Share Name Share Symbol Market Type Share ISIN Share Description
Glencore LSE:GLEN London Ordinary Share JE00B4T3BW64 ORD USD0.01
  Price Change % Change Share Price Bid Price Offer Price High Price Low Price Open Price Shares Traded Last Trade
  -2.15p -0.63% 341.30p 342.00p 342.15p 347.80p 341.65p 345.65p 30,031,274 16:35:11
Industry Sector Turnover (m) Profit (m) EPS - Basic PE Ratio Market Cap (m)
Mining 123,859.6 -444.6 8.1 43.9 49,129.25

The Magic Behind Glencore's Recovery: Mastering the Zinc Market

17/03/2017 2:32pm

Dow Jones News


Glencore (LSE:GLEN)
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6 Months : From Feb 2017 to Aug 2017

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By Scott Patterson and Timothy Puko 

Glencore PLC Chief Executive Ivan Glasenberg says his company is reaping the rewards of a bold and risky strategy: Using its dominance of the zinc market to orchestrate a supply shortfall and send prices vaulting.

Zinc prices jumped 7% on the day in October 2015 when the Switzerland-based miner and commodity trader said it was shutting down production amounting to 4% of global production of zinc. Prices for the steelmaking ingredient have climbed 70% since as demand outpaces supply, outperforming copper (up 15%) and aluminum (up 20%) during a broad-based global commodities rally.

Mr. Glasenberg is outspoken about Glencore's approach to managing supply and thus market prices, something that is typically verboten for mining executives, who are wary of complaints about market power.

"When we cut back our zinc production, we looked at the benefit it had on the rest of our zinc production," Mr. Glasenberg said on an earnings call last month. The result for prices: "A very positive effect," he said.

While the prices of zinc and other commodities have been powered by Chinese demand, analysts said zinc's greater buoyancy was a demonstration of one company's market power that is rare in the commodity market. Other miners such as Rio Tinto PLC and BHP Billiton Ltd., which have large positions in iron ore, have decided against pulling back production to lift prices.

On the earnings call, Mr. Glasenberg said zinc prices had fallen so low in 2015 that it made more sense to keep it in the ground for the long run. He credited zinc's price rise with Chinese demand and "voluntary cutbacks" of supply like Glencore's, "one of the leaders in that area."

Analysts agreed. The price rally has "been driven by Glencore's decision, " said Vivienne Lloyd, a metals analyst at investment bank Macquarie Group.

Glencore has said it can pull it off because it combines one of the world's largest mining divisions with a savvy commodity-trading house.

Glencore is the world's largest zinc miner, accounting for 8% of global mined output, according to Macquarie, ahead of Teck Resources Ltd. (6%) and Vedanta Resources PLC (4%). Glencore also controls about half the world's trading of zinc metal and the raw material that makes it, excluding domestic Chinese production, according to Wood Mackenzie and other analysts, roughly the same level it last publicly disclosed in 2011.

The company began mining zinc in the 1980s, when the firm was run by the late financier Marc Rich. Its acquisition of miner Xstrata in 2013 expanded its production assets in a heavily traded metal that is expected to become more widely used in developing economies such as India and China. Zinc is a key ingredient in U.S. pennies and is used as an anti-rust coating on many automobiles.

At about $2,800 a ton, zinc prices are historically high, though still about 35% below their peak in late 2006.

The rising costs can translate into higher auto prices and make steel used for construction more expensive. In the lightly regulated global zinc market, there are few rules governing a company's market share beyond some countries' antitrust regulations for mergers.

Instead, international commodity traders and miners generally resist cutting output for fear of losing market share to competitors. Miners like BHP and Rio Tinto say they have focused on producing the cheapest iron ore instead of holding back output to increase prices.

Glencore is different.

Zinc traders often compare Glencore to the Organization of the Petroleum Exporting Countries because, like the oil cartel in the 1970s and 1980s, it controls what is known as marginal supply. That means it can produce enough of a product -- or withhold enough of it -- to send supply and demand into a surplus or deficit.

For example, Mr. Glasenberg said in February that Glencore calculated that reducing its zinc production to one million annual tons from 1.5 million annual tons could move the price "a certain amount for you to get the benefit."

Analysts at Macquarie estimate that the zinc market is currently in a short supply of about 500,000 tons a year, equal to the amount Glencore cut in 2015.

Glencore has ways of offsetting revenue it might lose from the production cuts. It says its trading arm can make money no matter which direction commodity markets are moving in, making up for weaker commodity prices.

"They will know where people want zinc, they will know where people can get their hands on it, and they'll run zinc around the world," said Clive Burstow, investment manager at Baring Asset Management, which bought shares of Glencore last year.

Glencore's zinc supremacy is illustrated at its San Juan de Nieva plant in northern Spain on the Bay of Biscay. The world's second-largest zinc smelter produces about half-a-million tons of nearly pure metal a year.

But Wood Mackenzie estimates that about 200,000 tons of zinc sit unsold there, showing that even when zinc is produced, Glencore doesn't have to sell it. A Glencore spokesman declined to comment on the estimate.

Glencore also enjoys extremely low production costs at its zinc mines, which can pump out the metal at essentially zero expense in part due to added revenues they get from gold byproducts.

The company's zinc shutdowns were announced at about the same time it launched a comeback plan from a disastrous summer 2015, when investors concerned about its high debt sent the firm's share price down to record lows.

Glencore returned to profit in 2016, with net earnings of $1.4 billion thanks in part to zinc, which was responsible for 26% of its mining arm's earnings before interest, taxes, depreciation and amortization, according to securities filings.

Rising prices for coal and copper -- two of its biggest earnings drivers -- strong trading gains, and billions in cost cuts and asset sales were also instrumental in its comeback. Glencore cut its net debt almost in half to less than $16 billion, leading S&P Global Ratings to upgrade the company's credit and call its outlook positive.

The zinc strategy has risks. As prices rise and production becomes more profitable, other miners are more likely to increase output or restart idled operations, pumping more supply into the market, said Morgan Stanley analyst Menno Sanderse.

If demand in China cools unexpectedly, prices could plunge. Mr. Glasenberg has said he expects demand in China to remain strong, but he also said in February: "We don't understand China, exactly what may or may not happen from one day to the next."

Mr. Glasenberg has said Glencore also tried to lift copper and coal prices with supply cuts, though with less effect on those larger markets.

Write to Scott Patterson at scott.patterson@wsj.com and Timothy Puko at tim.puko@wsj.com

 

(END) Dow Jones Newswires

March 17, 2017 10:17 ET (14:17 GMT)

Copyright (c) 2017 Dow Jones & Company, Inc.

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