

400

1,600

200

0

1,000

1,170

2003 07 0804 0605

1,309

11 1612 20171513 14

1,090

1,593

1009

863

US Dollar

• Weak USD

• Peak oil

• Demand boom (4% pa)

• Productivity decline

(-10% pa)

• Strong USD

• Weakening Oil

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11McKinsey & Company

863

321

834

600

1,000

1,600

800

0

200

1,400

1,200

400

1,046

1,170

0504 0807062003

372

1,597

1,282

2017

1,309

161512

1,593

10

1,090

1,260

141309 11

Global Mining Revenue RevisitedNominal Currency (USD; GMU)

Global Mining Unit

US Dollar

SOURCE: McKinsey Mining Model

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12McKinsey & Company

863

321

834

600

1,000

1,600

800

0

200

1,400

1,200

400

1,046

1,170

0504 0807062003

372

1,597

1,282

2017

1,309

161512

1,593

10

1,090

1,260

141309 11

Global Mining Revenue RevisitedNominal Currency (USD; GMU)

Global Mining Unit

US Dollar

SOURCE: McKinsey Mining Model

▪ The Global Mining

Unit is a currency

basket made

up from major

“commodity”

currencies,

proportional to their

share in the global

mining revenue

▪ In GMU-terms,

neither the peaks

of 2011/12, nor

the crisis of 2015/16

appear. These were

largely due to USD

volatility since 2009.

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13McKinsey & Company

Copper Price DevelopmentNominal Global Mining Units per ton (and not USD) Copper Price

SOURCE: McKinsey Mining Model

▪ Modest volume

growth Modest

productivity declines

▪ Oil price decline

▪ Modest oversupply

(high-grading)

▪ Easing over-supply

▪ Medium volume

growth

▪ Sharp productivity

and grade decline

▪ Early “resetting

of the cost curve”

▪ Oil price increase

5,000

10,000

11,000

8,000

7,000

9,000

6,000

3,000

0

4,000

6,473

3,533

+1% p.a.

1613

+10% p.a.

201712

7,500

1411

6,973

10 15

6,863

09

4,985

0807

6,335

0605

2,061

042003

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14McKinsey & Company

Gold Price DevelopmentNominal Global Mining Units per Ounce (and not USD)

SOURCE: McKinsey Mining Model

▪ Large productivity

loss

▪ Gradual “resetting

the cost curve”

▪ Speculative bubble

▪ Oil price increase

Gold Price (GMU)

421

2,200

1,600

400

0

2,000

1,800

1,400

1,200

1,000

800

600

200

+4% p.a.+10% p.a.

1,555

20171605 07 1309

1,437

04

1,692

14 15

779

12062003 1008 11

▪ Demand curve shift

▪ Changing investor

sentiment

(worsening, more

recently improving)

▪ Oil price decline

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15McKinsey & Company

Thermal Coal FOB Export Price DevelopmentNominal Global Mining Units per ton (and not USD) Thermal Coal

Export (GMU/t)

SOURCE: McKinsey Mining Model

110

93

116

80

100

140

60

0

180

20

160

120

40

05

71

08200304 1409

+9% p.a.

1613

35

49

201715

+3% p.a.

07 1206

69

1110

▪ Oil price increase

impacting supply

curve & demand

curve

▪ Oil and gas

price decline, again

impacting supply &

demand curve

▪ Easing over-supply

(China,..) for now?

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16McKinsey & Company

Iron Ore FOB Price DevelopmentNominal Global Mining Units per ton (and not USD) Iron Ore (FOB; 62%)

SOURCE: McKinsey Mining Model

▪ Demand boom

and dropping

productivity (resetting

supply curve &

demand curve)

▪ New supply flattening

the cost curve

▪ Productivity gains

by majors

▪ Easing hi-grade over-

supply (China,..) for

now

80

124

94

160

180

60

140

120

0

100

20

80

40

16111008 09

+10% p.a.

1505 12 14

5660

0706042003

22

2017

-7% p.a.

13

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17McKinsey & Company

Expected evolution of price regimes

Based on Value Pool Model20202015 Based on average pricePrice regime Based on Qualitative Model2025

Divergent expectation for each commodity’s price regime in the short/long

run, mostly due to supply factors

Brownfield GreenfieldCash cost

2020 2025Aluminum Spot2015

20202025Gold Spot2015

2025 2020Seaborne thermal coal Spot2015

2020 2013Seaborne iron ore Spot20252015

Seaborne coking coal 20202025 Spot2015

2025Nickel 20202015 Spot

20202015 2025Phosphate rock Spot

2020 20152025Potash Spot

Fly-up

Alumina 20202025 Spot2015

2015 2025Copper Spot 2020

20202015 2025Zinc Spot

SOURCE: McKinsey Mining Model

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18McKinsey & Company

REVENUES AND EBITDA OF THE GLOBAL MINING INDUSTRY

USD billion (real as of 2017)

1.000

2.000

500

2.500

0

1.500

1006 14 18

11% p.a.

16% p.a.

Revenues

2422

1% p.a.

02981990 94

Robust price & volume recovery ahead, potentially

with some margin pressure

SOURCE: McKinsey Mining Model

Weakening $ Strong $

Revenues

EBITDA

▪ “Middle class”

consumers

underpinning

demand

▪ Revenue growth of

around 5-6%

in next cycle (2018 -

25)

▪ Robust EBITDA,

aided by “cheap”

oil and price

recovery

▪ Significant volatility

risk (+/- $250 b)

from USD AND

China: “the $ is

trying to ride a

Chinese tiger”