CL3 Minerals Markets Prices and The Recent Performance of The Mineral and Energy Sector

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CHAPTER 7
Mineral Markets, Prices and the Recent Performance of

the Minerals and Energy Sector
Phillip Crowson
Introduction
Market Structure Competitive Markets
Market Structure Oligopolistic Markets
The Rise and Fall of Cartels
Producer Pricing
Terminal Markets
Recent Trends in Mineral Markets
INTRODUCTION
The two preceding chapters examined the diverse influences on
demand for mineral products and the various forces acting on the
supply side. In essence, prices are determined by the interaction
of these opposing forces in the market place. The geographical
location of demand, the end uses and the nature and sources of
supply differ for each product, and these differences in market
structure dictate precisely how demand and supply interact to set
the prices of individual products. The nature of the pricing
mechanism is strongly influenced by the ease with which new
suppliers can enter the market (in other words by the barriers to
entry). In the short to medium term price levels can be affected by
political, economic and social conditions in mineral-producing and
consuming countries, but the main factors are geological and
technical. Where ore deposits are readily discovered and easily
exploitable with existing technology at prevailing price levels the
barriers to entry are low. Conversely, a scarcity of exploitable
deposits keeps the barriers high. Changes in exploration or
extraction and processing technology can rapidly change the
conditions of entry.
Leaving aside the complications flowing from the existence of

inventories, other than normal working stocks, prices will settle
in the near term where demand and supply intersect. Other
factors being equal, a rise in demand or a fall in supply will
prompt a rise in prices and a fall in demand, or a rise in supply
will prompt a fall in prices until equilibrium is restored. In
practice, prices will tend to fluctuate around the equilibrium
level, because conditions are continuously changing. Prices will
gravitate towards the industrys marginal cost of production: the
cost of production of the last (or most expensive) unit of supply
from whatever source, which is required to balance the market.
The nature of the supply curve in competitive markets and its
interaction with demand and price are illustrated in Figure 7.1.
D1
P1
MARKET STRUCTURE COMPETITIVE MARKETS

Where the barriers to market entry are low there is likely to be
a relatively large number of suppliers. The more present and
prospective suppliers there are, the more competitive they are
likely to be with each other. Price in such competitive markets is
determined by the free interplay of supply and demand, and it
will fluctuate to the extent needed to clear the market. The
demand curve facing each individual supplier is, to all intents
and purposes, flat rather than downward sloping to the right like
the industrys demand curve. Producers are price takers and
have little or no influence over the prevailing price. They can,
however, alter the amount they supply to the market, and each
supplier will produce as much as possible as long as their cash
costs are fully covered.
Australian Mineral Economics
Price
P
D2
P2
Quantity
Q2
Q1
Capacity
FIG 7.1 - Short-run supply and demand in competitive markets.
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CHAPTER 7: MINERAL MARKETS, PRICES AND THE RECENT PERFORMANCE OF THE MINERALS AND ENERGY SECTOR
When prices are very low there is no supply, as costs exceed

prices. Higher prices allow producers to cover their costs and
enter the market until supply is constrained by the available
capacity. Then no additional supplies can be immediately
forthcoming, no matter how high prices rise. It takes time for
new capacity to be developed, whether that comes from the
expansion of existing operations or from new facilities. The price
and the quantity supplied settle at the point where the supply and
demand curves intersect (P and Q when the demand curve is D).
If the demand curve rises to D1, higher cost producers will be
able to supply and the price and quantity will rise to P1 and Q1.
Conversely, when demand drops back to D2 (perhaps because of
economic recession or some technological change in end-use
markets) higher cost producers will be unable to cover their costs
and price and output will fall to P2 and Q2 respectively.
This assumes that suppliers merely have regard to near-term
demand and prices. In practice their reactions will be much more
complex. If they believe that a price fall is temporary they may
be prepared to stockpile rather than reduce their output, or to
incur losses for a period. The costs of closure, including the
repayment of debt, environmental remediation and redundancy
payments, may exceed the costs of continued operation. Also,
many suppliers may have more complex objectives than shortterm profit maximisation and may be prepared to produce at a
loss. Over the longer term, when the constraint of existing
capacity is lifted, the supply curve will shift to the right, with its
level dictated by technological change and shifts in the political
and regulatory climate.
The non-ferrous metals, gold and silver, are the mineral
products whose markets most closely approximate the
competitive model. They are typical commodities, in the sense
that the products of different producers are reasonably
homogeneous and any individual suppliers product can readily
substitute for that of another. There are many customers and a
variety of end uses, each with common standards and
specifications. Producers can exert little or no influence over the
markets for their products, which are usually regional or global,
and there is hardly any after-sales service, such as technical
support. Prices are uniform for the standard grades and the
producers concentrate on controlling their relative costs. There
are many suppliers spread throughout the world and no single
producer can influence the level of prices, except for very short
periods. There are many ore deposits being exploited or under
development, it appears relatively easy to discover new ones,
secondary materials are readily available and transport costs are
generally low relative to product prices. Information about recent
and prospective trends in supply and demand is rapidly and
widely diffused and the markets are reasonably transparent.
That prices and volumes will settle at the unique point where
the demand and supply curves intersect does not describe the
actual process of price discovery, except in an auction market.
There bids and offers are made in public until a price is derived
that just clears the market. At that price all purchasers and
suppliers are satisfied. The method is similar for gold, silver and
the non-ferrous metals in that their prices are settled in terminal
markets. The characteristics of such markets are explained in a
later section of this chapter.
developments by privately owned companies through much of

the 1960-1990 period, especially where such companies were
foreign-owned. Many countries prevent the mining of known ore
deposits in national parks or wilderness areas. Unstable political
conditions increase the risks of mineral exploration in many
regions, but particularly in Africa and parts of Asia, to
unacceptable levels. These various influences, either alone or in
combination, raise the barriers to entry and limit the number of
producers.
As Table 7.1 illustrates, there are typically relatively few
significant suppliers to the market for a wide range of minerals
and their first stage products. The table shows the shares of the
largest firms in the global production of a range of mineral
products, split between those that are traded in terminal markets
and those whose prices are fixed in other ways. Platinum appears
in both groups, as producers directly sell most production to
users at list prices that lag terminal market prices. The degree of
industry concentration is a major influence on pricing, but not
the only one. Often there are also relatively few major users.
TABLE 7.1
Concentration in mineral markets: percentage shares of largest
firms in world production 2002. (Source: Raw Materials Group,
2004.)
Leading
Top 3
Top 5
Top 10
22
29
41
Gold
23
32
47
Platinum
42
76
89
98
Copper metal (2003)
10
24
34
49
Zinc metal
14
31
42
60
Aluminium
13
32
43
60
Nickel
16
39
49
68
Zinc mine
23
30
43
Lead mine
10
25
34
48
Copper mine
12
25
37
58
Iron ore (2003)
18
37
46
58
Manganese
26
36
52
Metals traded on terminal markets

Silver
Negotiated or list prices
Alumina
15
33
46
71
Bauxite
16
34
49
68
Chromite
21
49
64
83
Diamond value
29
64
76
82
Titanium minerals
24
53
70
85
Lithium
23
68
77
83*
Mercury (1997)
39
87
90
Niobium
40
83
94
98
Platinum
42
76
89
98
Notes: top 4, top 7, * top 9.
MARKET STRUCTURE OLIGOPOLISTIC

MARKETS
The markets for most mineral products depart in varying degrees
from the competitive model. The geological availability of many
products is much more limited than for the non-ferrous metals or
the technology needed for their extraction and processing is far
more complex. The accessibility of ore deposits for commercial
mining may be restricted by a variety of political, environmental
or economic factors. For example, many developing countries
either totally prohibited or severely circumscribed mineral
60
Where there are only a few major producers the suppliers do

not have to take the demand curve as given and their actions can
have some influence on prices. Rather than a demand curve that
is flat, they face one sloping downwards to the right, just like the
industry. As there are usually few suppliers the supply curve is
likely to be stepped. Producers can exert some control, even if
strictly limited, over the prices they receive by differentiating the
characteristics of their products from those of their competitors.
In many instances there is considerable competition in the
non-price dimensions of the product, such as technical service or
delivery schedules. The chemical and physical characteristics of

the product are varied not just for particular end uses, but often
also for individual users. There is a wide variation in grades and
specifications, which is reflected in widely differing prices for
apparently similar products. The costs of mining the raw ore are
less important than its characteristics and the methods whereby it
can be modified to serve the end-uses that offer the highest
prices. Even producers of commodity metals and minerals look
for ways to upgrade and differentiate their products from those of
their rivals in order to achieve a premium over the basic market
prices. Their objective, which is sometimes attained, is to create
a market for their own output that is distinct in some way from
the market as a whole.
Where prices settle will clearly still depend on how and where
demand and supply intersect, no matter the precise structure of a
products market. Since the costs of most suppliers are lowest at
or near their maximum possible output they will tend to produce
to capacity. Without the safety valve of terminal markets
however, the costs of stockpiling excess supplies usually forces
suppliers to reduce their offerings in periods of weak market
conditions. The short run market conditions facing a
representative producer are shown in Figure 7.2. The shapes of
the demand and supply curves have been deliberately
exaggerated.
Marginal
Cost
P
Average
Cost
Above-normal
profit
Price
Demand
Marginal
Revenue
Q
Quantity
FIG 7.2 - Short run market equilibrium for a representative
producer.
As the producer faces a downward-sloping demand curve for

output, the marginal revenue from additional sales will also
decline with increasing output. Assuming that the producer aims
to maximise profits, they will produce to the level of output (Q)
where marginal revenue equals marginal cost of production.
The price (P) is rather higher than would be set in a completely
competitive market and the producer would earn above-normal
profits. That is not a stable position because such profits would
induce a variety of competitive responses. Exploration and new
mine development would be stimulated and technological
research on lower-cost processes encouraged. On the demand
side, the use of substitutes would be encouraged. In consequence
the demand curve facing the representative producer would be
pushed downwards, lowering the level of output associated with
a given level of prices. Subject to the ease or difficulty with
which the barriers to entry could be surmounted the excess
profits would eventually be eliminated by competition and the
long run equilibrium shown in Figure 7.3 would be attained.
The producer would still maximise profits at the point where
marginal cost equalled marginal revenue, but with only a
normal rate of profit. Also, the level of output would be rather
lower than would be reached in a perfectly competitive market,
were that to exist in the real world. As markets develop, and the
number and range of producers expand, prices drop towards the
Marginal
Cost
Average
Cost
P1
Price
Demand
Marginal
Revenue
Q1
Quantity
FIG 7.3 - Long run market equilibrium for a representative

producer.
marginal costs of production and any monopoly profits are

gradually whittled away. The theoretically relevant marginal
costs are those likely to pertain over the long run. In other words,
they will incorporate the opportunity costs of capital of the
facilities just needed to meet expanding demand over the long
term. In practice prices tend to gravitate, at least in the
competitive markets, towards the cash break-even costs of
existing marginal producers. New entrants will aim to have much
lower cash costs than these and to cover their full costs at
expected prices.
Markets with only a few suppliers are described as oligopolies,
and those with only a few customers, are given the less common
description of oligopsonies. In many such markets there may be
a penumbra of smaller suppliers or users around the few large
firms. Small customers are liable to absorb an unduly large
amount of time and effort from the suppliers sales staff and they
are often serviced through distributors. Although small producers
are unlikely to produce a full range of products, their persistence
in selling their own grades can undermine established price
structures. Major suppliers of many industrial minerals and
minor metals therefore have to take full account of their activities
and potential actions. The power of the major producers to
control their markets is accordingly circumscribed. In all cases
each producer has to take account of the possible impact any
decisions about pricing and production volume may have on
competitors and of their likely policies. How those differ will
partly depend on each producers relative costs and available
capacity.
In some instances the smaller producers may sell through
merchants, who may also acquire supplies from other sources.
These may include releases from redundant government
stockpiles, scrap and secondary recovery and in previous times
imports from state trading countries that were on the fringes of
the global market economy. Particularly when market conditions
are weak, merchants have been able to re-purchase excess
supplies from the customers of the major suppliers. Although the
producers naturally discourage resale of their products, they
cannot always prevent it.
At the theoretical extreme of a market with just one supplier,
or pure monopoly, the demand curves of the supplier and the
industry are the same. Monopolists can choose that combination
of price and volume that best suits their objectives. Assuming
that their objective is profit maximisation they will produce to
the point where the marginal revenue equals the marginal cost.
The short run position shown in Figure 7.2 would hold for the
monopolist over the long run. In practice there are no instances
of natural total monopoly in the mineral industries on a global
scale, although there have been cases of contrived monopoly
61
through cartels and similar collusive actions in restraint of trade.

