China lines up supplies much closer to home

BHP'S decision to abandon the expansion of its Olympic Dam copper-uranium mine is said to be another sign that the commodity boom is coming to an end.

Commodity booms occur when there is a prolonged increase in prices and supply cannot respond fast enough to rapidly escalating demand. Booms are destroyed when new large-scale capacity emerges to restore market balance.

Australia's mineral boom is being driven by China's apparent insatiable demand for all things mineral, but planned world-scale, low-cost mines in neighbouring Mongolia, Pakistan and even war-torn Afghanistan have the potential to destroy the boom for coking coal, copper and uranium and possibly other lesser known minerals such as rare earths and fluorspar.

In coking coal, an essential ingredient for the production of steel, Mongolia has already grabbed market share from Australian producers who once dominated the sector. Only three years ago, Mongolia supplied 11 per cent of China's demand compared with 65 per cent for Australian competitors. But as production at new mines has increased, positions have been reversed, with Mongolia now supplying 45 per cent of China's needs compared with Australia's 23 per cent. With mines yet to be commissioned and improvements in infrastructure, Mongolia's market share can only further increase.

Low cost is a feature of most of Mongolia's coalmines and is attributable to favourable geology, principally shallow, relatively thick, uniform seams of high-quality ore. Close to the border with China, the mines can deliver coking coal to Chinese steel mills for significantly less than Australian competitors.

Competition from Mongolia has driven down the price of coking coal, which 12 months ago traded for as much as $320 a tonne and now sells for less than $180. The collapse in the price has affected the profitability of Australia's coking coal producers, with BHP reporting a drop of 41 per cent in the earnings of its metallurgical coal division. This was certainly a factor in the company's decision to shelve expansion of its Peak Downs coking coal project in Queensland.

Mongolia is also home to Oyu Tolgoi, considered the world's largest undeveloped copper deposit. The mine's reserves are sufficient to support production for more than 50 years but, as with much of Mongolia, only a quarter of the country's territory has been mapped geologically and at a relatively coarse scale so reserve estimates most likely underestimate the true extent of mineral wealth.

Oyu Tolgoi, which will compete with BHP's Olympic Dam, is being developed by Rio Tinto-controlled Turquoise Hill Resources and the company is on the verge of commissioning a $7 billion mine and processing plant that will produce concentrate containing 425,000 tonnes per annum of copper, equivalent to 3 per cent of the world's copper supply. BHP once held the lease for Oyu Tolgoi but relinquished it so it could concentrate on developing other opportunities.

Large high-profile projects such as Oyu Tolgoi have attracted media attention, but Mongolia has many smaller projects large enough to dent Australia's commodity boom.

While Mongolia's mineral riches are being developed with Western money, equally rich deposits in other central Asian countries are being built with Chinese funds.

In Pakistan, a Chinese company has built the Saindak copper-gold mine and in Afghanistan the same Chinese company is developing Aynak, said to rival Oyu Tolgoi as one of the world's largest undeveloped copper deposits.

Like Mongolia, Pakistan and Afghanistan have long been known to be mineral rich, but because of their location well away from markets in the developed world they remained undeveloped. This changed, however, with the opening up of China, which now demands large volumes of minerals to sustain its relentless economic growth and being the world's largest consumer of metals, Beijing finds it advantageous to source its raw material from immediate neighbours.

Access to high-quality, large-scale mineral resources in a neighbouring country has three attractions for China. First, because of shorter supply lines regional deposits enjoy greater security than more distant suppliers. Second, being in a developing country, China is not disadvantaged by having to compete with long-established global champions. Finally, the development of new large mines can push down prices by restoring market balance - which benefits all consumers, especially one as large as China.

Western companies tendered for the right to develop Sanidak and Aynak, but lost to Chinese competitors who benefit from extensive support from their national government, which usually offers generous aid packaged as infrastructure that can support the mine and wider community. To secure access to the Aynak deposit, China offered to build a power station that could supply the mine and Kabul.

The infrastructure assistance is funded by Beijing so it does not affect the company's bottom line, while the benefit to China is that in addition to scoring political points with its neighbours the new capacity helps constrain prices. Mineral consumers encouraging suppliers to build excess capacity with the expectation it will drive down prices is not new - Australia's last mineral boom ended when Australian miners responded to ambitious demand forecasts from Japanese customers by investing in new capacity.

No sooner had the new mines been built than prices collapsed. It took another 20 years before excess capacity was absorbed. This time our mining companies seem to have learnt from their mistakes.

Michael Komesaroff is founder of Urandaline Investments, a consultancy specialising in China's capital-intensive commodity businesses.