Beware lure of shiny commodities boom

The Treasury’s view on the outlook for commodity prices will be unusually closely watched when the medium-term budget is presented next month.

Government revenue this year is expected to run at least 10% ahead of February’s budget estimates, thanks mainly to the commodity price boom and the huge boost it gave mining company profits in the first half of this year. The pressure is on to announce big new items of government spending, including on a basic income grant, and the rosy revenue picture will make it hard to fend off those demands.

But it is dangerous for any country to commit to permanent, structural increases in spending based on temporary, cyclical increases in revenue. And with the price of

SA’s particular basket of commodities now about 19% off its spectacular May peak, the question is how temporary is temporary? Is this a new supercycle or just an ordinary old cycle?

Earlier this year there was much talk of a supercycle, a 10to 35-year stretch in which commodity prices stay above their long-term average. And where the previous supercycle that ended in 2012 was driven by China’s industrialisation and urbanisation, this new one would be led by the green energy transition. But the supercycle talk has dwindled as prices have come off and the big picture has become more complicated to call. There is a high degree of uncertainty about the two main drivers of the recent commodities boom — the effect of the Covid-19 pandemic on supply and demand, and the energy transition — and how they will play out in coming months and years.

And the smaller picture for SA is tough to call too, with the outlook clouded lately for the commodities that matter most to our tax and export outlook — particularly the platinum group metals, (PGMs) iron ore and coal.

Take PGMs, of which SA has the world’s largest share (and in the case of rhodium, whose price went wild earlier this year, the only share). They are “green” metals, essential for the autocatalysts that clean petroland diesel-powered vehicle emissions — and for the hydrogen economy of the future — and prices hit exceptional levels at this year’s peak. As with other commodities globally, a dearth of investment in new mining capacity in recent years has constrained supply, and SA’s own production woes in 2020 added to the pressure.

But SA’s PGM basket price is down about 20% for this year to date. That’s mainly because of the global chip shortage and other supply chain issues holding back vehicle production. By the time those resolve, interest rates may have gone up and appetite for new cars may have fallen. The bigger concern, however, is that electric vehicle penetration is picking up much faster than expected, narrowing a window of opportunity for PGMs that had been expected to run for another decade or more.

Even so, PwC’s Andries Rossouw points out that PGM prices are still 40% higher than they were two years ago, and 80% higher than four years ago. Producers are seeking new uses for the metals. The party is not over yet.

It isn’t necessarily over for iron ore either, even though prices are down about 25% year to date. That’s primarily because demand from China has collapsed, with Chinese steel production down 20% on its May peak because of property woes, slowing growth and energy shortages. There’s talk of the world heading towards “peak steel”, though some see the US infrastructure drive reviving demand. And iron ore producers are still making good money at $125/tonne, says Ninety One’s Unathi Loos, even if it’s well off peaks of $235/tonne.

Ironically, it’s coal where prices continue to shoot the lights out, with thermal coal prices up almost 190% year to date. In a greening world, noone is investing in new coal supply — but demand for coal has increased, from China as well as from gas-short Europe.

Even if demand falls off again after the northern hemisphere winter, coal prices could still average 50% more in the next decade than in the last one. Trouble is, SA’s producers can’t get their coal to the port, because of the shambles at Transnet, which is costing the country tens of billions in lost exports and lost revenue. And while the supply-demand mismatch could keep prices high for a while yet, coal’s years are numbered.

Meanwhile, however, mining companies’ soaring profits helped corporate income taxes (CIT) to outperform February’s budget estimates by a wide margin in the first five months of this fiscal year. The Treasury doesn’t publish figures on how much of CIT comes from the mines, but we do know that R15.5bn of mining royalties were collected in the first five months, not far short of the R15.9bn that had been budgeted for the whole year.

Absa economist Peter Worthington expects total government revenue to overshoot budget estimates by

IRONICALLY, IT’S COAL WHERE PRICES CONTINUE TO SHOOT THE LIGHTS OUT

R169bn this year, with the overshoot carrying into next year. Some are more wary, not just because the price outlook for the rest of this fiscal year is uncertain but also steeply rising costs, particularly of the diesel that powers platinum, iron ore and coal mining trucks, could affect miners’ profitability — as indeed could logistics problems. And its profitability rather than prices alone that drive the level of tax and royalty collections.

Those are factors the Treasury will need to take into account as it sets out its revenue projections for the three years of the medium term. But it needs also to take a view on the long-term outlook for commodities, and whether SA will still be able to afford shiny new spending commitments when the downcycle comes.