ZINC MINERS LEVERAGE SCARCITY TO FLEX MUSCLES

If there were any doubt that the zinc supply chain is tightening, it should be dispelled by this year’s benchmark smelter treatment charge.

The treatment charge is the fee paid by a miner to a smelter for converting mined concentrates into refined metal. It is probably the best indicator of raw material availability: high during times of surplus and low during times of scarcity.

This year’s headline fee of $172 per tonne is the lowest in a decade, a firm swing in favour of miners and a tangible sign that the much-anticipated concentrates crunch has arrived.

Indeed, miners have used the squeeze on availability to make what might turn out to be a historic change in how these annual benchmark contracts are structured.

Zinc bulls have been waiting a long time for this supply squeeze, and they may have to wait a bit longer before it moves from raw materials to the refined metal parts of the chain. But at a mined concentrates level the squeeze has very surely arrived.

The treatment charge of $172 per tonne was confirmed by Nyrstar of Belgium, a zinc miner itself but a much bigger converter of concentrates. It represents a 15% decline from last year’s benchmark of $203 and is the lowest since 2006.

The comparison is worth noting because that was the year that zinc hit its highest-ever level on the London Metal Exchange (LME) at $4,580 per tonne.

As well as seeing their revenues reduced this year, smelters have also lost any price participation.

Price participation disappeared from copper concentrate contracts several years ago but it has persisted in the zinc market in the weird and wonderful form of “escalators” and “de-escalators”. These determine how much the treatment charge can change depending on how far the zinc price deviates from a preset “basis” price in the contract.

In 2016, for example, the “basis” price was set at $2,000, with escalators allowing for price participation up to $3,750 and de-escalators down to $1,500.

This year, however, both escalator and de-escalator have been set at zero, a partial victory for those miners seeking the complete elimination of price participation by smelters.

Escalators and de-escalators remain in the benchmark contract, in theory allowing for a resurrection at a future date. Whether price participation actually returns remains to be seen.

When BHP Billiton dropped price participation from its copper contracts in 2007, it was presented as a temporary market-driven phenomenon. But within two years everyone else had done the same and price participation was quietly consigned to the copper history books.

Smelters can probably afford to be sanguine about zero price participation this year. As Nyrstar chief executive Hilmar Rode told analysts recently: “If you go back and you monitor, say, the last 10 years, you’ll see sometimes that works in favour of the mine, sometimes in favour of the smelters, but over a longer period of time ... it’s pretty much a net zero.”

More important to a company such as Nyrstar is the retention of another strange component of the zinc treatment charge, namely “free metal”, which means that smelters pay for only 85% of the metal contained in the concentrate. This dates back to a long-lost time when most zinc smelters were pyrometallurgical and typically could only extract that amount of metal from the concentrate.

Times and technology have changed and a company such as Nyrstar can now typically recover 96-97% of the metal, meaning it gets 11-12% “free”.

Miners would no doubt love to eat into, if not eliminate, this “free metal” allowance, but the consensus seems to be that this would be a step too far right now.

The sharp drop in the benchmark treatment charge was widely expected. The zinc supply crunch has been a long time coming and there have been plenty of false starts for over-eager bulls. But the record 6.3% fall in global mine supply in 2016 transformed the concentrate market, notes Jonathan Leng, principal zinc analyst at Wood Mackenzie.

Concentrate stocks fell to “minimum working levels” last September, and smelters, particularly those in China, are having to cut production.

Nor does Wood Mackenzie see much change in the zinc concentrates market any time soon. It sees conditions remaining tight for the next couple of years, with treatment charges likely to remain at correspondingly low levels.

What does this mean for the refined zinc price? So far bulls have been frustrated that the mine supply crunch hasn’t translated into a refined metal crunch.

China’s imports of refined zinc remain subdued, while metal is still occasionally appearing on LME warrant at New Orleans, albeit not in the volumes as seen in the past.

Mr Leng, however, believes it’s only a matter of time. He expects to see acute tightness later this year, with stocks “projected to fall to historically low levels and remain so until 2020”. That will translate into a higher price next year “comparable to the 2006 price peak”.

Not everyone is quite so bullish. There are still a good number of “known unknowns” at work, not least the state of mine supply in China itself. But this year’s terms for benchmark concentrates make it hard to argue against the starting proposition of bulls such as Wood Mackenzie.

The concentrates market is as tight as it’s been since 2006. Whether that means a return to the historical peak in zinc prices in that year remains to be seen.