October 15, 2015 / 11:34 AM / 2 years ago

COLUMN-Glencore changes the debate, but can it change the zinc market? Andy Home

(The opinions expressed here are those of the author, a columnist for Reuters)

By Andy Home

LONDON, Oct 15 (Reuters) - Everyone's talking about Glencore .

The Swiss trading and mining giant is the hot topic of conversation in the myriad meetings and cocktail parties taking place in London for LME Week.

And, Glencore executives will be pleased to note, this isn't speculation as to whether the company is about to go bust. That particular panic seems to have passed for now after a flurry of announcements intended to shore up its balance sheet, most recently the proposed sale of two copper mines.

Rather, it was Glencore's announcement on Friday of massive cuts to its zinc and lead production portfolio that has been exercising the minds of the thousands of metal executives meeting in London this week.

The London zinc price went on a super-charged rally on the news, exploding from its opening at $1,701 per tonne to $1,875 in a matter of hours. As with last month's announcement of 400,000 tonnes of copper cutbacks, the timing was exquisite, catching off guard a market that had been grinding steadily lower for months under the weight of relentless short selling.

The collective mood is still decidedly downbeat as the market attempts to get to grips with the implications of a Chinese slowdown but Glencore has successfully changed the nature of the debate.

The question now is whether its cuts can change the fundamentals of the zinc market.

TIPPING THE ZINC BALANCE

Make no mistake. Glencore's 500,000 tonnes of annualised zinc cuts are both huge, amounting to around four percent of global supply, and unprecedented. No-one can remember a producer taking such decisive action in any previous downturn.

And as with its copper cuts, these zinc ones seem carefully calibrated to generate maximum supply-chain impact.

So while the copper reductions largely comprise leaching operations with a direct flow-through to the refined metal market balance, the zinc reductions will constrain the supply of concentrate.

The bulk of the cuts, 380,000 tonnes, will come from Glencore's two Australian mines, Mt Isa and McArthur River, with another 80,000 tonnes coming from the mothballing of the Iscaycruz mine in Peru. Only the residual 40,000 tonnes of reductions in Kazakhstan are integrated with smelter operations.

And this is significant since the underlying narrative in the zinc market is one of looming raw materials crunch.

The giant Century mine in Australia has recently closed, although it is still processing stockpiled ore, while Vedanta's Lisheen mine in Ireland is due to reach the end of its life in November this year.

Between them these two closures will remove around 675,000 tonnes of annualised mine capacity.

The International Lead and Zinc Study Group (ILZSG) was already expecting mined supply outside of China to fall by 1.8 percent next year, feeding into a forecast that the refined zinc market will be in supply deficit to the tune of 152,000 tonnes.

Glencore's announcement came too late on Friday for ILZSG to incorporate the numbers into its forecasts, but everyone can do the maths, right?

And doing the maths will be every other miner and smelter ahead of the annual negotiations on treatment charges, which is what smelters charge miners for processing their raw material.

Yearly benchmark treatment charges have actually been rising steadily over the last three years, challenging any bull narrative of mined supply shortfall.

Talks on next year's charges were always going to be interesting given the Century and Lisheen closures. They have just got a lot more interesting thanks to Glencore.

Moreover, it's worth noting that several big bank commentators have been pinpointing any change of trend in treatment charges as a possible long entry point for investors disappointed by the seemingly endless pushback of mine supply crunch.

TIPPING THE LEAD BALANCE

Overshadowed by the size of Glencore's zinc cuts have been the 100,000 tonnes of associated lead cuts, although lead too surged higher on last Friday's news, LME three-month metal jumping from $1,682 at the opening to a high of $1,821.50.

The company has not split out its lead cuts but the obvious inference is that the bulk of them will come from the two Australian mines, which between them produced 216,000 tonnes of the heavy metal last year. Iscaycruz, by comparison, is a relatively small lead producer with output of just 6,000 tonnes in 2014.

Interestingly, though, these Australian mines are integrated with the Mt Isa smelter, which produces lead bullion, which is then sent to Britain for refining into metal at Northfleet.

So the potential impact on the refined lead market might be a lot swifter than the cuts to mined zinc supply.

Again, the announcement came just as ILZSG was wrapping up its twice-yearly forecasting meeting in Portugal but the group was expecting a supply surplus of 97,000 tonnes next year.

A supply surplus, which on paper at least, has just been wiped out.

CHANGING THE MARKET?

You can start to understand then why everyone has been talking about Glencore and what the cuts mean for market balances and prices.

But there is, certainly when it comes to zinc, a key unknown here and it's one that is causing headaches across the base metals spectrum.

The biggest market for Glencore's Australian zinc concentrates is China.

Imports of concentrate from Australia totalled 780,000 tonnes (bulk weight not metal contained) in the first eight months of 2015, accounting for almost 40 percent of all imported zinc concentrates.

Chinese zinc smelters, it follows, are those most directly impacted by Glencore's cuts.

But China is itself also a massive producer of mined zinc, although quite how massive is difficult to say given perennial problems with the official statistics.

ILZSG estimates that the country's mined zinc output rose 11 percent in the first five months of this year and it is forecasting output to rise another 7.8 percent next year.

It's fair to say that Chinese zinc production, both mined and refined, has consistently surprised on the upside for several years, suggesting there is much more flex capacity in the country than assumed.

What if China simply raises output to offset Glencore's cuts? That question was posed by Paul Robinson, director of CRU Group, speaking at a Bloomberg event on Wednesday.

Robinson stressed such a scenario isn't the research house's base case but said that it would only take a 10-percent lift in Chinese mined production to negate Glencore's reductions, not an impossible scenario either.

And this has been one of the running themes during LME Week this week.

China accounts for a rising share of global metals production as well as consumption. In extreme cases such as aluminium, it actually produces more than the rest of the world combined.

This reduces the impact of any aluminium smelter closures since China is simply producing more and exporting metal into any supply gap in the rest of the world.

Parts of China's production base seem curiously inelastic to price weakness, in part because of government support, which reduces the impact of any closures elsewhere.

This may prove to be one of the features that differentiates this down cycle from previous troughs.

Another one, of course, is the existence of an entity like Glencore, which out of a combination of necessity and ideology is implementing production cuts that are unprecedented in previous cycles.

How these two new phenomena play out will determine just how much pain still lies ahead for the metals sector.

Editing by David Evans

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