BHP : BHPs economic and commodity outlook

Please refer to the Important Notice at the end of this article

Six months ago¹, at the time of our full year results for the 2021 financial year, we reported markedly improved operating conditions for the majority of the portfolio. Those commodities that had performed strongly in calendar 2020 had built on that momentum. Those that had lagged somewhat in calendar 2020 were showing clear signs of entering a recovery phase. As a result, most of our major commodities were trading at prices that were close to, or above, our estimates of long term equilibrium. As we release half year results for the 2022 financial year today, developments over the last six months make it more difficult to generalise about the portfolio in a narrative sense. The half year was characterised by (yet more) extraordinary volatility, but instead of a shared, albeit staggered recovery pattern, highly idiosyncratic trends have emerged within the energy and non-ferrous commodity clusters, as well as within the steel making raw materials complex. Nevertheless, and the aforementioned volatility notwithstanding, the statement that "most of our major commodities are trading at prices that are close to, or above, our estimates of long term equilibrium", is still - remarkably - absolutely valid.

For the 12 months ahead, we assess that weighted directional risks to prices across our diversified portfolio are tilted modestly downwards, a view that relies in part on the elevated price deck we face in many commodities at the outset of this calendar year, and a general belief that the most severe supply disruptions will ease, progressively, as the year unfolds - weather, COVID-19 and policy permitting. That said, very short term downside is arguably limited, with operating cost curves having moved higher and steepened in the midst of the global inflation shock. This has raised real-time price support above pre-pandemic levels in many of the commodities in which we operate.

We expect the demand-supply balance to remain relatively tight in both copper and nickel. Iron ore moved into surplus in the second half of calendar 2021, and, on balance, is likely to remain in that state across calendar 2022. We see no clear directional bias for oil prices from current elevated levels, while LNG prices are more likely to move lower than to sustain (or set new) all-time highs. Metallurgical coal prices have also achieved all-time records on multi-regional, multi-causal supply disruptions. The degree to which these ease, and by when, is the key swing factor for the coming year. Potash seems poised at the crest of its stunning bull wave, driven by strikingly positive downstream fundamentals at a time of both constrained and uncertain supply.

There is obviously still some residual uncertainty as to how vaccine deployment and the policy and behavioural response to the newer, highly transmissible strain of COVID-19 will interact over the coming quarters. There is also a higher level of macro complexity to deal with than in the recent past, as the world's two major systemic growth engines - the US and China - adopt diametrically opposite counter-cyclical policy stances. So while the "uncertainty discount" in the risk appetite of households and businesses we have noted in previous communications is definitely fading, it is doing so in uneven fashion across the world, and new vectors of uncertainty have arisen, such as the situation in Ukraine.²

Looking beyond the immediate picture to the medium-term, we continue to see the need for additional supply, both new and replacement, to be induced across many of the sectors in which we operate.

After a multi-year period of adjustment in which demand rebalances and supply recalibrates to the unique circumstances created by the COVID-19 shock, we anticipate that higher-cost production will be required to enter the supply stack in our preferred growth commodities as the decade proceeds.

The projected medium-to-longer term steepening of some industry cost curves that we monitor, which may be amplified if carbon pricing becomes more influential in both demand and supply centres, can reasonably be expected to reward disciplined and sustainable owner-operators with higher quality assets featuring embedded optionality.

We confidently state that the basic elements of our positive long-term view remain in place.

Population growth, urbanisation, the infrastructure of decarbonisation and rising living standards are all expected to drive demand for energy, metals and fertilisers for decades to come. We continue to see emerging Asia as an opportunity rich region within a constructive global outlook.

From a pre-pandemic baseline, by 2030 we expect: global population to expand by 0.8 billion to 8.5 billion, urban population to also expand by 0.8 billion to 5.2 billion, nominal GDP to expand by $74 trillion to $161 trillion and capital spending to expand by $14 trillion to $37 trillion.³ Each of these basic fundamental indicators of resource demand are expected to increase by more in absolute terms than they did across the 2010s.

By 2050, we project that: population will be approaching 10 billion; urban population will be approaching 7 billion; the nominal world economy will have expanded to around $400 trillion, with one-fifth of that - i.e. around $80 trillion - being capex.

Furthermore, with fiscal and monetary policy makers in key economies having shown their commitment to a reflationary agenda, the secular fundamentals that make our industry attractive may well be amplified this decade.

In line with our purpose, we firmly believe that our industry needs to grow in order to build a better, Paris-aligned world.⁴

The Intergovernmental Panel on Climate Change (IPCC) stated on August 9, 2021 that "Unless there are immediate and large-scale greenhouse gas emissions reductions, limiting warming to 1.5 degrees Celsius will be beyond reach". As illustrated by the scenario analysis in our Climate Change Report 2020 (available at bhp.com/climate), if the world takes the actions required to limit global warming to 1.5 degrees, we expect it to be advantageous for our portfolio as a whole.⁵

And it is not just us. What is common across the 100 or so Paris-aligned pathways we have studied is that they simply cannot occur without an enormous uplift in the supply of critical minerals such as nickel and copper. Our research also indicates that crude steel demand would be a net beneficiary of deep decarbonisation, albeit not to the same degree as nickel and copper. And some of the scenarios we have studied, such as the International Energy Agency's high profile Net Zero Emissions scenario⁶, would be even more favourable for our future-facing non-ferrous metals than what is implied by our own work to date: albeit with different assumptions and potential impacts elsewhere in our portfolio.

In this regard, we welcome the fact that the share of global emissions now covered by national level net zero or carbon neutral national ambitions has reached 85%, although we continue to monitor whether these ambitions will crystallise as tangible action. This includes our key Asian customer centres of Japan and South Korea (2050), China (2060) and India (2070). Less positively, the share of global emissions that are "priced" is much lower, at 25%, and the average price itself, at $26/t, is still too low to sponsor the radical change in the energy and land use system that is required if ambitions are to be met.⁷

Against this backdrop, energy transition investment, as defined and estimated by Bloomberg NEF, totalled $755 billion in 2021, up from $595 billion in 2020.

Easier-to-abate sectors - renewable energy and electrified transport - attracted 85% of those funds. Technology with the potential to unlock gains in harder-to-abate corners of the energy system, such as Carbon Capture, Utilisation and Storage (CCUS) and hydrogen, attracted just over $4 billion collectively. The aggregate and sectoral figures are both promising (in terms of growth) and underwhelming (in terms of level) at the same time.

