Euphoria, panic, fear and greed – avoid all four

Consolidation is progressing
With an unclear outlook of further economic developments in Europe, the USA and also Asia, and with corresponding negative reports also in the background, the consolidation phase in nickel continues for the time being. The previous relative low at the end of November was USD 15,840/mt, the lowest level since March 2021. A predominantly “bearish” (expectation of falling prices) positioning of speculative market participants with correspondingly large short positions in nickel on the London Metal Exchange (LME) is the main reason for the falling prices and, ultimately, for a very subdued mood.

While the reference price for chrome has hardly moved, since mid-November the price for molybdenum has seen more corrections. Just the price for iron ore and steel scrap could step out a little from the shadows and firm up slightly, also due to hopes of economic stimulus measures from the Chinese government. On the whole it is not really an environment where a lot of joy can be had. However, just in such times, it should be remembered that the present depressed market sentiment corresponds exactly to the conditions from which a future recovery phase can evolve.

The mood is, after all, so bad that it cannot get really any worse and prices are at a level that hardly allows the biggest part of the cost curve of the corresponding metals to make a positive contribution to costs.
In this respect, there is already speculation in the market about production cuts and changes in supply which could balance out the situation once more. In other words, before the next upswing there is always an exaggeration on the downside, just as there is always an exaggeration on the upside which inevitably starts a downswing.

The regular occurrence of this pattern is based on a phenomenon which can be described as the psychology of the Exchange. Even if emotions have no place in the markets and, especially, on Exchanges, market participants often show irrational behaviour because they let themselves be led by their own feelings. The following market wisdom summarises this quite concisely: “Euphoria, panic, fear and greed – avoid all four,”

Pressure on the interest rate front has further receded, due to both the significantly falling inflation rates and the realisation of the US Federal Bank, which had been the pacemaker for interest rate increases, that future interest rate policy must now be handled with care to have a hopefully “soft landing” for the US economy, without sliding into a recession after all. Therefore, talk of a bottoming out in the stainless steel and nickel market can continue, without suspicions of calculated optimism. And in the last few days a renewed upwards tendency could be seen, with a nickel price of USD 17,270/mt for the 3 months future, as, after all, the Exchange trades essentially on expectations and does not just reflect the current economic situation.

Construction mistake – the greedy state
Ludwig Erhard, the long-standing German Economic minister, Federal Chancellor (1963-1966) and economist – yes, this combination did actually exist at one time – is credited with the following saying: “A dog would stock up on sausages before a democratic government builds up a budget reserve”. But even in Germany there have long been no expectations of this, as really, politicians and their administrators know little else than to create debt, which is the same as living and governing at the cost of the future generations.

According to the Federal Office of Statistics (Destatis) the national debt of the Federal Republic of Germany in 2022 was around EUR 28,000 per capita. And yet the political reaction to the recent ruling of the Federal Constitutional Court on the economically sensible debt cap and contravention of the constitution by one or perhaps more shadow budgets and special funds, is that more emergencies would like to be retroactively declared, so that borrowing could then be legitimised after all.

This shows neither insight nor respect for the Federal Constitutional Court and the public, but rather an arrogance which can hardly be understood. For example, there are cries out in the open that one should not save to the point of ruin. This is a mockery for every child who has to manage with its pocket money each month, for every student who has to get though their studies, living elsewhere on limited means and part time work, and for each private household which is confronted with more or less limited means. Reality does not look like this and it cannot work indefinitely. Even an existing high credit rating is not infinite and available limitless.

However, it is not just a few of our politicians who do not want to realise this, as it is much nicer to use other people’s money and that of future generations, to shape their own livelihoods as parliamentarians or as full-time officials of a party or government. And when the problems of the people and voters are covered up by money, then this is a lot more comfortable and less painful than improving something sustainably and permanently at the root. And, in addition, there is another considerable advantage, different to that in other challenging professions. It is not only the (taxed-) money of mainly others which is being used, but their actions usually remain without consequences.

If failures are made within the Inner Circle, then very often a nice post is awaiting with an institution close to government or perhaps even on the Board of the Federal Railways. It is different with doctors, auditors, bankers, managing directors and tax payers, who today are personally held responsible for their mistakes and must pay with their own money. Therefore, it is not surprising that the system of professional politicians is almost self-perpetuating and outsiders are not really very welcome, as they also pursue the remuneration seen by some as extremely attractive.

