COLUMN-Re-thinking zinc as 2021 benchmark smelter terms tumble: Andy Home

(The opinions expressed here are those of the author, a columnist for Reuters)

* Annual zinc smelter terms 2008-2021: https://tmsnrt.rs/3tkWZg5

By Andy Home

LONDON, April 15 (Reuters) - A sharp drop in this year's benchmark smelter treatment charges amounts to a collective re-assessment of the zinc market's underlying dynamics.

Last year's benchmark terms were set at a 10-year high of $299.75 per tonne amid a broad consensus the zinc raw materials market was heading for a period of significant oversupply, allowing smelters to lift their charges for converting mined concentrate into refined metal.

However, the expected surge in mine production failed to materialise as large supplier countries such as Peru and Mexico were rocked by COVID-19 lockdowns.

As a result this year's benchmark smelter terms have almost halved to $159 per tonne with smelters forced to accept the changed dynamic.

Moreover, tightness in the zinc concentrates market is proving much stickier than expected, which is one reason London Metal Exchange (LME) zinc is holding close to two-year price highs despite some hefty inflows of metal into exchange warehouses.

SLASHING THE BENCHMARK

This year's benchmark zinc concentrates deal was negotiated between miner Teck Resources and smelter customers Korea Zinc and Glencore.

The deal was first reported by Fastmarkets and has been confirmed by miners such as Australia's New Century Resources , for whom the drop in charges is a big deal.

Treatment charges represent around 30% of New Century's cash costs, meaning the 47% year-on-year reduction "delivers a material operational cashflow increase," the company said in a stock exchange release.

For the second consecutive year the benchmark has no obvious price participation formulas, probably because after the price turbulence of 2020 no-one's agreed on what a fair basis price would be from which to calculate the "escalators" and "de-escalators" of past benchmarks.

It's possible that zinc concentrates pricing is following copper, which moved away from price participation a decade ago as an unprecedented rally challenged the long-held assumptions underpinning the concept of price-sharing.

What's clear, though, is that the profitability pendulum has swung in favour of miners this year after what with hindsight was an unrepresentative, top-of-the-cycle 2020 benchmark.

Moreover, this year's benchmark is the second-lowest in more than a decade. It's worth remembering that the lowest benchmark in the period - $147 per tonne - was set in 2018, a year of mined concentrates scarcity that pushed the LME zinc price to a decade high of $3,596 per tonne.

COVID-19 HIT

That price rally was expected to incentivise a wave of new and restarted mine supply.

When the International Lead and Zinc Study Group (ILZSG) met in October 2019, its forecast was for zinc mine production to grow by almost 5% over the course of 2020.

In the event, global production actually fell by 5.9% last year, according to ILZSG's latest assessment.("Zinc: Review of Trends in 2020", Feb. 25, 2021)

Zinc got unlucky in last year's lockdown lottery as mines around the world were forced to suspend or curtail production as the pandemic spread.

Mined output fell in Bolivia, Burkina Faso, China, Finland, Kazakhstan, Mexico, Peru, Sweden, Turkey and the United States, according to the ILZSG.

The slump in this year's benchmark is a reflection of that simple fact. A year of expected plenty turned out to be one of the worst production years in memory.

Moreover, recovery from COVID-19 is proving to be a slow process in some countries affected by continuing quarantine measures.

Smelters are still struggling to source sufficient material, particularly in China, where spot treatment charges continue to flounder at a current $60-74 per tonne, according to Fastmarkets.

Chinese buyers successfully navigated last year's choppy COVID-19 waters by tapping suppliers such as Pakistan, Saudi Arabia and Myanmar and zinc concentrate imports rose by 20%.

But momentum has stalled so far this year, imports falling by 2% over January and February relative to 2020.

With many northern Chinese mines only starting to emerge from winter hibernation, local smelters are evidently still scrambling to secure top-up material.

NO SHORTAGE OF METAL

The zinc concentrates tightness is not as acute as that in the copper market, where a lack of mined material is translating into a rolling series of maintenance shutdowns at Chinese smelters.

Indeed, Chinese refined zinc production is on something of a roll, national output up by 7% year-on-year in March, according to state research house Antaike.

This disconnect between the raw materials and refined metal segments of the zinc supply chain is not confined to China.

LME warehouses registered inflows of 31,700 tonnes in the space of just two days - April 9 and 12 - and headline inventory of 296,525 tonnes is now up by 47% on the start of January.

There is no shortage of refined metal. Despite last year's collapse in mine output, global refined production rose by 1.2%, according to ILZSG, which estimates the market registered a supply surplus of 533,000 tonnes of metal in 2020.

Some of that surplus is evidently washing around the LME system. It's worth noting that as of the end of February there were also 87,400 tonnes of zinc in LME "shadow storage", whereby metal is stored off-warrant but under warehouse agreements explicitly referencing the option of full exchange delivery.

There is almost certainly more zinc sitting in the deeper storage shadows.

MINE SURGE STILL PENDING

This abundance of metal is why most analysts, even those at the super-bullish super-cycle banks, don't much like zinc's prospects.

But then no-one's much liked zinc's prospects since the big rally of 2018 because of the expected mine supply reaction.

Last year's high treatment charge benchmark captured that narrative even as spot fees were collapsing as the COVID-19 hit to mine supply started to unfold.

This year's drastic cut to the benchmark is an acknowledgement that raw materials are still tight and that the mine supply wave is still pending.

It's running two years late and the current bombed-out spot treatment charges suggest it's a while away yet.

The zinc market has already stubbornly defied bear expectations and the longer mine supply takes to normalise, the longer it will do so.

(Editing by David Evans)