As the true costs of a lack of climate action are progressively recognised, and demographic change proceeds, we anticipate that a popular mandate for closing the gap between ambition and policy action will progressively emerge.

Here we note that the younger generations that will define our future - both Millennials and Generation Z - are more concerned about climate change than their elders in both East and West. They are also more favourably disposed towards globalisation. That is good news for the international cooperation that will be required to limit global warming in the most efficient manner. And it also offers hope that the current wave of populist economic nationalism that we observe, which represents a headwind for long term global prosperity, may also retreat in time.⁸

Now: add each of the generally constructive foregoing themes to the fact that the resources industry as a whole has been disciplined in its allocation of capital over the last half decade or so. With this disciplined historical supply backdrop as a starting point, any sustained demand surprise seems likely to flow almost directly to tighter market balances.

Investment that seeks to abate greenhouse gas (GHG) emissions and/or adapt to, insure against and mitigate the impacts of climate change is expected to rise to become a material element of end-use demand for parts of our portfolio. The electrification of transport and the decarbonisation of stationary power are expected to progress rapidly, and the desire to tackle harder-to-abate emissions elsewhere in the energy, industrial and land-use systems is building. Comprehensive stewardship of the biosphere and ethical end-to-end supply chains will become even more important for earning and retaining community and investor trust.⁹

The ability to provide and demonstrate social value to our operational and customer communities is both a core enabler of our strategy and a source of competitive advantage.

Against that backdrop, we are confident we have the right assets in the right commodities in the right jurisdictions, with attractive optionality, with demand diversified by end-use sector and geography, allied to the right social value proposition.

Even so, we remain alert to opportunities to expand our suite of options in attractive commodities that will perform well in the world we face today, and will remain resilient to, or prosper in, the world we expect to face tomorrow.

Table of contents

Global economic growth				China
Major advanced economies				India
Steel and pig iron				Iron ore
Metallurgical coal				Copper
Nickel				Crude oil
Liquefied natural gas				Energy coal
Potash				Maritime Freight
Inputs and inflation trends				Operational jurisdictions and labour markets
Trends in uncontrollable costs				Electric vehicles (EVs)
Important notice				Footnotes

Global economic growth

The world economy contracted around -3% in calendar year 2020 and we estimate that it bounced back by a little less than +6% in calendar 2021. Our starting point for world growth in calendar 2022 is +5%. The IMF's latest projections for 2022 are roughly -½% below this.¹⁰

The worldwide impact of the Delta outbreak, China's weak second half and a range of supply bottlenecks all restrained activity relative to our expectations at the outset of calendar 2021, when our base case was that growth could comfortably exceed 6%. Within the year, we were tracking well above our year-opening base case in the first half, but we fell below it in the second.

Against this backdrop exchange rate volatility has been relatively modest. Compared to the levels prevailing at the time of our full-year results, the US dollar index (DXY) was roughly 6% stronger as the first half of financial year 2022 closed. In real trade weighted terms, as of December-2021 the US dollar has increased in value by roughly 5% from June-2021, and was almost on par with the recent peak achieved during the COVID-19 panic of April-2020. US dollar strength was most clearly expressed against non-China emerging markets. The Chinese yuan appreciated by around 6½% against the US dollar in calendar 2021.

International trade collapsed by around -5 % in calendar 2020. The strong recovery from the nadir, which began in the second half of calendar 2020, has continued essentially unabated since, with Jan-Nov 2021 data showing growth of around 11% year-to-date YoY. As of November 2021, the volume of world trade was 4% above calendar 2019 levels. Exports from developing economies are 8% above 2019 (China 21%) and exports of developed countries are up 1% on the same basis. Unit prices of world exports are up 13% on the calendar 2019 level.

As global policymakers increasingly shift their attention to calibrating a delicate exit from the extraordinary policy settings they delivered in extremis, while keeping a weather eye on inflationary momentum, it is worth recalling that the underwhelming performance of the global economy in calendar year 2019 was in large part due to weak international trade and the associated negative impacts on business confidence.

Trade is the essential lubricant of global economic growth, and a reflationary agenda ought to embrace that fact.

In addition, we strongly encourage policymakers to prioritise structural reforms at home as the surest route to sustainable productivity growth, and ultimately, prosperity, coming out of COVID-19. Remaining open to the cross-border flow of people, goods, capital and ideas is vital to this end: free trade based on comparative advantage, competition, productivity and innovation are close companions. Some of the "bad" inflation we will refer to throughout this article is the direct or indirect result of natural flows of physical production inputs being impaired. The sooner the logic of comparative advantage in international trade and entrepreneurial "pull" migration can again be granted full play, with due consideration for public health concerns of course, the better.

These arguments highlight the importance of continued and vocal advocacy for free trade, open markets and high quality national and multilateral institutional design by corporations, governments and civil society.

A key feature of the global economic recovery in calendar 2021 was a series of upside surprises in measures of economy-wide inflation, with both headline CPI and upstream (PPI) readings elevated. Supply elasticity in a range of goods-producing and distributing sectors has fallen well behind the speed of the turnaround in demand. Normal movements of labour within and across countries to match with job opportunities has also been impaired. As a result, productivity has suffered, market balances have tightened and in some instances, scarcity pricing has emerged. These factors have driven the underlying cost base of some of the world's most essential end-to-end value chains higher - for example petroleum products, construction materials, semiconductors, automobiles and food - and the associated distribution industries (principally land, sea and air logistics). And the curve has been steep. As of December 2021, consumer and producer prices in the US were tracking around 7% and 10% YoY respectively. The most recent updates on producer price inflation in the EU, Japan, China and India are distinctly elevated at 26%, 8%, 10% and 14% YoY respectively (rounded). Major commodity producing countries such as Chile, Canada, Brazil and Russia are seeing equivalent or even higher outcomes. Australia is presently an outlier with PPI at "just" 3.7% YoY and CPI at 3.5% YoY in the December quarter. Both of these readings are obviously subdued by current international standards, but the Q4 CPI was still running well in advance of official forecasts made just a short time ago, in November-2021. That drove a +1 percentage point upgrade to the RBA's June-2022 YoY CPI projection released in early February-2022.¹¹

We anticipate that "bad" inflation due to supply bottlenecks in key value chains will remain challenging in calendar 2022, with only tentative signs of easing expected by the end of the period, with clear potential for some spillover to calendar 2023 in certain sectors. Additionally, we anticipate that "good" demand-led inflation will endure for some time, leading to higher average inflation outcomes across the 2020s than what we experienced across the 2010s.

