The growing cost inflation crisis in Australia’s resources sector
Another day, another cost blow-out.
This time it’s the Mardie potash project of BCI Minerals (ASX: BCI) which is facing construction costs almost double those of the original design, following a 40% blow-out at the Yangibana rare earths mine of Hastings Technology Metals (ASX: HAS).
BCI and Hastings are not alone in battling the effects of rampant cost inflation which is turning project economics on its head and ringing a loud warning bell for investors.
Nor is the costs crisis (and that’s what it is) the only hurdle confronting Australia’s resources sector which is also facing a renewed problem with commodity prices with iron ore said by leading investment bank Goldman Sachs to be heading for a steep correction later this year thanks to an unexpected slowdown in the Chinese economy.
Potash prices falling due to Chinese influence
But to see the full effects of the China challenge, which will affect most commodities because China is the biggest single consumer of most raw materials, you only have to consider what’s just happened with potash, a fertiliser widely seen as being immune from extreme price swings because many farmers regard it as essential for crop growth.
Canpotex, the Canadian potash marketing monopoly, sent shock waves through the potash industry when it signed a sales contract with Chinese authorities at a price 48% lower than the previous contract, a fall from US$590 a tonne for potassium chloride (the most commonly used form of potash) to US$307/t.
If graphed, the issues of rising costs (one line on the graph) and falling prices (the other line), looks a bit like crocodile’s jaws, wide open when times are good, but slamming down when the crocodiles takes a bite of his lunch.
Effects on traders and investors
For share traders and speculators programmed to move quickly what’s happening with project developers and established producers is not a significant problem and might even create opportunities to buy and sell swiftly.
But for investors with a buy-and-hold approach greater care is required to avoid being caught in a costs blow-out which can become a rush-for-the exits sell-off.
All of the once-popular potash stocks such as Kalium Lakes (ASX: KLL), Australian Potash (ASX: APC), and Salt Lake Potash (ASX: SO4) have suffered significant share price falls or an outright trading suspension.
Australian Potash, for example waved a white flag a week before BCI reported its costs blow-out on Monday, when it said it was pausing all activity at its Lake Wells project in WA while looking for other opportunities, perhaps in rare earths, gold or lithium.
Over the past 12-months the company’s share price has fallen by 82% from 4.1c to 0.09c.
The future of proposed mining projects
What comes next in this inflation driven costs crunch and price squeeze is a fresh look at the economics of every proposed mining project, including the biggest and best which have been enjoying a dream run with investors such as the Julimar palladium discovery of Chalice Mining (ASX: CHN) near Perth.
A world-class discovery which turned Chalice into a global sensation as its shares rocketed by more than 6000% from 16c five year ago to a peak in late 2021 of $10.21 there has been weakness evident since earlier this year with the stock down to $6.81.
No-one is questioning the quality of the Gonneville discovery (within the greater Julimar project area) or its potential to become a major producer of an assortment of high value minerals from its polymetallic orebody which includes nickel, copper, cobalt, gold, platinum and palladium.
But they are starting to question the “payability” of Gonneville, the project’s ability to generate profits because the ore is a complex cocktail of elements which will require careful processing, along with the tumbling price of palladium, once seen as the Gonneville profit driver.
Once priced at twice the price of gold and comfortably higher than platinum, its metallic twin, palladium today is selling for US$1402 an ounce, down 21% over the past six months.
Challenges of rising costs and falling prices
The challenge for Chalice is no different to other companies with a new project on their books at a time of rising costs and static (or falling) commodity prices with a study published last week in the investment bank UBS a guide to what’s happening.
UBS has not until now been researching Chalice so its June 15 report represented a fresh set of eyes on a company popular with investors thought it’s unlikely that many will like what the bank saw – an overpriced stock with a share price target of $6 on a day it was trading at $7.11, earning it a sell tip.
Disregarding the incongruity of a bank advising client to sell something they had never recommended as a buy and the UBS conclusion is significant because it goes to the heart of the development challenge at a time of rising construction costs and commodity price pressure – especially for palladium.
The costs issues are easy to understand because there are so many examples of blow-outs. The price pressure in the case of Gonneville is different because it largely involves one of the metals in its orebody being savaged by two others – a sort of metallic cannibalism.
Impact of EV penetration on palladium pricing
The primary use of palladium, which UBS estimates will account for 40% of Gonneville’s profits, is as an auto catalyst, capturing toxic gases produced by petrol engines whereas its sister, platinum is preferred as a catalyst in diesel engines.
Copper and nickel, two of the primary metals used in the batteries of electric vehicles (EVs), account for 46% of Gonneville’s forecast revenue, according to UBS (nickel 28% and copper 18%).
“Our bullish EV penetration rate of about 51% (of the vehicle market) translates into a bearish outlook for internal combustion engines and palladium pricing,” UBS said.
It expects a long-term palladium price of US$1100/oz, down another 21.5% on an already diminished price.
The challenges confronting Chalice are not unique, but it is an interesting example, if the UBS analysis is correct, of optimism overpowering the reality of an increasingly difficult business environment.