Finding the lowest-cost producer is becoming increasingly important in the mining industry. Prices for base metals are high. Some of this comes from supply/demand dynamics. And some is the result of inflation (a deteriorating U.S. dollar.) Either way, the price signals in the resource market are telling producers to produce more. And normally, producers would do just that, expanding capacity and, eventually, bringing down prices with increased supply.
Only producers are hitting a snag: energy costs. Rising energy costs are taking a bigger and bigger bite out of mining profits. So far, it has not discouraged producers from beginning new projects. But it's a real issue in the high-profile bidding war for resource stocks.
Take Alcoa's bid for Alcan. Both produce aluminium. Producing aluminium is energy intensive. It's no accident that Canadian hydro-power is a key ingredient in Alcan's ability to produce at a relatively low cost.
What other major multi-national metals and mining firms enjoy access to low-cost hydro-power. BHP (ASX:BHP)? Rio (ASX:RIO)? Certainly not. Both Aussie firms have ambitious plans to expand production here and abroad. But what effect will rising energy costs have on the economics of future projects? And more importantly, what effect will rising energy costs have on the share prices of these big producers?
We ask the question because we're clearly at the point, as resource investors, where finding the lowest-cost producer is a key factor in any long-term investment. It might not be so important for junior exploration firms, which have no intention to produce anyway. But it's certainly important for any outfit that tells you its going to cash in on high metals prices by producing from a new mine. That is a costly, capital intensive proposition these days. Not just anyone can pull it off.
Dan Denning
The Daily Reckoning Australia
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About the Author
Dan Denning is the author of 2005's best-selling The Bull Hunter (John Wiley & Sons). He began his financial publishing career in 1997 and has covered financial markets form Baltimore, Paris, London and, beginning in 2005 Melbourne. He’s the editor of The Daily Reckoning Australia and the Publisher of Port Phillip Publishing.