That view is partly due to both our constructive underlying view of world growth and the likely performance of the resources industry - the underlying source of upstream pressure in physical value chains - following a half decade (and counting) of disciplined capital allocation. This thesis also relies on the fact that policy makers have altered their medium-term strategies with respect to both monetary and fiscal policy in a way that is more accommodative of a moderate lift in core inflation than the frameworks they are replacing. The impact on private sector confidence of this pro-growth policy stance will be positive and durable, in our view.

Moderately higher inflation on average across the decade will also assist with the passive repair of strained public sector balance sheets. The extra half a percent or so on the global inflation rate that we envisage for the 2020s will increase the size of the nominal global economy by around $8 trillion by 2030, or 9% of 2019 GDP.

The phenomenon of structural "greenflation" is also real and will, we believe, impact upon price dynamics and the wider economy in the medium and long run. There is more than one definition of this concept in circulation, so let us be clear what we mean by this.

"Greenflation" is the process whereby the global price level progressively internalises the costs and benefits of both action and inaction pertaining to the impact of climate change and stewardship of the biosphere.

It is a fact that the global price level does not yet fully internalise the social cost of carbon, the emissions of other greenhouse gases (GHGs), other activity that negatively impacts upon natural wealth, such as deforestation and biodiversity loss, or degrades other eco-system services, or the future capex bill for governments and business to deliver on all aspects of the energy transition, from the provision of critical minerals to building the green infrastructure of the future. To date, regions or individual actors with positive footprints also find it difficult to quantify, let alone monetise their virtue. The process of internalising these costs, and remunerating positive actions, whether the process be swift or gradual, will inevitably alter the dynamics of price formation in all corners of the economy.

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China

China's economy traced a spectacular V-shape across calendar 2020, with strong momentum carrying over into the first half of calendar 2021. The authorities though were not comfortable with the nature of this growth, which was at odds with the "dual control" framework for energy policy, the desire to constrain macro-financial risks in the property market and the "zero-growth" steel mandate instituted at the beginning of calendar 2021. A range of policy interventions were launched that sought to course correct back towards official objectives. The net effect of these interventions, alongside the localised COVID-19 outbreaks that were summarily dealt with under the "zero-tolerance" framework, and the jitters in the property market as high profile developer Evergrande teetered on the edge of insolvency, was to halt the momentum in domestic demand abruptly.

The most obvious direct impacts of these multifarious forces were a sharp slowdown in heavy industrial and construction activity, an energy supply crunch and an insipid recovery in services demand. Robust export growth was a major support for activity throughout the year, but with such significant headwinds elsewhere, it was not enough to prevent a material deceleration. The reality of this aggregate slowdown, the scale and pace of which was clearly unintended, soon had the authorities announcing a series of counter measures designed to stabilise confidence moving into an important political year in calendar 2022.

A rapid turnaround between the last tightening measure of a cycle and the first easing measure of a new one is not unusual in China. The major uncertainty in such circumstances is how to gauge the appropriate lag between the change in policy stance and the response of real economic activity. The real estate sector has often been at the centre of past policy shifts. It is also expected to be the biggest single swing factor in calendar 2022. The strength of economy-wide credit data in the month of January-2022 reinforces the view that the downside risks that emerged in the second half of calendar 2021 are now receding.

In terms of the numbers, the real economy expanded by 8.1% YoY in calendar 2021, up from 2.2% in 2020. Our base case is that growth will be in the 5-5½% range in calendar 2022 and 2023. The 2022 projection assumes that the easing of policy headwinds will enable, in sequence, infrastructure and then the real estate and auto sectors to rebound from their weakened states at the close of calendar 2021. While a zero tolerance approach to COVID-19 outbreaks continues, the services sector is likely to operate below its potential. Note that growth targets released by provincial governments in advance of the national figure that is due in March, once it is adjusted for the traditional optimistic bias at the provincial level, points to an outcome near the top of a 5-5½% range in calendar 2022. The strength of economy-wide credit data in the month of January-2022 reinforces the view that the downside risks that emerged in the second half of calendar 2021 are now receding..

Prior to the imposition of growth suppressing policies in the September quarter of 2021, when the policy stance in China could still readily be described as accommodative, we argued that while in an absolute sense China has made a considerable effort to support jobs through the pandemic, in a relative sense policymakers have not over-stimulated. That judgement gauges the Chinese response versus developed countries during the pandemic, and relative to its own actions in response to the GFC. This assessment was initially made to inform the degrees of freedom the authorities were likely to have with their policy choices as the decade unfolded: i.e. would they be held captive by the legacies of the pandemic response, just as to some extent domestic economic policy making in President Xi's first term and the beginning of his second was dominated by addressing the structural imbalances that emerged in the Hu-Wen era.

With China having now compressed the initial pandemic recovery phase through discretionary policy action (including the unintended consequences of the same), we now face very different cyclical arithmetic from what we thought was most likely six months ago. Without last year's policy interventions, it is likely that the second half of the 2021 calendar year would have seen robust growth, prima facie, but with some signs of cyclical fatigue in both domestic demand evident upon closer inspection. That would have indicated that the second half of calendar 2022 was likely to be underwhelming, with some need for counter-cyclical support at that point to keep the labour market stable. Today, as described above, the reality is that we have some key elements of the economy set to work their way out of a trough (with the credit impulse finding a bottom alongside the real economy), rather than ascending from a peak. And the tilt towards easier policy is also now a fact, not a projection. Now it is the early part of 2022 which may feel somewhat underwhelming (albeit on a firmer footing than say, October/November, and abstracting from Q1/Q2 seasonality and lumpy base effects of course), while the second half of calendar 2022 now shows some promise as a recovery phase, which could be reasonably expected to flow into calendar 2023.

The abrupt slowdown in domestic demand was clearly visible in the under-performance of many key minerals end-use sectors relative to our expectations six months ago, although there were certainly pockets of resilience. Weakness in housing starts, conventional autos and water conservancy infrastructure, alongside a levelling off in machinery after a frenetic upswing, weighed down demand for steel. On the positive side, solid housing completions, consumer goods and accelerating decarbonisation efforts (with sales of new energy vehicles being exceptionally strong) assisted non-ferrous metals.

For some years, national level housing policies and rhetoric have been directed towards limiting speculation, managing macro-prudential risks and building rental markets. The telling absence of housing specific stimulus in the pandemic policy response, the initial unwillingness to come to the aid of developers in balance sheet trouble due to strategic missteps, alongside the use of macro-prudential tools and window guidance to dampen mortgage lending in mid-2021, and the announcement that property tax trials would be widened even as activity was clearly softening, were consistent with this posture.