The availability of secondary materials and of substitutes of
varying degrees of effectiveness for most mineral products
means that any individual suppliers power to raise prices by
holding back supplies is strictly limited.
That substitutes exist and that there are usually competing
suppliers to global markets does not rule out the probability of
more restricted monopolies. The key is the height of any barriers
to entry. These can be artificially raised for domestic producers
in a national market by protection against imports through tariffs
or quotas. Over the post-war years there was a steady trend in all
major economies towards dismantling quotas and other
quantitative restrictions and lowering tariff barriers on most
products. This gradually eroded local monopolies, often against
the strong resistance of the previously favoured suppliers. Some
developing countries still have highly protective tariffs against
imports, although there are continuing pressures for their
reduction. The cost of transport provides a less penetrable
barrier, especially for bulk products with a low value to weight
ratio.
Accordingly, the markets for sand and gravel remain largely
local, even in the US and Western Europe. For bulk products like
coal and iron ore, however, sharply declining costs of ocean
shipping during the decades following the Second World War
opened up local and national markets to international
competition, which had consequent repercussions on the market
structure and pricing of such products.
As demand for a product develops and expands from its initial
niche markets, new entrants are attracted over the prevailing
barriers to entry. The more suppliers there are, the more difficult
it becomes for any one of them to control, or even influence,
prices. In the initial stages of a products life cycle there may be
only a limited number of uses, or perhaps only one. Users will be
prepared to pay high prices to satisfy their needs. The owners of
the more accessible deposits are able to cream off monopoly
profits, especially where they also control innovative processing
technology. These profits naturally attract the envious attentions
of other companies, stimulating both exploration and research
into processes. Often both are successful and the initially high
barriers to entry are reduced.
New entrants can piggy-back off the marketing activities of the
initial pioneers. Capacity expands, probably at a faster rate than
demand, which remains dependent on specialist uses. Sooner or
later potential supply exceeds demand and prices come under
pressure. The initial producers will have probably recouped their
investment several times over and be prepared to drop prices both
to stimulate demand and to choke off new entrants. Conversely,
the latter may be forced into price cutting in order to gain market
share. Often they may be able to withstand lowered prices
because their deposits or processes are superior to those of the
pioneers. Normally production starts at those deposits that are
known or readily accessible, rather than at those with the
potentially lowest costs. Followers building completely new
facilities may be able to exploit process improvements more
easily than the originators in their established plants.
Military needs in wartime have often forced large increases in
the capacity to produce many mineral products and metals, often
irrespective of profitability. The physical need has been
paramount. When military demand has dropped, producers have
been forced to develop new uses in order to keep their capacity
running, often with price reductions. Changing technology has
also been a driving force. In all cases rapidly expanding markets
have allowed producers to exploit economies of scale.
The ways in which market prices, other than those fixed in
terminal markets, are actually determined varies widely between
different mineral products. Prices for some are posted by
producers, almost on a take it or leave it basis. Such producer
pricing, which is discussed later in this chapter, was once much
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more widespread. In effect, the producer acts like a monopolist,

offering to sell at a given price, with an implicit assumption that
output will be reduced to maintain that price when market
conditions are weak, and that some customers may be unsatisfied
when demand runs against the limits of capacity. Other producers
may voluntarily decide to follow the lead set by the price-setting
producer and accept satisfactory rather than maximised profits.
In other instances producer pricing may be sustained through
collusive behaviour, ranging from informal discussions to formal
cartels. The recent history of cartels is also described later in this
chapter.
Where there are only a few major participants on each side of
the pricing equation (which is true for many mineral products)
prices are largely determined by negotiation. Each participant
has to take account not only of the likely responses of the
customer to their actions, but also of the possible reactions of
existing and potential competitors. Such intelligence is usually
more important for the producers than the purchasers. Each
mineral product effectively forms a small village where all the
major participants know each other. This village-like nature of
global mineral markets facilitates the rapid transmission of
gossip and information and the sense of prevailing market
conditions, even where there is no explicit market place.
How companies behave when negotiating prices largely
depends on the point reached in the business cycle and on the
strength of any barriers to entry. A tougher negotiating stance is
more appropriate when markets are tightening than when they
are in the recessionary phase of the cycle. Where there are few, if
any, viable undeveloped ore deposits, or where complex
proprietary technology is required in the production process, the
existing producers bargaining position is strong. It weakens
markedly where there is ample existing and prospective capacity
and technology is readily available.
Thus the differing availability of ore deposits probably favours
manganese producers over iron ore producers in their dealings
with the steel mills. Neither has a very strong position however,
compared with the existing producers of titanium dioxide
feedstock during the 1980s and early 1990s. They benefited from
high barriers to entry in both ore reserves and technology. Their
market power was constrained by the comparative strengths of a
few large purchasers. Mutual deterrence is as much a feature of
some mineral markets as of international relations.
History suggests that price wars, once started, are difficult to
stop and that they normally benefit only the customers. Even that
benefit may be strictly short term if lower prices inhibit
investment in additional capacity to meet growing demand.
Much depends on whether the major producers concentrate their
attention on maximising prices and profitability, or on volume.
The pursuit of market share is a common corporate objective,
on the assumption that it can enhance a companys market
power. It does not usually appear to have been accompanied by
long-term profitability when it has been followed in the minerals
industry. One possible argument in favour of maximising
volume, even at the expense of weaker prices, is that it enables a
producer to achieve the designed economies of scale from
existing capacity. The structure of costs may be such that the
burden of fixed costs per unit of output rises sharply when the
mine and equipment are not fully utilised. The gains from
increasing the volume of sales may more than outweigh any fall
in prices.
Trade-offs like those are typical of the iron ore producing
industry. Producers of iron ore, like those of other minerals,
never look solely at one dimension of their sales contracts but at
them all simultaneously. Concessions on price may be set against
increased volume, but these are not the only dimensions of sales.
Quality, including such features as the grade and the physical and
chemical composition of the ore, is becoming increasingly
important. Quality involves far more than the ore itself. The
perceived reliability of a supplier and its susceptibility to strikes

and other disruptions is another aspect of quality. The provision
of technical service to customers is not really important for the
producers of metallic ores, but it can be a valuable competitive
tool for suppliers of industrial minerals. The terms on which
credit is granted to purchasers and the extent to which prices may
vary with the prices of the customers products are also relevant,
especially in the markets for base metals concentrates.
In iron ore and coal, as in many other products, pricing has
evolved over the past 30 years. When many exporting mines
were first established, trade was mainly based on long-term
contracts with prices fixed over long periods or indexed to
general indicators according to agreed formulae. Such contracts
have evolved into shorter term contracts covering several
years, but with periodic price negotiations. The volumes can also
vary within predetermined limits, depending on market
conditions. Negotiations do not start from scratch every year, but
from the prevailing prices, which roll over until a new agreement
is reached. In some product markets, and especially in industrial
minerals, prices are negotiated for the life of the contract, which
may be for three to five years. Provision may be made for prices
to move over the life of the contract in step with agreed indices,
such as US wholesale prices. When the contracts expire, the two
parties will negotiate a new agreement taking into account
changes in the balance between supply and demand and the
extent to which the expiring contract favoured one side or the
other. Very often one party will be keen to offset any
disadvantages it suffered during the previous contract term.
Usually agreement is eventually reached because there is a
mutual interest in a continued relationship, but discussions
occasionally break up in acrimony, with the parties resorting to
arbitration.
More frequent negotiation of prices tends to prevent such
disruptions since contract prices then move more closely with
market conditions. Sometimes prices are changed half-yearly or
even quarterly, as in sulfur and some fertiliser materials. Annual
price negotiation is now the general rule in iron ore, coal and
base metals concentrates. Large producers may divide their
contractual volumes, even with one customer, into blocks whose
prices are negotiated at different times. That softens the impact
of any large price movements resulting from the annual
negotiating round. The outcome of the annual bargaining
naturally depends on the relative strengths of the buyers and
sellers, but also on the changing objectives of individual
producers. The first major price settlement reached in the annual
bargaining round usually sets the tone for the entire market and
other suppliers quickly follow. The same supplier and customer
may lead the market for several years running, but the leadership
often changes. Published prices are normally only one facet of a
settlement that also includes arrangements on tonnage. The
producer that settles first in a weak market may have
counterbalanced concessions on price with increased sales
volumes, but the followers seldom derive those benefits.
Participants in the market have to weigh up all the alternatives in
their negotiating strategies. Obviously they will need to take
account of the size of their own and their competitors
inventories and of the balance between the capacity and output of
each producer. Eventually a global consensus about prices is
reached and prices in the main regional markets are closely
linked. Sometimes such a consensus is reached quickly, whereas
in other years the negotiations can drag on for months.
THE RISE AND FALL OF CARTELS