Not many elected politicians or representatives of the people would probably enjoy the same level of prosperity and privileges in the profession they actually started out in. A limit of the legislature period to a maximum of two would be a very sensible measure. And these “experts” should and must now decide on relevant laws on government revenue and expenditure. In all honesty, this is not a very nice thought.

Nickel producers slide into the “red”
Over the last weeks the nickel market came closer once more to fundamental data: this means the price fall, which has been seen on the LME, has started to reflect the actual surplus in supply. This was also the case during the summer months, at least if the segment is looked at as a whole. However, exchange-deliverable Class I nickel was not abundantly available physically, which at the time helped to support the price level to prevail. In the meantime, this situation has turned around, which is seen by the increase in the respective LME warehouse stocks. One reason for also Class I, along with Class II and, above all, nickel pig iron (NPI) are now slipping into an oversupply situation, is the ongoing capacity expansion of corresponding plants in Indonesia and China, by which NPI is initially converted into nickel matte that then is further processed into Class I nickel – thereby making it exchange negotiable. Estimates already put the amount of this type of converted NPI to marketable nickel at around 200,000 to 230,000 tons in 2023, with an increase of up to 50% expected in the coming year.

However, on the producer side, the price fall is meeting significant higher costs in quite a lot of cases: a fall in revenue in the sales of by- and co-products, for example cobalt, increased wage and mining costs, significantly higher interest rates etc. Analysts of Macquarie Bank recently examined the global cost curve and came to the conclusion that with a LME nickel price of USD 18,000/mt a good third of producers would not be able to cover their cash cost. A continuing fall in prices would push more producers into “red figures”. It is estimated that if prices were to fall below USD 16,000/mt, almost two thirds would be cash-cost negative and would, therefore, be burning money i.e. be in a negative cash flow situation. Two western producers have already announced they will cancel the financing of their loss-making assets in New Caledonia in the foreseeable future. As well as potential production adjustments the conversion of NPI to Class I nickel could just tip the scales, as also here, prices and costs regularly determine the respective production amounts.

Indonesia seeks partners
As the world’s most important nickel producing country, Indonesia is looking into more possibilities to invest in downstream industry segments. After nickel refinery and the production of stainless steel, then the question naturally arises about investments in the field of batteries for electromobility. It could recently be read in the press that talks had taken place at government level between Indonesia and the United States and are still ongoing. The first result is an action plan for critical raw materials, such as nickel and cobalt, with the option of further agreements.

That these talks have not immediately led to a dream wedding has basically two reasons. One reason is the influence of China. And the other are the concerns regarding the environment, social and governance, or, in short, ESG. The idea behind such an association with Indonesia is, of course, to establish a supply chain for the relevant raw materials to be independent from China. However, if progress can be made, the “Inflation Reduction Act” explicitly excludes, for example, the sourcing of raw materials from “foreign entities of concern (FEOC) – and this would include Chinese companies. The crux of the matter: the expansion of the nickel industry in Indonesia has been clearly dominated by the Chinese in recent years, and still is.

Now to the subject of ESG: such a deal and indeed the industry face immense challenges. Mining in Indonesia encroaches on an environment characterised by rainforests and is associated with further risks and environmental pollution, which has often been discussed in our reports over the year. The American NGOs (non-governmental organisations) are also aware of these circumstances and have already written to the US government to explicitly draw attention to the situation.

In environmental matters, the important question of the carbon footprint also, of course, plays a part. Indonesian nickel accounts for huge amounts of carbon tonnage due to coal fired electricity used in the country and by producers.

Nickel’s carbon challenge
Minviro, a think-tank and life cycle analyst based in Great Britain, has been looking specifically at the problem of nickel sulphate and its carbon footprint. As a pure nickel salt it is a core raw material for the production of electric vehicle batteries. In the study various processing routes were compared. This is basically because two main types of nickel ore exist: for example, one is a sulphide mineral, for example, mined in Canada, Russia or Australia. The other is a laterite mainly found in Indonesia, the Philippines or New Caledonia. Within this laterite category, a distinction is made between limonitic and saprolitic ores. Using various processing methods and steps, it is technically possible to produce nickel sulphate from all types of ores, not least, as already mentioned, thanks to the conversion of NPI to Class I nickel.