Ultimately though, at this stage of China's development, real estate is so significant in terms of its impact on employment, local government finances and consumer confidence, not to mention the backward linkages into heavy industry, that anything more than a shallow dip is difficult to absorb whilst also retaining desired levels of macro stability.

When the net impact of these policy and market forces brought about a steep drop in credit flow to developers and buyers in the September quarter, and housing starts and sales reacted by clearly breaching the "shallow dip" comfort threshold, once again the counter-cyclical imperative won out.

The immediate question we face in the near term is how responsive will buyers, developers and lenders be to the easing of policy? Will a normal cycle emerge with a physical response within 6-9 months?¹² Or will it be more protracted than that, given the considerable fright the supply side of the industry experienced in late 2021? Our base case incorporates something close to the first scenario. However, given we have never experienced a housing cycle with an explicit macro-prudential guardrail for developers in place, uncertainty is higher than normal at this juncture. We reiterate that the historical lead-lag relationships that exist between the four key fundamental floor space parameters (sales/starts/completions/under construction) are expected to be somewhat less reliable than in the past.

This is how the major housing data stood at the conclusion of calendar 2021. The volume of housing starts - the key indicator for contemporaneous steel use in real estate - declined by -11.4% in calendar 2021, and were tracking at -31.1% YoY in the month of December. Sales volumes edged up +1.9% in the year but were down by -15.6% in December itself. The equivalent comparisons for housing completions - the key indicator for contemporaneous copper use in real estate - are +11.4% and +1.9% on the same basis. Floor space under-construction finished the calendar year tracking at +5.2% YoY; land area sold was -33.2% YoY and developer financing was -19.3%.

A final observation on public housing. MOHURD, the responsible ministry, has indicated that 6.5 million units of public housing will be built during the 14th five-year plan (5YP) in key cities, with 2.4 million expected in calendar 2022 alone. In other words, we see some clear front-loading. In terms of our expectations, the 2022 figure is roughly 400k higher than we suspected. The extra 400k dwellings is worth 1 percentage point of growth (rounded) in starts over the year, on top of the ~3 percentage points in our base case: so this is helpful, but it is not a game changer.

Moving on to the other major end-use sectors, infrastructure ended the year in disappointing fashion, with overall growth of just +0.2% in calendar 2021, following a solid +3.4% outcome in calendar 2020. The sub-sector that has most obviously held infrastructure back is water conservancy, where spending has increased at a two-year compound growth rate of just -0.5%, despite periodic entreaties from the Premier to boost outlays in this area. At roughly 40% of spending in the broad infrastructure category (yes, it is bigger than transport or power generation), an uplift here could be impactful for overall end-use demand trends. We are looking to infrastructure to start calendar 2022 off on the right foot in advance of housing getting back on its feet. Bond issuance in January-2022 supports this proposition.

Infrastructure is a sector where the 5YP process is a useful guide to the medium term, and the first year of a new planning period is often associated with the launch of major projects and initiatives. A major takeaway from our reading of provincial level 14th 5YPs, has been heightened green transportation ambitions. This has encouraged us to materially increase our medium and long term projections of subway construction.

Auto production lagged other areas of manufacturing coming out of the COVID-19 trough due to supply chain issues, and conventional segment struggled to add velocity through much of the year. Total auto output grew just 3.4% YoY in calendar 2021, despite the low base established in 2020. NEVs are another matter entirely, with unit production 1.6 times the calendar 2020 outcome (160%). For calendar 2022, we see stronger outcomes for conventional production, with value chain supply constraints progressively clearing. This may be evident in the first half: but if not, certainly by the second.

Exports increased by around 30% in calendar 2021. Chinese manufacturers have been arguably the leading beneficiaries of the global boom in goods consumption observed over the last 18 months or so. Machinery, shipping, containers and white goods were all bright spots, providing strong support for indirect steel and copper exports. China's demand for imports was also strong, keeping pace with exports at around 30% YoY.

We estimate that China's share of world exports rose from 13% in calendar 2019 to around 16% in calendar 2021: easily an all-time high for China's share. When you are the world's largest exporter of manufactured goods to begin with, it is very difficult to outgrow the global aggregate by such a wide margin. To put that into some context, 16% is roughly double the highest share achieved by Japan during its 1980s heyday. Only one other country has ascended to such rarefied air since World War II: the US. And that was some time ago of course. The US last achieved an export share as high as 16% when JFK was in the White House. It should be no surprise then that the USD/CNY exchange rate moved materially in the CNY's favour across calendar 2021, even at a time of relative US dollar strength.

Moving on to the longer term, our view remains that China's economic growth rate should moderate as the working age population falls (noting total population essentially flat-lined in calendar 2021¹³) and the capital stock matures. China's broad production structure is expected to continue to rebalance from industry to services and its expenditure drivers are likely to shift from investment and exports towards consumption, with late stage urbanisation a complementary element in this shift.

Nevertheless, even as percentage rates of growth slow down, and the structure of the economy evolves, China is expected to remain the largest incremental volume contributor to global industrial value-added and fixed investment activity through the 2020s and likely beyond.

Within industry, we expect a concerted move up the manufacturing value-chain, in addition to a marked shift in the nation's energy system as it positions to meet decarbonisation objectives. This will require further improvements in the domestic innovation complex. Notwithstanding the emphasis now being placed on "dual circulation" and "common prosperity"¹⁴, given the times we live in, we anticipate that the concerted move outwards of recent years is likely to continue, with an emphasis on South-South cooperation, regional trade agreements¹⁵, and the Belt-and-Road corridors. More broadly, we anticipate environmental concerns will become an even more important consideration in future domestic and foreign policy design than they are today. Within this context, China's plans to see carbon dioxide emissions peak in advance of 2030 looks readily achievable, while hitting its 2060 carbon neutrality objective is a considerably more challenging task.

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Major advanced economies

The US has been the outstanding economic performer among the major developed economies, in part due to an astounding willingness and ability to mobilise public resources. Fiscal support of around $6 trillion has been committed and the Federal Reserve had expanded its balance sheet by around 21% of GDP.

Fiscal announcements have totalled $10 trillion (inclusive of the $6 trillion above), but the "Build Back Better" bill failed to move through the Senate after passage in the House in either its original or diminished form. The Fed has also adopted a new "average inflation targeting" (AIT) framework that prioritises the pursuit of maximum employment: and to help accommodate that pursuit, periods where inflation is sustained above the historical 2% objective are now explicitly condoned.