Even where prices are negotiated between major producers and
users of a product, there may be scope for collusive action
between producers. Adam Smith (1976) [1776] remarked on this
tendency over 200 years ago:
People of the same trade seldom meet together,

even for merriment and diversion, but the
conversation ends in a conspiracy against the
public, or in some contrivance to raise prices.
The same factors that facilitate producer pricing namely a
relatively limited number of producers tend to encourage
restrictive agreements to limit output or raise prices. The history
of the minerals and metals industry is littered with attempts to fix
prices through cooperative actions. These have met with varying
degrees of success, but most have ultimately failed. Some have
worked through producer pricing whilst others have operated
through terminal markets. Many, but by no means all, were
started in periods of over-supply as defensive reactions to
self-defeating price cutting. Those were often introduced with
the active support of or at least implicit connivance of,
governments.
Attitudes to cartels between producers are much affected by
prevailing political philosophies. During the period between the
First and Second World Wars, many governments accepted the
need for concerted action to restrict output in conditions of acute
excess capacity and weak demand in order to sustain prices.
In the decades following the Second World War such attitudes
persisted and they were reinforced by the widespread acceptance
of government intervention and regulation of economic activity.
The Organisation of Petroleum Exporting Countries
(OPEC) was one of many producer-based organisations
established during this period. It was founded in 1960 by five
countries, Iran, Iraq, Kuwait, Saudi Arabia and Venezuela and a
further eight oil producing countries had joined by 1973. For the
first decade of its existence OPEC achieved very little, but its
members chipped away at the power of the international oil
companies that effectively controlled their production. Strongly
rising international demand for crude oil, partly driven by the US
moving from a production surplus to a deficit, enabled the
producers to achieve moderate price increases in 1971. The
Arab-Israeli war of October 1973 and its aftermath encouraged
OPEC to go much further in gaining control of pricing and
production. The move was driven by political rather than
economic considerations, as a means of putting pressure on the
industrial countries. The price of oil quadrupled, transforming
the international oil market and prompting serious economic
dislocation in the global economy. The Iranian revolution in
1979, coupled with political upsets elsewhere, led to a further
round of sharp price rises in 1979-80.
The initial price increases held because the short run demand
for oil was highly price inelastic, but by the early 1980s
alternative sources of oil were being developed, partly under the
stimulus of the higher prices then ruling. There had also been
wholesale substitution away from oil to alternative fuels and
energy-saving measures of all types. By the late 1990s OPEC
supplied about two-fifths of the global production of crude oil
compared with well over half in the early 1970s. Although OPEC
introduced formal quotas on production in 1982 in order to
sustain prices, there was widespread cheating and crude oil
prices drifted downwards from the mid 1980s. The first Gulf War
in 1991 had but a temporary impact on oil prices.
By the late 1990s global demand was again starting to outstrip
the available capacity to produce and OPECs production quotas
became more effective. The collapse of Iraqi production in 2003
helped OPEC to sustain crude oil prices. Most of the surviving
members of OPEC (Ecuador left in 1992 and Gabon in 1995) are
Islamic states with a similar political outlook, although the
similarities between theocratic Iran, a feudal monarchy like
Saudi Arabia and Nigeria or Indonesia should not be overstated.
OPECs successes have sprung not so much from its own policies
and actions as from the global market conditions it faces.
OPECs share of world oil production between 1965 and 2004 is
shown in Figure 7.4.
63
100
OPEC
Non-OPEC
million barrels/day
80
60
40
20
0
1965
1970
1975
1980
1985
1990
1995
1965
1970
1975
1980
1985
1990
1995
2000
A
60
% share of world total
50
40
30
20
10
0
2000
FIG 7.4 - (A) World crude oil production and OPECs share of
world production. (Source: British Petroleum, 2004 the data
cover crude oil, shale oil, oil sands and natural gas liquids).
(B) OPECs percentage share of world oil production.
OPECs apparent success in raising crude oil prices in the

early 1970s prompted the formation of similar international
producer groups for a variety of mineral products, such as
phosphates, bauxite, iron ore, mercury and tungsten. Less formal
arrangements covered manganese, lead and zinc. Many groups,
nominally at least, excluded any discussion of prices from their
agenda. The articles of the World Phosphate Institute, for
example, were framed in such a way as to leave the three US
company members free of any anti-trust action. Australia only
joined the bauxite and iron ore associations on the understanding
that they would not attempt to increase prices unilaterally.
Nonetheless, the smoothing of price fluctuations was always an
important objective of most members of all these producer
groups and of the copper producers group, CIPEC, which was
formed in 1967. Most were inter-governmental bodies, although
the phosphate, mercury and tungsten organisations had
individual company members. Most lacked the wider common
interests that created the strong cohesiveness of the Arab
members of OPEC. Weak market conditions from 1974 onwards
prevented most producer associations from exploiting any power
they might have had. In any case, the basic economic conditions
that allowed OPEC to boost oil prices do not exist in most
commodities.
There are several preconditions for successful cartel action:
members should share some common interests and objectives;

there should not be a wide range of grades or qualities of the
product involved, but different producers output should be
closely substitutable (the scope for cheating tends to vary
inversely with the homogeneity of the product);
a high level of concentration of production and reserves is

required; and
the cost structures of each producer should be broadly

comparable.
64
Where costs of production diverge widely there is little

community of interest between the lower and higher cost
producers. Similarly, a wide diversity of sources of production
and undeveloped reserves raises the prospect of new entrants
undermining the cartel. In essence, the barriers to entry need to
be fairly high and not just in the short run. There should be few
viable substitutes in the products major uses and the
price-elasticity of demand should be very low.
Even during their heyday in the late 1970s, producer
associations formed merely to increase or stabilise prices were
unlikely to succeed, because some or all of the necessary
pre-conditions for success were lacking. Table 7.2 outlines the
fate of several international producer groups that were formed or
gained prominence during the 1970s.
Bauxite was perhaps the nearest parallel to petroleum in the
early 1970s and producing countries such as Jamaica raised their
returns from local bauxite production. That was a temporary
success however, because there were ample alternative resources
and the barriers to entry were relatively low. The raising of prices
provided leeway for potential producers in other countries such
as Brazil to develop new mines. Jamaicas share of global
bauxite output fell from around 18 per cent in 1973-74 to eight
per cent by the mid-1980s.
Morocco and the other members of the putative phosphate
cartel were unsuccessful in sustaining their price increases
because farmers effectively went on strike and delayed the
application of phosphatic fertilisers. Many of the
inter-governmental producer groups that were formed during the
1970s did not survive changes in market conditions and
prevailing political philosophies. The International Bauxite
Association, for example, saw a gradual loss of members before
collapsing in 1995. In copper, CIPEC saw many members
withdraw and contracted, leaving its residual coordinating
functions carried out in Chile.
Even if the necessary preconditions for cartels had been in
place, the marked change in global political conditions that
gathered force during the 1980s would have made their lives
difficult. The emphasis moved from collective to individual
action and to the primacy of market forces. Government
intervention became unfashionable with the view that prices
should be allowed to find their own levels in response to
competitive forces, which should be facilitated by effective
competition policies.
A major defect of producer cartels is that they do not explicitly
take account of the interests of consumers. Governments of
commodity-consuming countries are, therefore, wary of their
creation, especially where companies rather than governments
are involved. Both the US and the European Union came out
strongly against any effective cartels, whether these were
organised by individual producing companies (private or state
owned) or by governments. This opposition was less than total,
however, as the United States has explicitly allowed cartels that
enable US exporters to compete internationally. Thus US
exporters of phosphates and soda ash combine to sell in overseas
markets. Similarly, joint purchasing arrangements amongst
consuming companies are also acceptable. Examples include the
Japanese smelter pool, which arranges imports of copper
concentrates and joint purchasing by both the Japanese and the
German steel mills. One company may take the lead in dealings
with producers, with the ensuing agreement shared by all. Joint
purchasing can tip the scales in the purchasers favour, even
where they have an apparently weak initial bargaining position.
Until the mid-1970s only the US had strong anti-trust
legislation and non-US companies were prepared to collude to
maintain prices. The important proviso was that such collusion
did not affect US commerce, otherwise it would have brought
those involved under the reach of the extra-territorial provisions
TABLE 7.2
International producer associations in the minerals industry.
Bauxite
International Bauxite Association (IBA)

Formed March 1974 and by 1975 members controlled 85 per cent of non-socialist world output. Jamaica, Surinam, Dominican
Republic and Guinea successfully raised bauxite mining taxes, but Australia did not. The countries that did lost market share and the
IBA became increasingly ineffective. Jamaica withdrew in mid-1994 and the IBA collapsed in 1995.
Copper
Conseil Intergouvernmental des Pays Exportateurs de Cuivre (CIPEC)

Formed in June 1967 by Chile, Peru, Zaire and Zambia. Yugoslavia and Indonesia joined later and Australia and Papua New Guinea
became associates. In 1974-76 CIPEC unsuccessfully tried to stabilise copper prices through production cuts, but its members
controlled too small a share of the global market. CIPEC dwindled in importance with the collapse of Central African copper
production, the withdrawal of several members and the establishment of an International Copper Study Group in 1993. Its residual
coordinating functions moved to Chiles Copper Commission.
Iron ore
Association of Iron Ore Exporting Countries (APEF)

Developing country members pressed for attempts to set export prices in 1975, but Australia and Sweden refused. Neither Brazil nor
Canada joined. APEF collected statistics on market trends until its suspension in 1989. Its statistics gathering role was taken over for
a period by an UNCTAD Trust Fund.
Phosphate rock
World Phosphate Rock Institute

Morocco, the leading producer outside the USA, joined with Algeria, Brazil, Jordan, Senegal, Syria, Togo and Tunisia in 1973.
Morocco sharply raised export prices in 1974 and several other members followed suit. The United States export cartel, Phosrock,
also raised its prices. The global market collapsed in 1975 when the effects of recession were exacerbated by farmers ceasing to
apply phosphatic fertilisers.
Mercury
Mercury Producers Association (Assimer)

Formed in 1975 by Algeria, Turkey, Mexico, Italy, Spain and Yugoslavia. Most production was state-owned. In late 1977 Assimer
announced attempts to control the market with sales restrictions, followed by price increases. Its control was undermined in 1982 by
falling consumption, increased secondary supplies and sales from US stockpiles, but was reasserted for a brief period in the late
1980s. Growing concerns about the adverse impact of mercury on human health and the environment have led to even tighter
regulations on consumption. These have also boosted recycling and greatly reduced any pricing power of the primary producers.
Tungsten
UNCTAD Committee on Tungsten, Primary Tungsten Association

