David Whitten, Head of Janus Henderson’s Global Natural Resources Team, discusses the significance and implications of China’s crackdown on its worst polluters, which is creating attractive opportunities for many global commodity suppliers.
In 2013, the Chinese government revealed plans to clamp down on factories causing high levels of pollution, with the aim of reducing emissions from polluting industries by 30% by the end of 2017. This commitment was reinforced in October 2017 at the 19th National Congress of the Communist Party, where the Chinese authorities pledged to cut air pollution concentrations by 34% by the year 2035. These pledges have resulted in the inspection and closure of a large number of factories across the country, reducing supply, increasing prices and enabling foreign producers to fill the market gap and capitalise on the situation.
Capacity is being cut back to reduce marginal high-cost, high-pollution production, leading to a reduction in steel exports and in turn better prices in the US. The closure of uneconomic steel plants and their auxiliary businesses has created some unusual opportunities. For example, merchant supply of excess oxygen to industry is no longer available, meaning larger suppliers of oxygen are no longer being undercut on pricing. This means companies such as Air Products & Chemicals in the US − already the most profitable industrial gas producer in the world are enjoying higher prices in China for the first time in years.
Steel production cuts are being implemented through the heating season (northern hemisphere’s colder months from November 2017 to March 2018), which may see iron ore demand reduced significantly. However, the ramifications are not all negative since high grade ore is required to maximise production from the steel sector at a time when prices and demand are high. The higher grade producers such as Rio Tinto and BHP are likely to benefit from premium pricing and the maintenance of sales volumes at high levels, which may largely counteract weaker iron ore pricing.
Illegal production facilities and energy-inefficient smaller operations are being closed throughout the heating season. These initiatives have been implemented quicker and larger than expected by the industry, and consequently global supply has moved into balance. The cutbacks have already been significant, resulting in a recovery of the aluminium price from US$0.80/lb to almost US$1.00/lb. Rio Tinto, the world's second largest producer, has already been a major beneficiary from the Chinese cuts.
After many years of declining global production, we have seen zinc stocks steadily decline and prices improve markedly. But unlike previous cycles, smaller Chinese producers have not re-entered the market due to government controls to restrict pollution. Tighter supply and rising prices are likely to benefit companies such as Glencore, Teck Resources and New Century Zinc, held in the Janus Henderson Global Natural Resources portfolios.
Liquefied natural gas
China imports are already higher than a year ago with a visible shift from coal to gas underway. New demand from China is likely to absorb the majority of new global production as the nation pursues its anti-pollution targets.
Opportunities in the wind subsector continue to expand at a rapid pace. This is creating potential growth options for companies like Vestas, the world's largest and most diversified manufacturer of wind turbines.
Additional tailwinds in China for resource companies
China has 22% of the world’s population but only 6% of the water, which has big implications for agriculture, food production and health. Companies in the water treatment sector are likely to see growing demand for services in line with consumption and population growth.
China intends to blend ethanol, a plant-derived biofuel, into its petrol mix by 2020. This action has the potential to increase China’s annual ethanol consumption from 2.6m tonnes to around 12m tonnes, creating opportunities for international corn exporters and agricultural suppliers.
The shift to electric vehicles
China is expected to move towards predominantly electric vehicles (EV) by 2030-2040, which will have massive implications for the battery market. The battery raw material supply chain is already working overtime in the lithium, copper and cobalt sectors to prepare for a surge in initial demand from 2020 onwards.
A clean conclusion
China’s commitment to a cleaner, healthier and safer environment has broad implications and offers the potential for attractive investment opportunities. Given the strong levels of adherence the nation has demonstrated to commitments historically, we see this far-reaching theme as a long-term secular tailwind for the global natural resources sector.
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