The practical application of the Fed's new framework is undergoing its first test, with headline consumer price inflation reaching 7%. And while markets were temporarily unsettled by the projected Fed funds rate increases in calendar 2022 that were unveiled by the "dot plot" in December, it is clear from the quantum of change envisaged by the Fed that it plans to ease off on the accelerator, rather than shift to the brake, now that it assesses that its primary objective of maximum employment has been reached.

Six months ago we stated that: "… some aspects of the global inflation spike are almost certain to be transitory. Even so, in the US there are genuine fundamentals tailwinds for growth and employment - and by extension inflation - due to the robust strength of the real economy. These tailwinds feel as if they could persist for some time, with or without further impetus from fiscal policy."

The housing market and business investment remain major activity bright spots. And the huge pool of excess savings on household balance sheets (now circa $2.5 trillion, or 11% of GDP) that we have repeatedly drawn attention to have begun to be put to work. Total consumer expenditures are now around $1½ trillion higher than pre-pandemic levels, almost one-third of which is attributable to a stepwise increase in purchases of durable goods. As spending inevitably rotates back in the direction of services (noting that six months ago one-half of the consumption uplift was goods related), there should be an additional boost for the labour market, which is running hot on strong demand and indifferent supply. Unit labour costs (compensation scaled by productivity) have accelerated to 6.3% YoY.

Wages are of course a critical factor in any medium term forecast of aggregate inflationary pressures in services, which dominate inflation index weights. In this regard, we note that wage increases for those changing jobs have accelerated to around 4½% YoY, and wage outcomes for those staying in jobs are also beginning to move (3½% YoY).¹⁶ Even with the recent acceleration though, we note that wage inflation is still lower than in the late 1990s boom, when a "job switcher" received an average change of around 6%, versus CPI inflation around 2%. As stated above, US CPI is currently sitting around 7%, which means even a job switcher is presently underwater vis-à-vis the average cost of living. And with labour force participation still well below pre-pandemic levels as December-2021 (63.4% versus 61.9%), this story feels like it is a long way from its conclusion.

In the wake of the inauguration, twelve months ago we wrote that "The Biden administration is a pivotal one in global history:

• It has the potential to rapidly accelerate global decarbonisation trends.
• It faces monumental geopolitical choices, both in terms of its approach towards multilateralism and its attitude towards key bilateral relationships.
• It has the potential to re-set the prevailing macroeconomic policy orthodoxy.

Much depends on these choices, for the US itself and the world."

In terms of signposts to date, we note that:

• In trade and foreign policy, there is continuity from the previous administration in terms of the apparent determination to treat China as a rival, and to pursue a nationalistic line on trade more broadly. However, there have also been clear efforts to re-engage constructively with both immediate allies and with the multilateral architecture. How the current situation in the Ukraine will play out is a major uncertainty.
• Climate action has clearly entered into the Administration's everyday domestic and foreign policy discourse, and the US clearly attempted to lead constructively at COP26. That said, as mentioned above, the failure of Build Back Better, and the trimming back of some green elements of the Bipartisan Infrastructure bill, are reminders that all politics is ultimately local. And the mid-term elections loom, the results of which may increase the complexity of delivering the announced agenda.
• The overriding commitment to reflating the economy and creating jobs is clear, with the White House, the Treasury and the Fed seemingly of one mind on this score. The next step is how to carefully manage the success of the combined policy push, with both growth and inflation on the move. An emerging issue here is that "bad" inflation (as defined above) is now a pressing political concern, with gasoline well above $3 per gallon in early calendar 2022.

In Europe and Developed Asia, the scale of recovery since the deep contractions of the June quarter of 2020 have been respectable viewed as an aggregate, but experientially it has felt quite stop-start, reflecting both additional waves of the pandemic and supply constraints in key sectors. In the bellwether auto sector, where each region is a critical cog in the global value chain, supplier delivery times remain deeply unfavourable versus historical norms, but are past the absolute worst, according to the global sector PMI produced by I.H.S Markit. The backlog of work also appears to be past the peak, but there is considerable catch-up to come before operating conditions can be said to have normalised.

Common to the US experience, upstream inflation is painfully evident, while business surveys are implying generally favourable operating conditions with respect to demand (if not supply). Inflation has picked up most noticeably in Europe, with the energy crisis of the 2021/22 winter quadrupling power prices, with households and industry alike buffeted by this fierce headwind. The ECB has held its nerve so far in the face of the price uplift, reflecting its newly minted, balanced mandate: another marker of the reflationary bias now prevailing among the world's systemically important economies. The contrast to the "currency wars" and failed austerity of the 2010s is stark - and favourably so.

Japan and South Korea are both expected to benefit directly and indirectly from the resolution of the global semiconductor supply bottleneck. While the auto and consumer electronics supply chains rightly receive a lot of attention in this space, and these are obviously strategic sectors for both, their role as a provider of semiconductor manufacturing equipment and both commodity and higher end chips may be less well known. There is a multi-year boom in chip manufacturing capacity underway, as the world sprints to catch up to escalating demand, and these two economies are at the centre of it, either via new fabrication plants at home, or via exports to Greater China and South-east Asia. Manufacturing PMIs ended the 2021 calendar year around 54 in Japan and 52 in South Korea: that is 2 points higher in Japan versus the mid-year reading, but 2 points lower in Korea. That partly reflects a correction to the unsustainable export pace Korea achieved in the June quarter, of around 40% YoY. We note with interest that South Korea quietly surpassed Japan in terms of GDP per capita (PPP terms) back in 2018, and with a sprightly growth performance through the pandemic, will finish calendar 2021 roughly 7% wealthier than its larger neighbour.

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India

India's economy has been unusually hard to read in the pandemic era. With its distinctive combination of scale and volatility, it has become a major swing factor in short term forecasts of global growth. Activity completely collapsed under the lockdown of the June quarter of 2020, with the scale of India's contraction more than double what China experienced the quarter before. Then activity rebounded smartly from the nadir, and the second half of the calendar year ended up being quite good - and versus expectations, spectacularly good. Tragically, the story soon reversed 180 degrees. With a dramatic re-escalation of COVID-19 cases requiring strict restraints across many major economic and population centres, the economy suffered through another double digit quarterly decline in the June quarter of 2021. The rebound observed in the wake of the June quarter lockdowns has once again been decent (a double digit quarterly gain): and the economy is tentatively on a firmer footing as calendar 2022 opens: the current Omicron wave notwithstanding.