International Tungsten Industry Association
An Ad Hoc Committee on Tungsten, an inter-governmental body, was established under the auspices of the United Nations in 1963.
One of its tasks was to examine ways of stabilising prices. In due course, the Committee and its various offshoots moved under the
UNCTAD umbrella. Its main role was the collection of statistics but it also attempted to reach agreement on means of stabilising the
market, especially during the late 1970s. It was complemented by a producer organisation, the Primary Tungsten Association (PTA),
established by major producing companies in 1976. With changing attitudes to market intervention, the UNCTAD Committee was
replaced in October 1992 by an Inter-governmental Group of Experts on Tungsten, whose remit was solely statistical. The PTA was
replaced by the International Tungsten Industry Association in early 1988. This brought together mining companies, processors,
consumers and traders in a research organisation under Belgian law.
of the US anti-trust laws. It was reasonable to assume that

producer pricing outside the US was beyond reach as long as the
US was self-sufficient in the affected products. Imports into the
US of many minerals and metals began rising strongly in the
early 1970s however, for a variety of different (usually specific)
reasons. That led the US Department of Justice to examine
possible breaches of anti-trust laws by foreign companies.
Simultaneously, the European Unions competition policy was
being developed and enforced through case law.
International zinc producers were amongst the first to
experience the changed climate. Companies who had established
and maintained the well-publicised European Producer Price
system for zinc from 1964 onwards with the tacit approval of
their host governments were questioned by the US anti-trust
authorities in 1976 and a case was brought against them by the
European Competition Directorate. That eventually resulted in
fines and the effective collapse of the system of zinc producer
prices, which had been enforced through an agreement to
stockpile, intervene on the London Metal Exchange and reduce
output when necessary. The vestiges of the system lingered on
for some years, but without the previous effectiveness. Even
when it was fully operational those involved in the system had
been quite prepared to cheat their colleagues if they could. Also
during the late 1970s the European Competition Directorate
successfully prosecuted a group of companies who had
collectively purchased all exports of aluminium from Eastern
countries in order to keep them off the London Metal Exchange
and damage the prevailing producer price structure.
These actions, and others in different industries, made
suppliers of minerals and metals into North America and the
European Union much more careful about the anti-trust rules.
For example, the major aluminium producers took great pains to
involve governments in ways of tackling the problems raised by

the sudden and unexpected outflow of aluminium metal from the
former Soviet Union in the late 1980s and early 1990s. The
Memorandum of Understanding signed between Russia and
certain major aluminium-producing countries in early 1994 was
an inter-governmental agreement. It provided a fig leaf behind
which the companies could shelter when they cut their output in
order to restore market balance. Those cuts coincided with an
influx of speculative funds into purchasing non-ferrous metals,
especially aluminium. During 1994 prices rose sharply, by far
more than anyone had forecast, and some aggrieved users of
aluminium attempted to sue the US producers for anti-trust
violations.
The diamond market provides the longest running example of
a price setting cartel that has been treated as unlawful in the US.
For many years De Beers operated an effective cartel amongst
the mining countries and controlled market prices through its
sales policies and by stockpiling. The US anti-trust authorities
were strongly antagonistic and would have prosecuted both the
company and its officers had they ever been within US
jurisdiction. That was not however, a sufficient impediment,
notwithstanding the considerable funds that had to be raised to
finance stocks during periods of weak demand such as the early
1980s and early 1990s. The collapse of the Soviet Union in 1991
and the development of new mines outside De Beers control
weakened its influence. Australian production, mainly of
industrial diamonds, began in the early 1980s and the Australian
producers became increasingly assertive towards the De Beers
Central Selling Organisation. Gradually De Beers tight grip on
global diamond marketing weakened, especially with the start-up
of Canadian production in 2001. A considerable degree of
market discipline remains however, largely because of the nature
65
of the market for diamond gems. Consumers, perhaps even more

than producers, have an interest in maintaining high prices for a
product whose value is as a status object rather than for its
intrinsic properties in use. If the global diamond market is
cartelised, it is a cartel in which consumers are as guilty of
conspiring as producers. That makes diamonds very much a
special case. Even in diamonds, a form of producer pricing does
not eliminate the need for careful analysis of market trends, for a
willingness to stockpile, or for a need for production cutbacks in
periods of weak demand.
Notwithstanding strong anti-trust legislation in major
minerals-consuming countries, collusive actions to restrict
competition persist. In 2003 for example, the European Union
fined European producers of copper tube for price fixing. It also
began an investigation into the copper concentrate market jointly
with the relevant Canadian and US agencies. There were
suggestions that meetings to discuss market conditions and
industry statistics provided a front for price fixing. The
investigations were eventually dropped without any actions being
taken. The nature of the markets for minerals and their first-stage
products means that producers will always seek ways of
restricting competition. The search inevitably intensifies during
prolonged periods of weak market conditions. Most collusive
agreements are likely to prove temporary because demand is not
sufficiently price inelastic over the medium to long term and
because the barriers to entry are not high enough.
PRODUCER PRICING
Collusive action of any type is not a pre-requisite of producer
pricing. Where there are only a few suppliers to a market but
many end-uses and customers, producers may quote list prices.
Such producer prices may be set by a dominant producer or
price leader and followed fairly closely by the other suppliers.
They may have similar cost structures and have learned from
bitter experience that vigorous price competition brings only
temporary gains in market share that are usually whittled away in
the next round of price cuts, to the benefit of users rather than
producers. Concentration on the other competitive dimensions,
such as product quality, marketing or technical service, may be
more effective means of attracting and retaining customers.
Where producers set prices they tend to keep them fixed for
long periods. They often set them not by reference to marginal
costs, whether their own or those of the industry, but to some form
of average cost. Prices change in response to clear external
stimuli, like movements in the costs of major raw materials such
as crude oil. They are also responsive to their setters financial
needs and changes in productive capacity, which often go together.
Customers claim to like producer prices because of their
apparent stability and their air of predictability. The infrequent
changes enable consumers to plan ahead with confidence,
especially where their purchasing is subject to annual cash
budgeting. That has been the typical pattern not just for
state-owned companies and government departments but also for
major purchasers such as automobile producers. In the
immediate post-war decades, producers set prices for most
minerals and metals and true market-related pricing was
relatively rare.
The stability of producer pricing was (and is) more apparent
than real. It is impossible to maintain complete control over both
prices and the volume purchased, except under total monopoly.
No matter how clever the forecasters, there are always
unexpected changes in the balance between supply and demand.
Stable prices are only realisable where suppliers are prepared to
reduce their offerings when markets are over-supplied and to
expand their offerings rapidly in times of shortage. That in turn
means a willingness to stockpile and even reduce production in
weak markets and to raise output rapidly in the boom. This
implies that there will be a degree of over-capacity throughout
66
most phases of the business cycle, which in turn means that

really effective producer pricing is only achievable in those
markets where there are only a few strong companies. High
barriers to entry into the market and a perceived community of
interest in price stability between the suppliers are usually
preconditions for success.
Producer pricing has been strongest and most tenacious in
national or regional markets that are protected in some manner
from imports. The basic cost structures of producers within one
country may differ, but they are subject to similar variations in
costs and demand and to a common regulatory framework. Often
the producers of the primary materials may be integrated with
downstream users of their products. That means that the actual
price of the raw materials is not of great importance, but it
merely indicates where profits are recorded for accounting
purposes. The tax authorities will have some interest in ensuring
that transfer prices between the various stages are not being
used to evade taxes, but that need not impinge on market prices.
The list prices for the raw materials may only be paid on the
modest portion of sales, often to small users, made outside the
integrated network. That was the case in the US primary
aluminium industry and largely still is. The prices of
semi-fabricated products are infinitely more important to the
major US aluminium producers than the price of ingot. The
progressive reductions in tariffs and other barriers to trade
between major metal producing and consuming countries in the
1960s and 1970s lowered barriers to foreign competition and
made the defence of domestic producer prices much harder:
prices could be more easily undercut by imports.
Even where producers are able to tailor their production to
fluctuating demand, the fit will rarely be perfect. Individual
producers may be unable to bear the burden of financing large
inventories, even with accommodating financial institutions.
When markets are weak for extended periods the patience of
such institutions soon becomes strained and their willingness to
grant additional credit distinctly limited. Hence, recourse has to
be made to production cutbacks, which are seldom easy to
engineer unless one supplier is prepared to shoulder the entire
burden. Individual producers may believe that they have an
inherent cost advantage that enables them to carry on producing
at a profit when others make losses. They may expect an
imminent improvement in market conditions, or they may be
loath to countenance any drop in market share that might flow
from their cutbacks. This all means that collusion between the
suppliers has often been necessary to ensure the appropriate
cutbacks. This might be no more than following the example set
by a dominant market leader, such as International Nickel in
nickel, or the former Amax in molybdenum. More than that
invites a legal riposte. The US has long had legislation
prohibiting collusive action in restraint of trade, but the diligence
with which it has been enforced has varied. The legal sanctions
include possible imprisonment of those individuals found guilty
and the threat of triple damages for any aggrieved parties.
Even where producers published list prices have been
apparently stable for long periods, the prices at which business is
actually transacted can diverge markedly. Large customers may
enjoy volume discounts that rise when market conditions
deteriorate and other forms of incentive then creep in. When
demand presses against the limits of capacity and redundant
plant has been brought into service premiums may be imposed
on groups of customers, or even on all. Moreover, rationing will
sometimes be introduced, with long-established customers
favoured over casual trade. That naturally creates a constituency
amongst the aggrieved parties in support of potential new
entrants. It was International Nickels inability to supply nickel
during a strike in 1969, and the ensuing acute shortages, that
triggered a massive exploration boom and the subsequent
development of new mines elsewhere. That in turn undermined
International Nickels hold on the nickel market.
Typically producers list prices have tended to rise over time,

at least in money terms, with cost-justified, or market-driven,
increases much more common than price cuts introduced when
conditions are bad. The burden of those is taken more on
volumes supplied. The benefits of productivity improvements of
all types are not fully passed on to customers, except when new
entrants threaten to undermine the established order. Indeed,
effective producer pricing may discourage suppliers from
pursuing productivity as aggressively as those who are forced
continuously to lower their costs to survive in periods of falling
market prices. The inherent discipline of market pricing is one
reason why producers always nostalgically incline towards
producer pricing.
The ability of producers to set prices has been gradually
weakened not just by trade liberalisation but also by the spread
of demand away from its traditional locations, and by the
development of new facilities to meet that rising demand. In the
immediate post-war decade the US was the dominant producer
and user of minerals and metals, and prices were heavily
influenced by the actions of US companies. Gradually, first
Western Europe, then Japan and more recently other countries,
emerged to challenge the US hegemony. Simultaneously, the
nationalisation of foreign-owned mines and processing plants by
many countries, particularly (but not exclusively) in the
developing world, weakened the ability of US companies to
control supply. The newly state-owned companies were often
mainly concerned with maximising their throughput and revenues.
Also, new mines and plants were established in developing
countries, often by state enterprises. These lacked any established
marketing experience and they were initially content to sell
through merchants, who could grant credit as well as obtain access
to markets. Aluminium was far from alone in this regard, although
investment in new aluminium smelters was stimulated by the oil
price rises and changing energy costs of the 1970s.
Another nail in the coffin of producer prices for products that
are produced and sold in a range of countries was the collapse of
the post-war system of fixed exchange rates that culminated in
the devaluation of the US dollar in 1971. This ushered in a
regime of floating exchange rates that was initially
accompanied by rampant cost and price inflation. Although
currencies could (and did) change their parities under the regime
of fixed rates, such changes were infrequent. The prevailing
assumption, broadly justified by experience, was of stability.
Nearly all producer prices were denominated in US dollars,
which had been regarded as a completely stable yardstick.
Floating exchange rates soon undermined that faith and
contributed to diverging interests between producers with
different currencies, let alone between them and consumers.
What was a stable price in one currency was not necessarily
stable in another, which meant that fixed dollar prices no longer
provided unequivocal signals about the changing balance
between supply and demand. Producers with appreciating
currencies saw their receipts shrink in their own currencies,
sometimes even when dollar prices rose. Conversely, those with
devaluing currencies saw their domestic revenues rise even when
markets were oversupplied and dollar prices eased. The stability
of producer pricing, and hence one of its basic rationales, was
undermined. Domestic prices still diverge even when global
prices are market-determined and currencies fluctuate, but no
one has ever claimed that market-driven prices are stable.
A summary of the history of producer pricing in non-ferrous
metals appears in Table 7.3.
Collusive action to fix prices has long been illegal in the US,
but overseas markets had not been subject to similar anti-trust
legislation. That changed during the early 1970s, with the
development of the European Unions competition policy. As
discussed in the previous section, anti-trust actions forced the
TABLE 7.3
The history of producer pricing in major non-ferrous metals.
Aluminium: The US Producer Price (Alcoa) was dropped in 1986.
Alcans World Price was the yardstick for pricing outside the US to the
end of 1988. It co-existed with various free-market quotations. LME
pricing began in 1979 and progressively superseded producer pricing.
Copper: Central African and Chilean producers set a producer price
between 1961 and 1966, when it collapsed. Most sales outside the US
have subsequently been based on LME prices. Within the US producer
pricing continued until well into the 1980s.
Lead: Within the US posted producer prices persist, but the vast
majority of the lead industry has long used LME prices as their pricing
basis.
Nickel: International Nickel posted its world producer price until
December 1987. LME quotations began in late 1978. For much of the
1970s there was heavy discounting from posted producer prices, and
free market prices were more reliable guides to transaction prices. LME
quotations now dominate.
Tin: Prices in the London and Penang markets, which were the basis of
most trade in tin, were effectively controlled by the operations of the
International Tin Council (ITC) between 1956 and October 1985. With
the collapse of the ITC, prices became entirely market-determined.
Zinc: Most global business is now based on LME prices. Within the
US producers posted prices until 1993. Elsewhere most producers
nominally used the International Producer Price from its inception in
July 1964 until its final demise in 1988. Its hold weakened from the
mid 1970s, as described in the main text.
demise of the European producer pricing system for zinc during

