End of the road for Merafe Resources?
Merafe Resources, once a punters’ favourite, may be at the end of the road as power cuts and low prices bite
In a dark portent for SA’s ferrochrome industry, the Glencore-Merafe Chrome Venture is restructuring, and could cut up to 665 jobs at its Rustenburg smelter, which is suffering "material financial losses".
It’s particularly ominous if you consider that, with an installed capacity of 2.3Mt a year, the Venture is not just the largest ferrochrome producer in the world, but the lowest-cost producer in SA.
But Glencore says that despite investments to make the smelter more competitive, its fate was sealed by a deterioration in market and operating conditions — including real cost inflation and unsustainable electricity tariffs and supply interruptions.
In fact, a great many smelters have closed since 2006, over which time Eskom has hiked electricity tariffs 523% for its large industrial customers such as mines and smelters.
Merafe’s woes have been well flagged by the company: in December it warned shareholders that stage 4 and 6 load-shedding, in this tough economic environment, would have "a negative impact on the future economic viability of some of the company’s operations and the wider ferroalloys sector in SA".
The thing is, SA is one of just four countries that produces chrome in large quantities.
Most chrome is converted into ferrochrome, the raw material used to produce stainless steel.
And China is the largest consumer of ferrochrome.
The Glencore-Merafe Chrome Venture was formed in 2004, when Xstrata and SA Chrome joined forces.
Soon thereafter, SA Chrome changed its name to Merafe Resources, while Xstrata went on to be taken over by Glencore in 2013.
The Venture operates five ferrochrome smelters, 22 ferrochrome furnaces, five chrome ore mines and six plants, in three provinces.
Merafe Resources holds a 20.5% stake in the Venture, from which the company derives most of its earnings, while Glencore holds the remaining 79.5%.
So how did it go so wrong?
The blame lies partly with Eskom.
Electricity availability has plagued the Venture since 2007, when Eskom first implemented rolling blackouts.
And as energy prices rise in SA, the local ferrochrome industry has been overtaken by China’s, which used to be neither large nor efficient.
"But when China decide they want to do something, they do it," says Peter Major, director of mining at Mergence Corporate Solutions. "They decided they wanted to beneficiate the chrome themselves to lock in more of the margin."
That effort has been so successful that "even if Eskom dropped prices dramatically, China doesn’t want our ferrochrome", Major says.
In fact, it’s been passing increasingly stringent laws around various ferrochrome imports.
The electricity problem for SA producers is especially harsh when metal prices are low, as is the case at the moment.
Chrome prices have dropped 17% year on year.
"Demand has been sluggish, resulting in an increase in chrome stocks on surface in China as there’s been an excess supply to the market of UG2 chrome," says Luvuyo Booi, equity research analyst at Noah Capital Markets.
Traditionally UG2 — named after the Upper Group 2 Reef — was a poorer, more difficult grade of platinum ore compared to ore from the Merensky Reef, and it has a high concentration of chrome.
Today, thanks to technological advances, SA’s platinum group metals miners are recovering and exporting several million tons a year of chrome fines, compared to nothing 10 to 15 years ago.
Considering it was previously a waste product, it was "money for jam" for the platinum miners, Major says.
As a result, "we have sort of flooded the world with chrome ores and the Chinese can now get all they want cheap and then take the margin from beneficiating it", says Major.
By Booi’s estimate, above-ground stock of chrome in China totals more than 3Mt.
It is arguably Merafe Resources which stands to lose the most, as Glencore has a diversified portfolio of assets and a much bigger balance sheet.
Recognising that the ferrochrome business was highly cyclical, Merafe was once on the acquisition trail, targeting possible investments in coal and iron ore.
But nothing materialised and with its only operations being the Venture, its fortunes are now inextricably tied to the SA ferrochrome industry.
Booi sees better days ahead, at least in terms of metal prices, potentially stoked by the recent conclusion of phase one of a trade deal between the US and China.
But Major can’t see a happy ending for the domestic sector.
"SA ferrochrome is going the same way as ferromanganese. There is no margin left in it," he says. "I don’t think there is hope of saving this industry."
For a country that holds the world’s largest chrome reserves, that’s a sobering thought.
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