The key takeaway from all these rapid reversals is that India's recovery trajectory and the associated release of pent-up demand has further to run, rather than being heavily concentrated in calendar 2021 as would have been the case without the June quarter wave.
In terms of the numbers, the economy shrank around -7% in calendar 2020 and rebounded around +8% in calendar 2021. Our starting point for calendar 2022 is 10% growth.

Indian inflation has lifted sharply against this backdrop, in line with the global trend. While inflationary pressure was pronounced in calendar 2020, the pressures were relatively narrow with petroleum and food leading the way. These pressures have broadened in calendar 2021, even as food prices increases have slowed.

The wholesale price index registered close to 14% YoY in December 2021, while consumer prices have been holding in the 5-6% YoY range.

The Union Budget for IFY 2023 (beginning April 1, 2022) projected real GDP growth of 8.5%, and nominal GDP around 12%: both feel conservative. Total nominal capex in IFY 2023 is expected to grow by +10.4% over last year's slightly weaker than planned outcome. Railways, roads & transport, defence, power and telecommunications have been earmarked for large capital outlays. Additionally, loans to state governments to implement infrastructure projects have been increased more than five-fold.

Beyond the immediate matter of COVID-19 recovery, returning India to a healthy and sustained medium-term growth trajectory will require a reduction in policy uncertainty, further progress on balance sheet repair, an increase in social stability, a greater focus on unlocking the country's rich human potential, and an increase in international competitiveness in both manufacturing and traded services. The emphasis on moving up the "ease of doing business" rankings, and the steps taken to increase India's share of geographically mobile foreign manufacturing investment that has come through during COVID-19 are sensible steps.

Labour law reforms passed in 2019/20 are a significant positive for flexibility and simplicity, and should complement the focus on attracting foreign direct investors, with production linked incentive schemes across 13 key manufacturing sub-sectors reportedly generating considerable interest.¹⁷

The decision to move away from the controversial farm bills in the face of concerted opposition from rural voters illustrates the difficulty any Indian administration will face as they attempt to establish a more modern and commercialised farm economy.¹⁸ Alongside the farm bill question, the decision to be less engaged with the regional trade agreement landscape, and inconstant attitudes towards domestic market access for foreign players (be it old or new economy), collectively present a mixed message in terms of reform appetite, given the positive impact that freer trade and increased competition would have on productivity growth and innovation.

Briefly, we note that key economies in South-east Asia struggled to generate consistent growth momentum in calendar 2021, with COVID-19 a major factor both constraining domestic demand and curtailing the tourism inflows that are very important in regional pockets. Collectively South-east Asia is not far behind India in scale (around 7½% of world GDP versus 8%, with a population of around 660 million people), so this sluggish growth in the aggregate matters. From a supply perspective, the region is also a globally significant supplier of a number of commodities, including natural rubber, palm oil, coal, copper, gold, tin, petroleum and nickel. It is also becoming an increasingly important satellite destination for Chinese industry responding to policy changes at home, with scrap processing and merchant coke making two industries that are benefiting from such shifts.

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Steel and pig iron

Six months ago we stated that "On current estimates, the world is expected to produce slightly more than 2 billion tonnes of crude steel in calendar 2021: needless to say, that is a record." Unfortunately, that was wrong. Global steel production fell short of 2 billion tonnes, eventually reaching 1.95 billion: still a record, but a little short of what seemed possible last August. The shortfall is principally due to China. Rather than setting another all-time record of its own somewhere in the vicinity of 1.1 Bt as seemed likely at the mid-way point of the calendar year, Chinese production declined abruptly in the second half, with the full year finishing at 1033 Mt, roughly -3% versus the 2020 figure of 1065 Mt. In pig iron, the global figure of 1.35 Bt was up 0.7% on calendar 2020, weighted down by a -4.3% outcome in China (869 Mt).

In real-time, the speed and scale of the turnaround in Chinese momentum was stunning. With the benefit of near term hindsight, it remains so. On a monthly peak to trough basis, accordingly to official NBS data production peaked around 1.2 Btpa in May and it troughed around 840 Mtpa in November: a swing of almost 350 Mtpa. How much is 350 Mtpa? Merely the equivalent of the combined production of Japan, India, South Korea and Germany! Notwithstanding this immense volatility, China still recorded a third straight year of production exceeding 1 billion tonnes: something no nation has done before and something no other nation is likely to ever do.

Our starting point for thinking about calendar 2022 is that a continuation of China's policy stance of "zero growth" ought to be the baseline, with scenarios built around that. A fourth year above 1 billion tonnes accordingly seems likely, as the nation's "plateau phase" extends.

While we note with interest that some local institutes are anticipating a further small decline in production from the calendar 2021 level, on balance, a flat outcome is our preferred starting point for considering the skew of risks, based primarily on the foregoing macro discussion. There are risks in both directions, but they are, in our view, of relatively modest scale. The easier macro policy stance should be able to establish a floor under domestic demand, protecting the downside from a major delta. On the positive side of the ledger, even if there is some pragmatism applied in the interpretation of the "zero growth" mandate given the desire to stabilise the economy, there will still be limits to such tolerance. On this point, we note that base effects will keep the YoY growth rate of steel production deeply negative through the first half of the year, due to last year's amazing sprint coupled with the lower starting point and strict early year controls for the Winter Olympics.

Broad-based strength across the majority of end-use sectors in the first half of calendar 2021 gave way to a near universal softening in the second half. Housing starts were particularly weak, as discussed in the macro section, while infrastructure disappointed, conventional autos struggled for momentum while machinery levelled off after a very strong run. The main bright spots were shipping, containers and white goods, including for export: and none of these are "tier 1" in terms of their size.

In the face of policy headwinds, China's blast furnace (BF) utilisation rate tumbled from an average above 90% in the first half of calendar 2021 to around 80% in the second: so roughly 10 percentage points lower on average. Higher frequency data shows that the weekly low-point for utilisation was 74.1% in mid-December. Easing restrictions saw a rebound towards 80% in the weeks leading up to the Chinese New Year holiday.

China's pig iron production contracted at a faster pace than crude steel in calendar 2021, (-4.3% YoY to 869 Mt versus -3% for crude steel) reflecting the aforementioned volatility in BF open rates. BFs saw wider variability than electric-arc furnace (EAF) mills, whose utilisation rates declined just -2.5 percentage points half-on-half to 62.6% on average. That is despite the challenges facing EAF mills in September and October as power rationing and shortages impacted.