the late 1970s. It was, however, already suffering from
differences of interest between the different suppliers. Given its
fungible nature, there is nothing to distinguish between metal of
a given quality from different producers. Some are fully
integrated from mine to refinery, whereas others are not. Custom
smelters face a fluctuating market for their raw materials as well
as for their products. Costs of production, responsiveness to
fluctuating exchange rates and ability to vary output varied
widely between producers. There was no long-term community
of interest between the different producers that would persuade
them to tailor their supply to demand for long periods, or to build
up their own stocks rather than sell into the market, and cheating
was rife. There was a tendency to set producer prices at a high
enough level to placate the least efficient producer. That
discouraged consumption and provided scope for the more
efficient to expand. It also eased the path for new entrants who
may have been outside the system. Excess capacity inevitably
resulted. The aftershocks of the collapse of producer pricing
reverberated around the zinc industry for years.
There was always a tendency for all producer prices to be too
inflexible in response to changing market conditions and over the
long term to be set too high. The world copper producer price of
the late 1950s and early 1960s probably accentuated the
over-supply of the early 1960s. The European zinc producer
price and the stable nickel producer prices of the 1970s also
tended to create excess capacity during the 1970s. Inevitably
some countries or companies will not actively participate in
producer price schemes but will exploit them to full advantage.
These, rather than the active participants, gain the most. Over the
longer term there is a tendency to cheat and to discount in
periods of weak demand.
Aside from any tendency for over-rigid producer prices to
encourage excess capacity, there is a need to fund large stocks in
periods of weak demand. If producer prices are to be credible
compared with free market quotations, the latter must be
supported, however thin the market. In a severe recession almost
limitless funds and nerves of steel are needed to support a given
price. Unless the support level is carefully chosen, the available
funds will run out, market prices will plunge and the participants
will be faced with large book losses.
67
That collusive action amongst suppliers to enforce list prices

is illegal in the major industrial economies by no means rules out
producer pricing. Some other countries lack effective anti-trust
rules, or may accept that the resultant price stability is beneficial
to their export earnings. The publication of list prices, even
without collusive action, is still common in the minor metals
and some industrial minerals. It often co-exists with a dealer
(or merchant) market in which prices are far more volatile. This
is not just because the latter quickly reflects changes in the
balance between the global supply and demand, but also because
merchants will gain access to varying proportions of the total
supply over the course of the business cycle. In good times
producers will control a much greater share of the total supply
than when conditions are depressed. Customers may have more
than they need and offload the excess onto merchants.
When merchant prices diverge from list prices in either
direction for extended periods, the producers list prices become
merely nominal and of little practical relevance. In time they may
be completely withdrawn and all pricing then becomes based on
the merchant market. Prices are usually indicated through regular
compilations in the technical press of the averages or ranges of
the quotations of individual merchants for specified grades and
volumes. No matter how assiduous and careful the compilers of
such prices, there is no guarantee that much trade actually takes
place at them. They are indicative at best. On occasion, market
participants have raised strong concerns about the validity of
some published prices.
For many market participants, price transparency is a mixed
blessing. There is often dispute about the relevance of published
prices to particular trades. Those purchasers who have managed
to obtain special deals and their suppliers, often prefer secrecy
rather than publicity. Prices are something agreed between
consenting adults in private, rather than blazoned over the pages
of the technical press. Traders also thrive where they can exploit
their unique knowledge of market conditions. Even so, the next
logical step from a large merchant-based market with opaque
price formation is the transfer of the process of price discovery to
some form of terminal market. That not only enhances
transparency, but offers opportunities for hedging price risk.
Comex Division, the Tokyo Commodity Exchange started an

aluminium contract in 1997, Kuala Lumpur trades tin and
Shanghai deals in several metals. New York, Tokyo, Hong Kong,
So Paulo and the London Bullion Market trade precious metals.
Crude oil and natural gas are quoted by Nymex and the
International Petroleum Exchange in London.
The London Metal Exchange

The London Metal Exchange was first established in 1877. It was
extensively re-organised in 1987 following the default of the
International Tin Council and the passage of the United
Kingdoms Financial Services Act, and became a limited
company owned by its shareholders in 2001. Its activities are
closely related to the physical metals trade, but it had to be fitted
into the framework established under the Financial Services Act.
It is a Recognised Investment Exchange regulated directly by the
Financial Services Authority, which closely defines the
conditions under which the Exchange operates, and above all
requires that it maintains orderly markets in all its contracts. In
its activities in the US, such as the listing of approved
warehouses, the Exchange is governed by the relevant US
legislation and by the Commodities and Futures Trade
Commission (the CFTC). It is also subject to any relevant
Directives of the European Union. The Exchange is responsible
for maintaining and policing its trading rules and regulations.
A branch of the Financial Services Authority regulates the
commercial and ethical conduct of its members. Although the
Exchange is based in London, foreign companies ultimately own
most of its members and it is a truly global market.
A historical summary of LME contracts appears in Table 7.4.
The copper, lead and zinc contracts have a long history, as do
those for tin. Trading in the latter, however, was halted after the
collapse of the International Tin Council in October 1985 and
only resumed in 1989. The zinc contract was given new leases of
life by the final demise of European producer pricing in the
1980s and by the adoption of an LME pricing base by the US in
1993. Trading in aluminium started in 1978 and nickel followed
in 1979. Their respective industries initially shunned both
contracts and it was some years before they were fully accepted
TERMINAL MARKETS
The essence of terminal markets is that prices are set at least on a
daily basis to balance that days marginal offerings and demand.
Directly or indirectly, those prices govern all that days
transactions, whether or not they are actually made through the
exchanges. The offerings and demand may come not only from
industrial companies, whether producers or users, but also from
merchants and investors of all types. Thus supply and demand in
these markets are much broader than production (whether of
primary or secondary material) and industrial usage.
Terminal markets may have four main interlocking functions,
which they fulfil in varying degrees. These are:
the determination of daily reference prices for the products

traded;
the provision of facilities for hedging against price risk;

acting as a market of last resort through a dedicated
warehouse network; and
giving opportunities for investment in metals as assets.

Each exchange has its different methods and traditions. The
leading terminal market for trading non-ferrous metals is the
London Metal Exchange (LME), which accounts for over 90
per cent of global exchange business for those metals it trades.
These are aluminium, aluminium alloy or secondary aluminium,
copper, lead, nickel, tin and zinc. The New York Mercantile
Exchange (Nymex) trades copper and aluminium through its
68
TABLE 7.4
London Metal Exchange contracts.
Copper: 1877, with specification periodically changed. First official
LME contract 1883. Present Grade A contract June 1986.
Tin: 1877, with specifications periodically changed. Contract
suspended 25 October 1985 and re-introduced June 1989. First official
LME contract 1883.
Pig iron: 1877 until 1920s.
Lead: 1920, but traded unofficially before then. The specifications
have been periodically changed.
Zinc: 1920, but traded unofficially before then. The specifications have
been periodically changed. Present Special High Grade 99.995%
contract introduced June 1986.
Aluminium: December 1978, with the contract changed to High Grade
in August 1987.
Nickel: April 1979, with specifications periodically changed.
Silver: 1969 until mid 1989. New contract in May 1999 suspended in
March 2002.
Aluminium alloy: October 1992.
North American Special Aluminium Alloy Contract (NAASC):
March 2002.
Index: April 2000. Based on the six major metals.
Polypropylene and linear low density polyethylene: 27 May 2005.
as being representative. The contract for aluminium alloy began

trading in early 1992 and was also slow to gain acceptance. It
was joined by a North American aluminium alloy contract
(NASAAC) in March 2002. Pig iron was traded for a period until
the 1920s and trading in silver began in 1969, ceased in mid
1989, resumed on a new basis in May 1999 and was suspended
once more in March 2002. The relative importance of each
contract varies annually depending on the market conditions for
each metal. In 2003 aluminium accounted for almost 39 per cent
of the total number of lots traded, copper for nearly 28 per cent
and zinc for 15 per cent. Lead and nickel each provided around
six per cent of the lots traded, and the two aluminium alloy
contracts for roughly two per cent. Trading in two plastics
contracts started in May 2005.
Only a very small percentage of the volume of non-ferrous
metal produced and traded is physically delivered into LME
registered warehouses, but the bulk of the worlds non-ferrous
metals are traded by reference to LME prices, and the LME
captures by far the greater share of hedging business. Trading is
by open outcry across a ring, in which the dealers sit and shout
their bids or offers. This is backed up by a telephone-based
inter-dealer market outside ring trading sessions and by a screen
trading system, LME Select, which system was first introduced
in early 2001 and has been gradually refined. Like the telephone
market, it is only open to trading between LME member brokers.
The share of total LME business transacted through the Ring
itself has gradually declined to under two-fifths.
The basic contract for each metal is for three months forward,
with each working day being good for delivery against the
prompt, or delivery dates. Daily cash prices are also fixed, with
additional prices for 15 months ahead for lead and tin, going to
27 months for nickel, zinc and aluminium alloys and to
63 months for aluminium and copper. The period for those two
was extended from 27 months in September 2002. The prices are
strictly forward prices for future delivery on specified dates
rather than the futures prices traded in most other markets such
as Nymex. This is one of the LMEs distinguishing features. All
prices are fixed in US dollars, the prime currency of the
non-ferrous metals industry, but with facilities for also clearing
in sterling, Japanese yen and euros.
The prices established by open outcry at the close of the
second or official rings become the official settlement prices for
each days trading. These rings concentrate bids and offers from
the whole world into one brief and orgasmic trading session,
which reaches its climax at the closing bell. The prices reflect the
marginal tonnage offered and demanded that day, no matter the
source or the destination. They inevitably fluctuate daily, but
broadly reflect, under normal circumstances, the global markets
balance of supply and demand.
Trade is conducted in lots rather than tonnes, with each lot of
aluminium, copper, lead and zinc amounting to 25 tonnes. Nickel
is traded in six tonne lots, tin in five tonnes and aluminium alloys
in 20 tonnes. Prices are set for metal that meets the prevailing
contract specifications, which are established with reference to
the needs of the producing and using industries. Individual
producers brands that meet the contract specifications can be
registered and are good for delivery once they have been tested
and accepted. The contract for each metal sets out the shapes,
weights and methods of strapping. The contract specifications
are not for the lowest common denominator of industrys needs,
but for that quality and shape which is most widely traded and
demanded. Specifications have tended to rise over the years. In
the 1980s, for example, the aluminium specification was raised
from a minimum of 99.5 per cent aluminium to 99.7 per cent,
and the copper contract moved from wirebars to Grade A
cathode. The quality of zinc has been progressively raised,
initially from good ordinary brand to high grade, and then the
special high grade with minimum 99.995 per cent zinc that is
traded today. The contracts specify minimum standards, which

