Another interesting angle that supports the J curve theory is this article by Robert Gottliebsen.
Banks are keeping mining and oil companies alive because it is so costly to close them down.
The problem is that they can't or wont spend any money on these oil or mining companies, thus rendering them dead in the water and really only Zombie businesses.
Clive Palmer is a classic case in point.
His nickel mine in Townsville needs at least $100 million spent on it to modernise it but there is a snowflakes hope in hell of anyone ponying up that sort of money.
Same thing will be happening to oil companies all over the world.
The carnage is immense.
I doubt the Saudis even need to take oil lower for longer.
I think the damage is already done.
The present glut will vanish in a heartbeat and will be replaced by a severe shortage.
The idea that mothballed or broke oil companies can simply flick a switch is nonsense.
Oil is completely different to iron ore or coal.
It gets used all day everyday everywhere.
Without oil everything grinds to a stop.
Why bankers are watching Palmer’s Townsville refinery
Queensland Nickel's Yabulu refinery at Townsville.
Around the world there are large numbers of mines and metal plants like Clive Palmer’s Townsville nickel refinery where the fall in mineral prices should have caused them to close a long time ago. And the same applies to a large number of US oil producers.
But the cost of shutting these plants and mines, in terms of the severance pay in job losses, the bank loan losses and the site rectification bills, causes the owners and banks to keep production going for much longer than normal market forces would dictate.
The Townsville nickel plant is a classic illustration. In theory what should have happened is that during the nickel boom the cash that was generated was reinvested to modernise the old plant and bring down its costs. But the nickel slump was not predicted and Clive Palmer had other adventures to fund that were more exciting than modernising an old plant.
In most countries, and certainly Australia, the options for old mines and old plants are contracting rapidly. The capital markets are now effectively closed to raising equity unless the mine or plant has strategic importance to BHP, Rio or one of the few majors with cash. But they are all protecting their cash. Sometimes an adventurous private equity group will take a look, but it’s difficult.
In Australia, Santos managed to raise $2.5bn in a share issue — it just made it and the market has now closed that option for Santos-style situations. The Santos issue was heavy discounted but those who took up the stock are now losing money. Hopefully Santos raised sufficient cash and one can only ponder what would have happened without its capital raising exercise.
At Townsville, raising equity to restore or maintain the plant is no longer an option. So Clive Palmer must go to state and federal governments seeking money, trying to scare them with the consequences of plant closure. Apart from job losses there will be no money available from the owner-company to rectify the site so it may become a major pollutant. Governments, particularly in Australia, struggle to find money to keep open old plants and there is no love for Clive Palmer.
So then it’s back to the banks and other lenders. If the plant closes they will lose all their money — and they need to watch their step or they will be up for rectification costs. The banks have to choose between that fate and keeping the plant open. As long as it can produce cash, most banks are choosing the “keep the plant/mine going” option in today’s world. That’s the sort of dilemma the bankers are now facing at Townsville. The local stories indicate that time is up.
Bankers around the world will watch Townsville because there are so many mines and plants in the same position. The bankers think that while the plant is still going there is hope. But as long as these loss-making plants continue the market cannot adjust and this has been a major contributor to deepening the slump in mineral prices. Nickel fell 2.5 per cent last night.
That many miners and plants have invested in extra capacity to lower their costs only worsens the situation.
But make no mistake, closing a mine and a treatment plant is not a pleasant exercise. If the owner is broke there are worker payments, but an even larger item is the clean-up bill including, in the case of mines, maintaining old tailings dams for the foreseeable future.
I do not know what is involved at Townsville but it is an old plant built before modern standards. Clean up of the site will not be cheap and made more urgent by the fact that it is in a tropical climate and near the Great Barrier Reef.
Clive Palmer will be reminding everyone of the consequences as only Clive can. But for him there are also personal consequences that might end a political career.
That’s a consequence that will be welcomed in many political quarters.
FAR Price at posting:
7.3¢ Sentiment: Buy Disclosure: Held
(20min delay)