That is as much a comment on the underwhelming first half of calendar 2021 for EAFs (just 65.1% utilisation) as it is a metric of resilience in the face of production cuts.

Realised margins for Chinese steelmakers have been highly volatile, with periods of break-even or loss-making and high profitability above $100/t observed within weeks of each other. Both major raw materials saw huge two-way volatility within calendar 2021, with (unusually) little synchronisation between iron ore and metallurgical coal pricing.¹⁹ These large swings in feedstock cost were a big part of the story for margins. Averaging things out, the second half of calendar 2021 saw spot margins at $72/t, much higher than $29/t in the first half. While on the subject of industry financials, as an aside we note that the aggregate liability-to-asset ratio reached 61% in calendar 2021, -9 percentage points from the 70% peak that was reached just before the Supply Side Reform (SSR) of the sector was launched, and just short of the original SSR target of 60%.

We estimate that net exports of steel-contained finished goods accounted for slightly more than 10% of Chinese apparent steel demand in calendar 2021. That is a lower degree of external exposure than, say, Japan or Germany, where the number is about one-fifth. An additional 4% or so of Chinese production was exported directly. Having seen their direct trade surplus in steel narrow and then turn to deficit in the middle of calendar 2020, Chinese mills came back quickly early in calendar 2021, with the surplus rebuilt towards 52 Mtpa at the midway point of the year. With an eye to their commitment to restrain growth in total steel production, the authorities stepped in at this point, cancelling export VAT rebates for most steel products and removing import tariffs for semi-finished steel. Net exports fell to a run-rate of 31 Mtpa in the second half of the calendar year as a result.

Turning to the long term, we firmly believe that, by mid-century, China will almost double its accumulated stock of steel in use, which is currently 7-8 tonnes per capita, on its way to an urbanisation rate of around 80%²⁰ and living standards around two-thirds of those in the United States. China's current stock is well below the current US level of around 12 tonnes per capita. Germany, South Korea and Japan, which all share important points of commonality with China in terms of development strategy, economic geography and demography, have even higher stocks than the US.

The exact trajectory of annual production run-rates that will achieve this doubling of the stock is uncertain. Our base case remains that Chinese steel production is in a plateau phase in the current half decade, with the literal "peak" to be the cyclical high achieved in this phase. Strategically speaking, the plateau concept matters. Different to early and mid-2010s though, trying to define the literal peak now that we have attained and sustained 1 billion tonne plus run-rates, is no longer anything more than a tactical question.

We estimate that the growing stock described above will create a flow of potential end-of-life scrap sufficient to enable a doubling of China's current scrap-to-steel ratio of around 22% by mid-century. The official target of a scrap-to-steel ratio of 30% by 2025 is thus directionally sound, but is more aggressive than our internal estimates by a few percentage points. Uncertainty regarding the future availability of imported scrap (as discussed below in the context of emergent nationalism in the scrap exporting regions), makes China's official targets a little more challenging.

As we argued in our blog on regional pathways for steel decarbonisation, increasing scrap availability is a powerful lever at the Chinese industry's disposal as it seeks to contribute to the national objective of carbon neutrality by 2060. Beyond the considerable passive abatement opportunities available to it, of which scrap availability is the largest, the decarbonisation choices of Chinese steel mills will be determined by the age of their integrated steel making facilities, the policy framework they are presented with, developments in the external environment impacting upon Chinese competitiveness, and the rate at which transitional and alternative steel making technologies develop. We note that the combined 14th five-year plan for the "raw material industry", which is more qualitative and less numerically prescriptive than the targets embedded in the 13th, is calling for a carbon dioxide emissions peak before 2030. That is within our base case expectations.²¹ In addition, a guidance document for the steel industry's "high-quality development" has been jointly issued by three Ministries/Commissions: the MIIT, NDRC and MEE. The document restates the "before 2030" carbon objective, but the 2025 deadline outlined in the draft plan released in calendar 2020 is no longer there. Other industry targets, such as the 15% EAF share in crude steel production and 80% of steel capacity equipped with ultra-low emission facilities remained unchanged from the draft plan. The guidance also reiterated the prohibition of steel capacity growth and the ambition to raise the industry concentration ratio (without a quantified target). Also on the policy front, the first extension of China's ETS from the original sectoral scope included cement and aluminium - but not steel as yet. We expect that it will be included before the conclusion of the 14th 5YP period.

Steel production outside China (hereafter ROW) has recovered strongly from the mid-2020 collapse, with robust growth (albeit inflated by base effects) of 12.5 percent YoY to 918 Mt in calendar 2021. That compares to 882 Mt in calendar 2019. ROW capacity utilisation rate has been tracking very mildly above normal pre-pandemic ranges (72-75%) throughout calendar 2021. ROW pig iron production increased by 11.4% while pig iron production in seaborne met coal regions increased by 12.6%: mildly undershooting crude steel growth, as it did in China.
India's crude steel output increased by around +18% to 118 Mt - a record - while pig iron output increased by around +15% YoY. Output in Japan, Europe and South Korea increased by +15.8% (pig iron +14.2%), +14.4 % (pig iron +13.9%) and +5.2% (pig iron +2.6%) YoY respectively. The US had a strong year too, backed by a robust economy and record prices behind its tariff wall, with production expanding around 18%.

Despite these superficially impressive growth rates in production across multiple ROW regions, it has not been enough to match the steep recovery in end-use demand. For the first three quarters of calendar 2021, inventory levels fell markedly and prices surged - with some regions recording all-time records. At mid-year, benchmark prices in India (ex-tax), Europe, and the US had surpassed US$900/t, US$1,400/t, and US$2,000/t respectively. These figures have since receded somewhat to (still very high absolute levels) of $864/t, $1,039/t and $1,488/t respectively as of January 24, 2022. Further weakness emerged in the following weeks, especially in the US, where inventories are now normalising, along with lead times. As of February 9/10-2022, prices were sitting at $885/t, $1120/t and $1235/t respectively. In India and Europe specifically, lower steel prices in the second half of calendar 2021 have coincided with increasing metallurgical coal prices, which has trimmed margins from the extreme highs of the first half.

This major boost to profitability has provided a fillip to a number of struggling mills - it has been a tough few years for many ROW steel makers both prior to the pandemic and then in calendar 2020. The cash flow injection has also enabled an acceleration of deleveraging efforts and boosted shareholder returns. It may also be increasingly reflected in more ambitious decarbonisation efforts, the financing of which has always been a question mark in this traditionally low margin sector.