many producers easily exceed. The daily prices do not
distinguish between the individual registered brands, but brokers
and traders may pay premiums for particular brands that are
especially in demand. Similarly, the price is for delivery into or
out of any registered warehouse, no matter where it is located,
and premiums may be established for specific locations.
Whether they are concluded on or off the ring, all LME
contracts are cleared through the London Clearing House.
Before the clearing arrangements were introduced in 1987,
brokers acted as principals, which meant that the markets users
faced a risk of their broker defaulting. The clearing mechanism
offers security to all users of the market that their contracts will
be honoured, even if the initiating broker were to go bankrupt.
The prime distinguishing feature of LME contracts is that they
are not cash cleared. In other words, users of the market do not
have to contribute additional cash when their contracts are
making losses, nor can they take out profits ahead of the prompt
date; rather the contracts are cleared against bank guarantees,
with brokers granting credit to their clients. Most trade users also
do not insist that their business is segregated. These features
make the Exchange particularly useful for trade users, who do
not have to commit variable and uncertain amounts of working
capital to use the market.
Other exchanges that trade in metal futures or in energy
products, like the New York Mercantile Exchange, are cash
cleared. It was the ability to take out paper profits when prices
were rising that enabled the Hunt Brothers to drive up silver
prices so dramatically in 1979-80, when they were attempting to
corner the silver market. They could reinvest their paper profits
in margins on yet more futures contracts. When the bubble burst
and prices started falling, repeated calls for additional cash
margin accelerated and accentuated the decline of genuine
hedging as well as speculative business.
Credit clearing makes it easier for the metals industry to use
the market to hedge against price risks. Hedging is the
elimination of uncertainty at a known cost. Users of the market
with future commitments for purchase or delivery of physical
metal can buy or sell an equivalent and offsetting forward
contract that matures at the same time. The prices are known
today. When the time comes to deliver or buy, the user can close
out the forward contract and take either a loss or a profit to set
against the offsetting profit or loss on the physical contract. The
liquidity of each contract tends to diminish rapidly the further
forward they go beyond three months.
In addition to conventional forward contracts, the LME also
trades options. These give the purchaser or the seller the right, but
not the obligation, to buy or sell at the strike price. The premium
paid for this right varies inversely with the amount by which the
strike price varies from prevailing price levels. It is like an
insurance premium to protect against a known event. The LMEs
traded options are mainly so-called European options, which
refer to prices on specified future dates, the third Wednesday of
each month. Most users are much more interested in achieving
average prices over a period, such as a month or a year. Until 1997
the substantial and fast growing business in Asian options of this
type was conducted over the counter (OTC) in deals specifically
tailored for the individual users. The LME introduced traded
average price options (TAPOs) in early 1997, initially for
aluminium and copper but now for all the metals, to provide the
protection of the clearing mechanism to such widely used
contracts, and to increase market transparency by bringing them
into the open. Most OTC options deals are denominated in US
cents per pound of metal, whereas LME contracts are expressed in
US dollars per tonne. The LME strike prices have, therefore, been
too coarse and inconvenient for it to attract as much business to its
contracts as it initially expected.
69
Metal brokers can provide an infinite variety of combinations of

forward prices and options to cover virtually any eventuality. The
underlying mathematics and the jargon of these price derivatives
can be complex, but their basic function is to enable producers and
users of metals to eliminate the risk of uncertain volatile prices at
a known cost. The use of options overcomes one of the basic
problems of forward contracts, which lock in specified prices. Use
of those denies the seller the benefit of any upside if prices at the
time of delivery greatly exceed the contracts forward price, and
the purchaser the benefit of any fall below the forward price. The
latter is particularly important for fabricators who are actively
competing for business and operating on tight margins. One of
their major concerns is that their competitors do not buy their raw
materials on more favourable terms. No matter what combination
of hedging mechanisms is used, it is always the responsibility of
the users management to ensure that it is aware of exactly what is
being done and of the potential risks involved. The well-publicised
incidents in which companies have lost heavily in metals trading
have all been ultimately traceable back to lax management in the
affected companies.
The growth of options trading has been of especial value to
investors in metals, who are known pejoratively as speculators.
There always have to be individuals or firms who are prepared to
invest in metals in order to provide adequate liquidity to the
market. Without such liquidity, the costs of hedging could
become prohibitive. Moreover, prices could periodically swing
uncontrollably in one direction or another unless there were
always people who were willing and able to take contrary views
to the market as a whole. Trade use of the LME still accounts, on
average, for around 80 per cent of its total business, but the
Exchanges turnover greatly exceeds the global production and
use of each metal. In 2003 the multiples of LME turnover to
global output varied from 17 for lead, up to 34 for copper, with
nickel at 22, aluminium at 26 and zinc at 28. The multiples were
much lower (three to six) for the aluminium alloy contracts.
These large multiples by no means reflect the amount of
speculative activity. A proportion of LME turnover comes from
brokers adjusting contract dates and volumes to meet the precise
needs of their customers.
We always have to be cautious in attributing sharp and

unexpected shifts in prices to the speculators. However good the
statistics about consumption and production in the recent past,
prices also reflect expected trends. We do not always have
sufficient knowledge about the present and the future. Forecasts
usually cluster together and they are often wrong, perhaps
because of random shocks. Sometimes market sentiment can
change dramatically, almost overnight, and prices have to catch
up. Sharp and apparently inexplicable price movements can often
be explained retrospectively by fundamental forces. Speculative
investment tends to even out over time and prices do broadly
reflect relative shifts in supply and demand. At times, however,
investment in metals as such can become substantial and prices
can then be driven up or down more than might seemingly be
warranted by underlying trends in supply and demand.
Much of the LMEs turnover arises from its use as a market of
last resort. LME contracts provide for physical delivery, and in
support there is a network of registered warehouses throughout
the world (see Figure 7.5). The Exchange itself does not own or
operate the warehouses nor does it own the metal they contain. It
approves warehouse locations, with the objective of having a
widespread network throughout the world in all important areas
of net consumption. Warehouse locations must have appropriate
fiscal and regulatory systems, be served by a good transport
network, have the facility to store goods without payment of duty
and enjoy political and economic stability. These requirements
rule out some apparently desirable locations. Once locations
have been decided, warehouse companies may apply to open
facilities. The contract between the Exchange and those
companies that satisfy its criteria sets out the warehouse
companys rights and obligations and provides for a disciplinary
procedure. Metal of approved brands may be delivered into a
warehouse to satisfy delivery commitments in exchange for LME
warrants. These are bearer documents giving title to a specific
parcel of metal in a specified warehouse. The terms on which
metal is delivered and stored are agreed between the warehouse
companies and the companies who deliver it.
5 locations in the UK; all metals. 19 th century to 1994

12 locations, 6 countries in Europe: all metals 1962 to 1995
2 locations in Korea; not zinc 2001

7 locations in USA; all metals 1991 -98
4 locations in Japan; aluminium 1989

2 locations in Malaysia; all metals 2004
Singapore; all metals 1987
Dubai; not aluminium 1999 -2001
FIG 7.5 - LME registered warehouse locations in 2004. Note: the number of locations was increased during the 1990s to cope with an inflow of
metal associated with the collapse of the former Soviet Union and a global recession, and several little-used locations were recently de-listed.
70
When markets are over-supplied, metal flows into warehouses

and moves out again when markets tighten. Movements in the
stocks held in LME-registered warehouses are thus useful
bellwethers of market conditions. Over the years there has been a
progressive move towards placing a greater proportion of surplus
metal in LME warehouses. This partly reflects the growing use
of the Exchange for hedging and as a price reference and the
extension of the warehouse network. Warehouses were originally
confined to the UK, with locations first authorised in mainland
Europe during the 1960s. Singapore and Japan followed in the
late 1980s and the US in 1991. Dubai and Korea were added in
2001, although Dubai was good for silver delivery from 1999 to
2002, and Malaysia was being registered in 2004. Some locations
may not store particular metals, either because they are close to
major producing areas such as Singapore was historically with
tin (until the LME lifted this limitation in 2002), or because of
local restrictions on trade. Thus Japanese warehouses only store
aluminium, Dubai does not take aluminium and Korea may not
accept zinc. LME copper trading only commenced in the US in
1995.
The growth of LME stocks relative to total reported
inventories is also part of, and primarily mirrors, a global trend
towards reducing the amount of working capital tied up. If metal
is held in LME registered warehouses, there is much less need to
hold stocks in producers or consumers yards, and no need for
the metals industry itself to arrange their financing. LME
warehouses became magnets for surplus metal during the
recessions of the early 1990s. Excess western supplies were
greatly augmented by outflows from eastern countries. Although
much of the latter was not registered for LME delivery, it partly
displaced metal that was, allowing the latter to be delivered into
warehouses. Had the surplus metal not gone into LME
warehouses, most of it would have been absorbed elsewhere and
there would have been little, if any, cutback in production beyond
what actually occurred. From 1994 onwards the tonnage of metal
held in warehouses contracted, but the withdrawals did not
necessarily flow into final consumption. Much was taken out of
LME-registered facilities, partly to reduce its visibility and
influence prices. The expectation was that final demand would
soon rise sufficiently to absorb excess stocks. In actuality
demand rose less than expected and LME stocks levelled out.
The spread of the LMEs warehouse network from its
predominantly European focus changed LME prices from mainly
reflecting European balances between supply and demand into
global indicators. That in turn altered the structure of premiums
over and above LME prices for delivery in particular locations.
The LMEs settlement prices will inevitably reflect the balance
between deliveries of metal into warehouses and shipments out.
There may be net inflows in some locations at the same time as
metal is flowing out elsewhere. Not all locations and warehouses
are equally accessible or convenient and the charges for
removing metal vary. The warehouse companies in the less
favoured locations have sometimes offered inducements to
traders to place metal in their warehouses, and once it is there it
tends to stick.
The wider the warehouse network, the easier it becomes to
deliver metal onto warrant when markets are tight. When markets
are well supplied they are usually in contango. In other words,
prices for future delivery exceed cash prices by a margin that
represents the costs of storage and insurance and the rate of
interest, or the time value of money. To the extent that warehouse
companies offer any special deals on rents, the normal contango
will be reduced. Other things being equal, a rise in warehouse
rents or interest rates would be accompanied by a widening of
the contango. Often, however, such an adjustment would be
swamped by other influences on prices. The further forward the
quoted price, the greater the margin above cash prices, although
a lack of liquidity for the far forward dates could influence the
relationship. Without any extraneous shocks, the relationship
between prices for the different delivery dates is stable.
When, for one reason or another, there is a shortage of metal

