Base metals, steel outlook becoming negative as growth and demand weaken

S&P says the credit outlook for Europe’s mining and steel sectors is becoming negative, as demand weakens, and economic development in emerging markets slows.

RENO, NV - 

Standard & Poor's says the credit outlook in the European mining and steel sectors is becoming negative, "pressured by vulnerable prices, higher costs, and tightening liquidity."

"Demand in the developed markets of Europe and the U.S. is weakening, and concerns are growing that economic growth in emerging markets is also slowing," S&P Primary Credit Analyst Alex Herbert and Secondary Credit Analysts Elena Anankina and Trevor Pritchard said.

"Market prices for many base and precious metals are declining-some sharply, thought prices for bulk commodities remain high. Input costs have risen considerably, especially in steel, and, after a significant rise in steel prices in response, prices are now turning down," they said, noting that "large scale spending on capital expenditures and acquisitions continues to consumer cash flows.:

"Even risks remain, notably from merger and acquisition activity, where the willingness to pursue quite large transactions persists, albeit at a lower level than in recent years, but where the ability to close them has become more difficult."

The analysts advised that "liquidity is a growing concern, as access to debt and equity capital markets is still tight and expensive, especially for lower-rated issuers, against a backdrop of highly turbulent credit markets."

S&P advised that metals markets present a mixed picture. "In exchange traded base metals, copper and aluminum prices have seen a notable sell-off over the summer months. ...Nevertheless, prices for both metals-especially copper-remain higher than longer-term averages. " While nickel, lead and zinc spot prices remain weak and more than 50% below their bull-market peaks, the analysts said those prices remain higher than in the past.

"The brightest segment in the mining sector" are iron ore and coal with prices set by annual contracts which lessen volatility, according to S&P.

Nevertheless, "growing concerns about global economic growth are creating uncertainty on the demand side," the analysts said. " In addition, very unstable credit markets, a broader exit from commodities by financial investors, falling oil prices, and a stronger U.S. dollar, are all bearish factors." However, supply constraints are continuing due to project delays, adverse weather, strikes, accidents, and power disruptions.

The analysts emphasized that "demand concerns remain at the fore for investors."

S&P noted that financial results of many mining companies were strong during the first half of this year.

FORECAST

"Looking to the second half of 2008 and into 2009, we expect producers of iron ore and coal, such as diversified miners Rio Tinto, Anglo American, and Xstrata, to show a stronger relative contribution, as annual prices, which typically increase only from April 2008, take effect for the full period," the analysts predicted.

"Cost pressures are intensive, especially in aluminum given its high energy intensity, and profits will likely stay relatively low, as margins continue to be squeezed by rising operating and capital costs. For Rio Tinto and Norsk Hydro, such margin pressures will remain negative factors," the analysts advised. "Miners in all segments are, however, continuing to partly mitigate cost pressures through efficiency programs, and generally good progress is being made."

S&P also predicted that steel prices will weaken in 2009, although these have risen significantly to record levels during the last few months. "Higher steel prices reflect largely successful efforts in passing higher input costs for iron ore, coking coal, scrap, energy, and labor on to customers, albeit with time lags, and against some resistance."

Nevertheless, the analysts warned, "Steel prices are beginning to decline, so we see some vulnerability here for 2009. However, better market discipline on the supply side will be a mitigating factor." Steel producers with their own raw materials supply of iron ore, coking coal and scrap "will be better placed to cope with rising input costs and fluctuating steel prices," S&P advised.

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