Zinc prices: Up, up and away

Krishnan Thiagarajan

AIDED by the 6 per cent and 9 per cent increase in zinc demand from Asia and the US in the first six months of 2000, and the sharp drawdown in warehouse stocks at the London Metal Exchange in the first half of 2000, the international zinc prices have been on an uptrend (subject to some downward swings in a couple of months).

After ruling relatively firm in the $1,100-1,200 band over the past year, zinc prices, despite touching a high of $1,194 in September 1999, did not breach the $1,200 mark. Zinc prices were trading at $1,170 in August and if the average monthly prices breach $1,200, it will only be the second time in the last five years.

The first time, China was responsible for zinc prices shooting past the $1,200 mark, in mid-1997. As a major exporter of zinc to the Western world and accounting for nearly 15 per cent of the world production, China is a major player. By misreading the demand and price trends in the market, the Chinese producers made a contract of purchase which they failed to honour, leading to a sharp drawdown in inventories, and, in the process, fuelling a bull run in zinc prices. The international prices which were ruling at around $1,087 in January 1997, soared to $1,654 by August 1997, and dipped marginally to $1,641 in September.

This time around, the firm trend underlying zinc prices is attributed to the robust demand growth and a sharp drawdown in inventories. Some analysts feel the tight supply position is also due to the large long position built up by a certain section of the zinc market.

According to the International Lead and Zinc Study Group, in 1999, the demand for (refined) zinc in the West exceeded overall supply by 96,000 tonnes, accounting for a deficit in the West for the fifth successive year. As the demand growth in the West continued to outstrip supply in the first six months ended June 2000, the sharp uptrend in prices were only to be expected.

However, as these high zinc prices are likely to encourage new projects, the restoration of the demand-supply parity may neutralise the impact of this uptrend. Probably, the 15-month and 27-month forwards, ruling at $1,150 and $1,130 respectively, seem to suggest that international prices are likely to swing back to the conventional levels of $1,050-$1,150 in the near- to medium-term.

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Will this uptrend help?

Although this recent uptrend will help the beleaguered zinc industry, it may prove of limited value as the industry as a whole is plagued by certain fundamental problems. A recent report by CRU International, an expert on the metals industry, prepared for the International Zinc Association, has highlighted the following factors for the poor growth of the zinc industry compared to aluminium and copper:

*In the last ten years, the zinc industry has consistently destroyed shareholder value (or capital) with returns on capital averaging half the cost. Over this period, shareholders in zinc companies lost 30 per cent of their investment.

*The industry's operating profit margins were significantly lower than its other non-ferrous metal peers, such as copper or aluminium. To compound matters, the overall returns on capital employed declined sharply over the past twenty years (1979-1999).

*The increases in operating efficiency and cost-cutting exercises undertaken by different companies in the industry had very little impact, because they generally translated into lower international zinc prices.

*The solution for these problems appears to lie in better supply-side management. Unless the industry reacts rapidly to market surpluses by resorting to either production cutbacks/plant closures, or in the case of deficits (if they were to arise) by encouraging additional zinc production capacities, the zinc producers' returns may continue to be abysmal. This has to be an industry-wide initiative, taken by individual companies. Practically, all the merger and restructuring initiatives of the aluminium and copper industry have been oriented to dynamically handle the critical issue of market surpluses or deficit and use the consolidation efforts to impart greater price stability in the market.

Domestic scene

Domestic zinc prices have been moving in tandem with international prices. After dipping to a low of Rs 86,900 in March, the domestic prices of zinc ingots recovered to touch a high of Rs 89,290 in May and was trading at around Rs 88,680 in July. Hindustan Zinc and Binani Industries, the two primary zinc producers, with production capacities of 1.49 lakh tonnes and 30,000 tonnes, cater to the domestic demand of 2.50 lakh-2.75 lakh tonnes. With aggregate production levels of 1,96,163 tonnes (1,45,796 tonnes by Hindustan Zinc and 50,367 tonnes by Binani Industries), these two producers catered to 70-75 per cent of the domestic demand.

The operational profile of Hindustan Zinc has been steadily improving over the years. Hindustan Zinc, put up for disinvestment recently, has a good financial record, with turnover growth of 15 per cent and post-tax earnings growth of 20 per cent over the past five years. In 1999-2000, it recorded a post-tax earnings growth of Rs 90.42 crore, up 18 per cent on a turnover of Rs 1,515.60 crore. Though the operating profit margin dipped marginally, by 0.42 percentage points, the decline in interest costs propped the bottomline. As a diversified entity focussed on zinc, cement and glass fibre (hived off to a subsidiary), Binani Industries recorded an impressive 152 per cent growth in post-tax earnings to Rs 21.09 crore on a modest 10 per cent rise in turnover to Rs 255.91 crore. As long as international prices rule around $1,050-1,100, the primary zinc producers will continue to make reasonable profits. If the average monthly prices spurt past $1,200, as it has threatened to do so over the past year, the producers can expect to record a material improvement in their profitability.

Dry cell manufacturers, the key customers of the zinc industry, who have already had to contend with higher prices over the past year (relative to the previous year), may suffer a further dent on the operational profile if the zinc prices sustain at levels higher than $1,200.