for immediate delivery, prices move into a backwardation. That
means that cash prices for immediate delivery rise above the
forward prices. There may be sound fundamental reasons for a
backwardation, like a prolonged shortage of supply relative to
buoyant demand, perhaps caused by transport disruptions or a
strike at a major producer. The only cure is an influx of metal
into LME warehouses that is sufficient to restore balance. A
backwardation often makes it worthwhile for those who have
excess tonnage, however temporarily, to deliver into warehouses
in order to earn a rate of return that may greatly exceed the cost
of finance. The emergence of bubbles in the pattern of prices is,
however, often a sign that someone is attempting to squeeze the
market. In other words, they may have gained control of the
greater part of the available LME inventory and also have large
long positions which give them potential access to far more
metal than they need to meet their future commitments. Those
who are short will have to pay the backwardation or borrow
metal at a cost in order to meet their commitments. Occasionally
a merchant may inadvertently squeeze the market, but more
usually there will be deliberate manipulation, which offends
against the preservation of orderly markets, one of the LMEs
prime functions as a Recognised Investment Exchange.
Backwardations raise the costs of hedging for physical users of
the market, sometimes prohibitively. They can also distort the
validity of LME quotations as reference prices for the global
metals industry. The LMEs Rules and Regulations give it
considerable powers to prevent manipulation and punish any
members who break those rules. Unfortunately, although it is
relatively easy for market participants to suspect when a price is
being manipulated, proof is usually difficult. Also, the Exchange
has no jurisdiction over either the parallel physical market or
non-LME business. Squeezes may often be engineered in the
over-the-counter market rather than in LME contracts, although
they find their full flowering in the behaviour of LME
quotations. The best defence against market manipulation is the
greatest possible transparency in all types of trade. Since
mid-1996 the LME has greatly increased the amount of
information that it publishes, but it always faces a difficult
balancing act. An excessive insistence on transparency could
lead to trade drying up or being driven offshore, or to
over-the-counter markets that are outside the scope of any
regulation. That would not necessarily be in the users best longterm interests.
The LMEs main competitor, the New York Mercantile
Exchange, has claimed that it has lost trade to the LME because
the latter has been less tightly regulated. Close inspection
indicates that the methods of regulation in London and New York
are certainly very different, but that the LME is no less tightly
controlled and policed than its US counterpart. The main reason
that the LME captured most of the global business in non-ferrous
metals is that its contracts and methods of trading have been
more suited to the needs of trade users than those operated in
New York. The LMEs main attractions include its system of
prompt dates, its extensive warehouse network and its credit
rather than cash clearing. It also straddles the three main global
time zones, picking up the close of business in Asian markets
early in the day and overlapping with New York in the afternoon.
Finally, the UK does not have a large domestic mining and
smelting industry with vested interests, but it has a long tradition
of open markets and liberal trading. The Comex Division of the
New York Mercantile Exchange has much lower liquidity, with
trade concentrated on hedging by domestic US companies and on
speculative investment business. A considerable amount of its
trading is conducted on their own account by locals, rather than
for trade clients. Arbitrage between the London and New York
markets has ensured that their respective prices rarely step too far
out of line with each other.
71
RECENT TRENDS IN MINERAL MARKETS

At the start of the new millennium most sectors of the minerals
industry seemed set for a prosperous decade. The major
international political tensions that had persisted since the
Second World War were largely resolved, market capitalism had
seemingly triumphed over more dirigiste systems and the global
economy was becoming increasingly unified. It had quickly
shrugged off the Asian crises of 1997-98 and had resumed
apparently healthy expansion, inflation had been tamed, currency
markets were relatively stable and oil prices remained subdued.
Subsequent events showed that any complacency was sadly
misplaced and that turbulence was developing beneath an
apparently smooth surface. Led by the US, the major industrial
economies were on the brink of recession and new political
tensions and uncertainties were developing in the world at large.
Demand for mineral products is driven by economic activity,
which faltered in 2001 after a strong start to the decade.
Figure 7.6 shows the annual rates of change of output, both
globally and in the major advanced economies (Canada, USA,
Japan, France, Germany, Italy and the UK) from 1998 onwards.
World
World GDP
Refined copper usage
Crude steel output
0
1998
1999
2000
2001
2002
2003
2004
-2
FIG 7.7 - Global GDP, copper usage and steel output, percentage
per annum changes 1998-2004. (Sources: International Monetary
Fund, 2005; International Copper Study Group, 2005; International
Iron and Steel Institute, 2005.)
Major advanced economies
% per annum change
10
-4
0
1998
1999
2000
2001
2002
2003
2004
2005
FIG 7.6 - The growth of economic activity (gross domestic product),

1998-2005. (Source: International Monetary Fund, 2005.)
72
From 1999 onwards global growth was much greater than that of
the advanced economies, but the world economy was knocked by
the latters recession in 2001-02. The upswing in 2003-04 was
unexpectedly strong, with overall activity rising rapidly in 2004.
Growth continued in 2005 at a slower rate (International
Monetary Fund, 2005). The strength of global activity over the
period owed much to the strength of the Asian economies,
especially of China. The buoyant Chinese economy has been one
of the main forces driving demand for mineral products over the
past decade. Its share of world output (measured on a purchasing
power parity basis) rose from 10.2 per cent in 1988 to 13.2 per
cent in 2004. This has been partly at the expense of growth
elsewhere, with Chinese exporters benefiting from a low cost base
and an undervalued currency, but it mainly reflects strongly
growing internal demand, led by heavy investment in plant,
equipment and infrastructure.
The relationship between overall economic activity and the
mineral and metals industry is brought out in Figure 7.7, which
compares annual percentage changes in global GDP, the usage of
refined copper and the output of crude steel. Although demand
for each mineral and metal product is driven by different end-use
markets, all follow broadly similar trends. Many depend directly
on the performance of the steel industry. Copper usage grew
particularly strongly in 1999-2000 when the US economy was
booming, but it fell in 2001 and grew more slowly than global
activity in 2002-03. By contrast steel production was relatively
weak in 1998-99, but has grown much more strongly than global
GDP since 2001. Its strength derives from Chinas burgeoning
output, which increased by 23 per cent in 2004 alone. Chinas
production of crude steel rose from 115 Mt in 1998, under 15 per
cent of the total, to 272 Mt (26 per cent of global production) in
2004. It accounted for 57 per cent of the growth in global steel
output over the six year period. Inevitably this rapid growth has
spilled over into strongly increased demand for raw materials
from overseas and in that regard steel has been typical of most
minerals, including fuels.
% change on previous year
The present systems will only survive, however, as long as the

markets users are content that they give prices that are properly
representative of market conditions. The prices set are far more
chaotic and seemingly more haphazard than producer pricing
systems, but more transparent and reflective of changing market
conditions.
Some criticise LME prices as being excessively volatile, under
the influence of investment in metals by financial institutions of
all types, often grouped under the general description of
speculators. Certainly, prices can move markedly even within
the course of a day, let alone from one day to the next. The
explosive growth of options-related business also appears to have
introduced extra volatility. Much of that business, however, is
conducted on the behalf of producers and fabricators insuring
against adverse future price trends. To the extent that a
significant proportion of annual production is protected for
months (or even years) ahead, that much will be less responsive
than it might previously have been to weakening prices. The
protected producers will have no immediate need to cut their
output because they are incurring cash losses. That in turn means
that the burden of any excess supplies in recessions is thrown
more heavily than in the past on prices rather than volumes. That
alone will give the appearance of increased price volatility, but it
owes nothing to speculative activity. Any genuine evidence that
prices of non-ferrous metals have become more volatile in recent
years because of speculative activity is rather tenuous. Those
who assert that prices have become more volatile have usually
looked at trends over relatively short periods and have failed to
allow fully for the many factors influencing prices.
A strong global economy not only boosted demand for

non-fuel minerals, but also for fuels including petroleum. World
demand for crude oil, shown in Table 7.5, rose by 3.4 per cent in
2004 (the largest percentage increase for many years) forcing
demand against the constraints of effective capacity. Iraqs output
had not recovered from the ravages of war and some members of
OPEC held back production. The OECD countries, led by the
US, raised their consumption in 2003 and 2004 after several
years of stagnation. The US accounts for 25 per cent of global
off-take, OECD Europe for 19 per cent and Japan for seven per
cent. China (eight per cent) and India (three per cent) were major
contributors to the 6.7 per cent rise in non-OECD demand.
130
World oil demand (million barrels per day).

(Source: International Monetary Fund, 2005.)
Year
World
OECD
Non-OECD
1998
74.7
46.6
28
1999
76.1
47.4
28.8
2000
76.9
47.6
29.3
2001
77.4
47.5
29.9
2002
78.2
47.6
30.6
2003
79.6
48.1
31.5
2004
82.3
48.8
33.6
50
US $/barrel
40
30
20
10
0
2001
2002
2003
2004
2005
FIG 7.8 - Monthly average prices of crude oil (US$/barrel for

Brent crude). (Source: International Petroleum Exchange, 2005.)
Prices had weakened in 2001-02 in response to recession, with

the attack on the World Trade Centre in September 2001 having
no real impact. The Iraq war caused a minor blip in 2003, but
prices really only started to rise strongly during 2004. Whereas
prices around the $30/barrel level had been regarded as
acceptable, their rise to over $50/barrel has raised concerns about
possible adverse effects on global inflation and levels of
economic activity. Forecasts of economic growth were
consequently being shaved down in early 2005. Not only do high
oil prices have potentially adverse effects on demand for mineral
products but they also directly raise production costs.
In part, the rise in oil prices was initially justified by an
accompanying weakening of the US dollar in currency markets.
Some oil producing countries tailored their supply in order to
raise prices sufficiently to offset the dollars decline, but such
fine-tuning is seldom possible. The performance of the US dollar
has been a major influence on the prices of all internationally
traded mineral commodities. Figure 7.9 plots two measures of
the real effective exchange rate since January 1998. It
strengthened by 21 per cent against a weighted average basket of
major currencies (those of Australia, Canada, Euroland, Japan,
Sweden, Switzerland and the UK) between October 1999 and
February 2002. It followed a similar trend, but to a less marked
extent against the currencies of a much larger group of its trading
partners, partly because some of those currencies are pegged to
the dollar itself.
Major currencies
110
US trading partners
100
90
1998
60
2000
120
80
The effects of this strong growth of demand on prices were

accentuated by existing political tensions in the Middle East and
by fears that unrest is spreading to major producers like Saudi
Arabia. Speculative pressures were further influences in driving
crude oil prices up to their highest levels in real terms since the
1970s. In money terms, prices have never been higher. Their
behaviour from 1999 onwards, as expressed in the spot price of
Brent crude on the International Petroleum Exchange in London,
is illustrated in Figure 7.8.
1999
Index numbers. January 1998=100
TABLE 7.5
1999
2000
2001
2002
2003
2004
2005
FIG 7.9 - Effective monthly average real exchange rates of the

