Citibank Weighs In On Long-Term Pricing

Rising structural costs, limited projects, riskier geographies and infrastructure bottlenecks will all put “upside pressure” on long-term commodity prices, Citigroup Global Markets asserts in a Jan. 19 research report.

Citigroup argues that over the last two years the mining industry has witnessed significant structural changes including rising oil prices, falling ore grades, increasing input costs, a lack of water and power availability, a decrease in tax incentives for the development of new projects. As well as, the exhaustion of many of the world’s premier projects, the smaller size of new projects, infrastructure limitations (particularly for coal in Australia and South Africa) and rising political and sovereign risks, will all impact long-term prices.

“Such increased pressure (on the cash and capital costs of new projects) would lead to lower returns under ‘normal’ long-term commodity price assumptions, reducing the likelihood of project development, exacerbating the lack of supply and thus keeping prices high,” Citigroup’s analysts maintain.

In their study, the analysts assembled the 15-year average margins for commodities and their current unit costs, allowing them to calculate where long-term prices would need to be to maintain average industry margins.

Between 2004 and 2009, unit costs for gold have increased by 59%; platinum, 169%; aluminum, 28%; copper, 109%; nickel, 18%; zinc, 100%; uranium, 85%; hard coking coal, 167%; thermal coal, 92%; and lump iron ore by 100%.

Of all the commodities, copper, platinum, and thermal coal have some of the best long-term pricing fundamentals, and equities exposed to those metals “should deliver the higher NPV increase,” the report asserts.

“Copper and thermal coal markets are structurally tight enough (both from the demand and supply sides) to warrant a future margin to be higher than their historical averages,” the report states. “This would either require a fall in costs (unlikely in the current climate) or more likely a continued elevation in long-term price.”

The report adds that commodity analysts are likely to reassess their assumptions for long-term prices over the coming year and that as a result, the NPVs of companies are likely to increase — “resulting in higher target prices and a continuous positive stance on the sector.”