However, these different processing methods are the ones which are mainly responsible for the carbon footprint. As a result, the study shows a range of the carbon footprint from the carbon equivalent of 5 kg in the best instance, but can be up to an equivalent of 105 kg carbon per kg nickel in the nickel sulphate. The “best case” scenario is based on sulphide ore, mined in North America, using a process which also involves hydropower and gas. The “worst case” scenario, according to the study, would be the processing of laterites in South East Asia with the so-called RKEF process, which uses coal-fired electricity and then coal and coke as reducing agents. This type of nickel sulphate production has a carbon footprint which is calculated at up to 18 times higher. Not a lot of fantasy is needed to see that this scenario is more or less the same process chain in which the Chinese side is investing: from the production of NPI to the conversion into nickel matte and finally into Class I nickel with the corresponding nickel salts.

This study basically also shows just how important it is to look at the carbon footprint taken in its entirety. This is because, with a closer look, significant differences in the equivalents of carbon appear resulting from the levels of direct (scope 1), indirect (scope 2, from electricity production) and from the preceding value chain (scope 3). A calculation which only includes scope 1 and 2 could therefore lead to considerable distortions, since scope 3, depending on production methods, could make a difference of up to one third of carbon emissions in production.

This is not just valid in this one example, but also critical in considering the carbon emissions of stainless steel, its manufacturing route and how much climate friendly stainless steel scrap has been used.

Local business tax has a nasty surprise ready
In this context attention should to be paid specifically to a source of income for the state, whose “new” logic of calculation has not really been examined, and probably many companies are presently not even alert to it just yet. The aim is to raise certain awareness and not to ruin Christmas which is just before us.

It is certainly well known that the German local business tax is a very important financing instrument of cities and communities, so that they are able to fulfil the obligations to which they are legally bound. Therefore, the local authorities can also determine the size of the so-called assessment rate, which is the absolute rate of tax at local level. This has resulted in a type of competition between the various authorities in regard to companies subject to business tax. So far so good.

It is also well known that, above all, the big national and international companies are eager, but hopefully within the limits permitted by tax law, to profit from the differences in the respective tax rates. For example, by appropriately structuring a high proportion of loan financing and interest to be paid, the taxable profit of individual companies or branches could be significantly reduced. Even to the point that some large companies (and other “smart” guys) no longer paid any business tax at all in certain communities, even though they are in locations where several thousand are employed, who also, logically, make use of the infrastructure and facilities of those communities.

Understandably, lawmakers did not consider this fair and, therefore, initially adopted a regulation which also included the interest on so-called long-term debt to calculate the profit liable for business tax so that the communities could ensure enough business tax income regardless of the capital structure of companies. Of course, there was an opportunity for tax payers, in legitimate cases, to explain why this inclusion was not really fair and appropriate. This worked reliably well until the year 2008.

At this time a law was waved through parliament by the “experts” mentioned above, which meant that the regulation was “simplified” in that now 25% of borrowed capital interest (regardless of which type) had to be calculated into the profit liable to business tax in every case. This had the result that now, particularly in difficult economic years, quite a few companies had to pay huge amounts of business tax, even though they were hardly making any substantial profits. Even if the regulation has been in force since 2008, since the financial and sovereign debt crisis of 2008/2009, zero and negative interest rates have prevailed which have greatly eased the problem and distortions. Historically interest rate expenditure had been, on the whole, very low.

Nowadays however, with the US-dollar key interest rate around 5.25 – 5.50% and the Euro rate at 4.5%, the situation looks completely different. When the tax returns for the 2023 financial year are submitted, some companies will probably feel sick and that it is indeed a widespread myth that corporate taxes in Germany are at a healthy average of less than 30% in international location competition. Particularly in difficult economic phases, companies with a high proportion of financing due to their business model can be facing, as described, tax rates of 50% and significantly more. Is this fair? No. Will it be loudly debated anywhere? No.

And so concludes our reporting for this year. It will, of course, be continued in the coming year. We hope you have enjoyed our reading matter, and would be happy to receive any feedback. We wish a merry Christmas and a happy New Year to all our readers and their families. Stay healthy and keep well.