US dollar. (Source: US Federal Reserve Board, 2005.)
Prices of most minerals and metals are denominated in US

dollars and the US exchange rate is a strong influence on those
prices. Other things being equal, a strengthening of the US dollar
leads to falling dollar prices, and a weakening dollar to rising
dollar prices. Many producers whose currencies strengthened
against the dollar also saw rising costs and falling margins in
2000-02 to the point where they were forced to suspend or curtail
operations. The adverse impact of the currency squeeze was
accentuated by the simultaneous weakening of demand because
of recession. Capital spending of all types, but especially on
exploration and grassroots projects, was pared back as the
industry strove to minimise costs. These years witnessed a surge
in mergers and consolidations in many sectors of the industry,
with a pronounced peak in 2001 (Raw Materials Group, 2004).
The gold industry was especially hard hit by weak prices in the
late 1990s and early 2000s. Exploration spending of all types, but
especially on gold, had peaked in 1997, and it subsequently
plummeted, not just in response to weak markets, but also
because of the adverse effects of the Bre-X fraud (where a gold
project in Indonesia had been hyped on the basis of non-existent
ore reserves) and the competing lure for speculative investors of
dot com projects. The trough in exploration spending was
reached in 2002, with that on gold down from 1997s US$ 2.6
billion to under US$ 0.8 billion. Exploration for other products
dropped from US$ 2.5 billion to US$ 1.1 billion over the same
period. The recovery in prices from their recessionary trough
brought a corresponding revival of exploration, with spending on
gold rising to US$ 1.9 billion in 2004, and that on other products
up to US$ 3.8 billion (Metals Economics Group, 2005).
The inverse relationship between real US dollar exchange rates
and gold prices is illustrated in Figure 7.10. Gold prices averaged
below US$ 400 per ounce throughout the 1990s and had fallen
sharply from 1996. The recovery began in late 2001, after the
attacks on the World Trade Center, and it was fostered not just by
the weakening US dollar, but also by rising international
tensions. Rising oil prices and fears of resurgent inflation gave an
added boost from late 2004.
Prices of non-ferrous metals lagged behind gold prices in
2002-03. In some cases capacity had outstripped demand,
notwithstanding mine and plant closures and cutbacks. There
were also large inventory overhangs, particularly in the most
visible form of Exchange stocks. Their existence initially
moderated the impact of improving supply/demand balances on
price levels. Table 7.6 shows the end-year levels of LME
warehouse inventories from 1998 onwards.
LME warehouses are not the only sources of readily available
metal and stocks have moved substantially within each year.
Nonetheless, Table 7.6 gives a broad indication of the changing
pressures of demand for the various metals. They all danced to
the beat of economic activity, but with different timings and
variations. Speculative activity by financial institutions of all
types, including hedge funds, may have hastened (and even
enhanced) some price rises, but the basic determinants were
73
150
Index numbers January 1998=100
Gold price
140
130
120
110
100
90
80
35796 35977 36161 36342 36526 36708 36892 37073 37257 37438 37622 37803 37987 38169 38353
FIG 7.10 - Index numbers of monthly average gold prices and real
effective exchange rates of the US dollar against major currencies.
(Source: US Federal Reserve Board, 2005; London Bullion Market
Association, 2005.)
TABLE 7.6
Inventories in LME warehouses at year-end, 1998-2004
(thousands of tonnes). (Source: London Metal Exchange, 2005.)
Until recent years, demand grew relatively slowly and producers

were fairly reluctant to invest in capacity in anticipation of future
sales. In consequence the 2003-04 spurt in demand created
supply bottlenecks and suppliers seized their advantage with
sharp price rises. Mine expansions and new capacity are under
construction that will improve the market balance within a few
years, but markets will remain tight in the interim. Contractual
US dollar prices of internationally traded thermal coal rose by
nearly 70 per cent in 2004, whilst those of coking coal rose by
about 26 per cent in 2004 and by roughly 116 per cent for 2005
deliveries. Prices of iron ore also jumped for 2005 deliveries, but
by a more modest 71.5 per cent. Even allowing for the
weakening of the US dollar, producers are earning handsome
profits at these prices and potential new entrants are jostling for
position. Figure 7.12 compares yearly index numbers of prices of
iron ore and of base metals. Iron ore had lagged until the 2005
price settlements.
260
240
Index numbers 1999=100
160
Iron ore
(Hamersley fines to Japan f.o.b.)
220
200
180
160
140
Year
Aluminium
Copper
Lead
Nickel
Tin
Zinc
1998
635
592
108
66
317
1999
774
790
176
47
279
100
2000
322
357
131
10
13
195
80
2001
821
799
98
19
31
433
60
2002
1241
856
184
22
26
651
2003
1423
460
109
24
14
740
2004
695
49
40
21
629
120
Non-ferrous metals
(The Economist index)
1999
improving demand and a weakening US dollar. Figure 7.11

shows the behaviour of a weighted average index of non-ferrous
metal prices from the start of 1999. Prices rose during 1999, but
levelled out in 2000 and fell back between September 2000 and
late 2001. The recovery did not really get into its proper stride
until after May 2003.
That the rise in prices sprang from much more than speculative
activity in a terminal market was shown by the simultaneous
improvement of the prices of many minor metals, of industrial
minerals and of bulk minerals, including coal and iron ore. The
latter two have greatly benefited from Chinas burgeoning
demand, but their latest price increases should be judged against
their lacklustre performance for much of the preceding decade.
Whereas the non-ferrous metals are priced on terminal markets,
which provide both opportunities for hedging price risk and a
market of last resort, producers of bulk minerals have neither.
160
Index numbers 2000=100
150
140
130
120
110
100
90
80
70
Jan-99
Jan-00
Jan-01
Jan-02
Jan-03
Jan-04
Jan-05
FIG 7.11 - The Economist index of non-ferrous metal prices.

Monthly averages, 2000 = 100. (Source: The Economist, 2005.)
74
2000
2001
2002
2003
2004
2005
FIG 7.12 - Index numbers of prices of iron ore and non-ferrous

metals, re-based on 1999 = 100. (Sources: The Economist, 2005;
Metal Bulletin, 2005; Mining Journal, 2005.)
Many commentators in late 2004 and early 2005 were

heralding a lengthy period of strong prosperity for the metals and
minerals industry. Few had properly observed the lessons of
history that barriers to entry are fairly low and that demand is
dependent not just on the performance of a single country
(however bright its prospects might seem) but on a complex
interplay of global forces. Profitability depends on the ratio
between prices and costs and many of the factors that lowered
costs in the preceding decade or so have worked themselves out,
or have even reversed.
REFERENCES
British Petroleum, 2004. BP statistical review of world energy [online].
Available from: <http://www.bp.com>.
International Copper Study Group, 2005. [Online] <http://www.icsg.org>.
International Iron and Steel Institute, 2005. [Online]
<http://www.worldsteel.org>.
International Monetary Fund, 2005. World economic outlook database,
April [online]. Available from: <http://www.imf.org>.
International Petroleum Exchange, 2005. [Online] <http://www.ipe.com>
now listed under Intercontinental Exchange: <http://www.theice.com>.
London Bullion Market Association, 2005. [Online]
<http://www.lbma.org.uk>.
London Metal Exchange, 2005. [Online] <http://www.lme.co.uk>.
Metal Bulletin, 2005. [Online] <http://www.metalbulletin.com>.
Metals Economics Group, 2005. [Online]
<http://www.metalseconomics.com>.
Mining Journal, 2005. [Online] <http://www.mining-journal.com>.
Raw Materials Group, 2004. Database, May, Stockholm, Sweden.
Smith, A, 1976 [1776]. An Enquiry into the Nature and Causes of the
Wealth of Nations (eds: R H Campbell, A S Skinner and W B Todd)
(Oxford University Press: Oxford).
The Economist, 2005. [Online] <http://www.economist.com>.
US Federal Reserve Board, 2005. [Online] <http://www.federalreserve.gov>.

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Mineral Markets, Prices and the Recent Performance of

Leaving aside the complications flowing from the existence of

MARKET STRUCTURE COMPETITIVE MARKETS

Australian Mineral Economics

FIG 7.1 - Short-run supply and demand in competitive markets.

When prices are very low there is no supply, as costs exceed

developments by privately owned companies through much of

Copper metal (2003)

Iron ore (2003)

Metals traded on terminal markets

Negotiated or list prices

Notes: top 4, top 7, * top 9.

MARKET STRUCTURE OLIGOPOLISTIC

Where there are only a few major producers the suppliers do

Australian Mineral Economics

delivery schedules. The chemical and physical characteristics of

As the producer faces a downward-sloping demand curve for

Australian Mineral Economics

FIG 7.3 - Long run market equilibrium for a representative

marginal costs of production and any monopoly profits are

through cartels and similar collusive actions in restraint of trade.

more widespread. In effect, the producer acts like a monopolist,

Australian Mineral Economics

perceived reliability of a supplier and its susceptibility to strikes

THE RISE AND FALL OF CARTELS

Australian Mineral Economics

People of the same trade seldom meet together,

% share of world total

OPECs apparent success in raising crude oil prices in the

members should share some common interests and objectives;

a high level of concentration of production and reserves is

the cost structures of each producer should be broadly

Where costs of production diverge widely there is little

Australian Mineral Economics

International Bauxite Association (IBA)

Conseil Intergouvernmental des Pays Exportateurs de Cuivre (CIPEC)

Association of Iron Ore Exporting Countries (APEF)

World Phosphate Rock Institute

Mercury Producers Association (Assimer)

UNCTAD Committee on Tungsten, Primary Tungsten Association

of the US anti-trust laws. It was reasonable to assume that

Australian Mineral Economics

involve governments in ways of tackling the problems raised by

of the market for diamond gems. Consumers, perhaps even more

most phases of the business cycle, which in turn means that

Australian Mineral Economics

Typically producers list prices have tended to rise over time,

Australian Mineral Economics

demise of the European producer pricing system for zinc during

That collusive action amongst suppliers to enforce list prices

Comex Division, the Tokyo Commodity Exchange started an

The London Metal Exchange

the determination of daily reference prices for the products

the provision of facilities for hedging against price risk;

giving opportunities for investment in metals as assets.

Australian Mineral Economics

as being representative. The contract for aluminium alloy began

Australian Mineral Economics

traded today. The contracts specify minimum standards, which

Metal brokers can provide an infinite variety of combinations of

We always have to be cautious in attributing sharp and

5 locations in the UK; all metals. 19 th century to 1994