Despite the profitability sweet spot, protectionism remains a feature of the ROW industry landscape. The US and the EU removed their bilateral tariffs as part of a broader pact on green metal trade struck in the days before COP26 began, but for other nations the EU has extended its safeguard measures (which were due to expire in June 2021) by another three years. With tight supply driving steep inflation, complaints from steel end-users have also prompted some countries to actively discourage exports. China's efforts to curb steel exports were described above. Russia imposed export tariffs (from August 2021) to secure domestic supply and fight inflation - with other metals also included in the policy (such as nickel and copper)²². China is somewhat unique in lowering barriers for the import of semi-finished steel, although at present there is very little incentive for ROW steelmakers to pursue sales into China given pricing in other regions is higher.

The release of the EU's draft carbon border adjustment mechanism (CBAM), the US-EU deal on steel and aluminium trade, India's 2070 net zero emissions ambition, the EU's updated directive on waste (i.e. circular economy implications) and the launch and evolution of China's emissions trading system (ETS) are important signposts to monitor for progress towards steel industry decarbonisation. Note that steel is in the current scope for the proposed EU CBAM (albeit with delayed implementation) but not for phase one or phase two of the Chinese ETS (as discussed above - although we do not see this being the case for too long).

A new wild card has emerged at the nexus of decarbonisation and protectionism: scrap nationalism.

There is speculation that Russia and the EU may be contemplating scrap export bans (an escalation from the current high export tariff of €100/t in Russia). Mandated circularity of local waste generation, including scrap metals, or establishing stringent conditionality on trade in waste, are other potential levers.²³ Were bans or "hard" domestic prioritisation to occur in major export regions, thereby materially reducing the availability of scrap imports in developing nations (whose domestic scrap generation capability is limited by their stock of steel in use²⁴), it would incentivise the building of new blast furnaces (average emissions profile being around 2.0 tonnes of CO2 emitted per tonnes of steel) rather than EAFs (about a quarter of the emissions of an unabated BF - and even lower if using green power). It would be perverse if decisions were made in Europe seeking to assist the local industry to pursue transitional rather than end-state technology, while developing nations are left stranded from some of the feedstock that would allow them to bring about an early step change in the emissions profile of their young and expanding fleets.

As we are fond of saying - both because it is true and also because it serves as a timely reminder and reality check - the decarbonisation battle cannot be won in Europe alone, but it can certainly be lost in the developing world. That is particularly true of steel.

That is why we are focussing our Scope 3 partnerships in steelmaking on Asia, where our four MOU partners to date represent around 12% of reported global steel production, roughly 4 percentage points more than EU production combined. Unsurprisingly, their share of global pig iron production is even higher.

Our approach to ranging uncertainty regarding the future pathway for steel decarbonisation remains to blend bottom-up, regional analysis leveraging our deep corporate knowledge of this sector with two other pillars of our proprietary foresight method, which are scenario analysis and framework design. The results have been discussed here and here, as part of our Pathways to Decarbonisation blog series. Where our findings differ from others in steel, it is often due to our differentiated regional approach, which is supplemented by the insights we glean as a key cog in both the Asian and European steel value chains.

On the topic of decarbonisation more broadly, our latest research shows a modest net uplift in our base case for long term steel demand from the combined impacts of:

• Rising investment in green technology and the infrastructure of decarbonisation [+]
• Lower demand from the fossil fuel value chain (e.g. upstream petroleum) [-]
• Higher capital stock turnover as the lifetimes of equipment and structures are reduced by the harsher physical conditions they are expected to endure as the climate changes in coming decades. [+]
• Lower growth rates in GDP versus baseline due to the physical impacts of climate change and the imposition of carbon policies [-]

We will detail this research in a forthcoming blog.

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Iron ore

Iron ore prices (62%, CFR, Argus) were volatile over the first half of financial year 2022, with the spot index ranging between $87/dmt and $223/dmt, averaging around $136/dmt. That is -$47 lower than in the prior half year, but +$10/t higher than the corresponding half of financial year 2021. Seaborne lump premia were also volatile, trading in the range of $0.03 to $0.74/dmtu, averaging $0.23/dmtu.

Six months ago, we provided the following précis of the state of play in the iron ore market:

"Before prices can correct meaningfully from their current high levels, one or both of the Chinese demand/Brazilian supply factors will need to change materially."

Fast forward to the end of calendar 2021, and while Brazilian supply did nothing to materially disturb the status quo, Chinese demand certainly did. Strict implementation of the "zero growth" mandate for steel production in China, as detailed in the preceding section, pushed the supply-demand balance for iron ore into a marked surplus essentially overnight. The correction in prices was swift. The first phase was associated with the realisation that the authorities would act with resolve to enforce a slowdown in steel production. That saw prices come down from above $200/t to the $140-$160/t range between mid-July and late-August. The second phase saw prices come down to real-time cost support in the $80-$100/t area in mid-September, with the additional move catalysed by disappointment on end-use demand and the consequently slow rundown of steel inventories, weak sentiment due to Evergrande's financial distress, very steep falls in official NBS steel production data and a consistent march higher in iron ore port stocks. With the exit of higher cost seaborne supply around these price levels, and the turn towards easier policy settings late in the December quarter, prices were able to drift upwards and finish the calendar year around $120/t (with further consolidation in January 2022). A sharp increase in the days leading into the Chinese New Year holiday that took prices just short of $150/t was met by stern rhetoric from the National Development and Reform Commission.

Chinese port stocks of all iron ore products²⁵ closed the calendar year 2021 at 156 Mt, substantially higher than the closing positions of 124 Mt for calendar year 2020 and 122Mt for the first half of calendar year 2021.

All-in-all, seaborne demand is estimated to have declined by roughly -1% in calendar 2021 against broadly flat supply from the seaborne majors. ROW provided strong support on the demand side in calendar 2021, in contrast to calendar 2020, in line with the double-digit percentage rebound in pig iron production reported above.

We estimate that price sensitive seaborne supply will decrease by around -16 Mt (natural grade wet basis) in calendar 2021 from the prior calendar year, with the substantial CFR price drop, higher freight rates cutting into netbacks and steeper discounts for lower grade products all contributing to the withdrawal of very high cost tonnes. The ebb and flow of this swing supply, in particular higher frequency run-rates of Indian lower grade exports, was instructive for the definition real-time cost support in the fluid operating environment.

Chinese domestic iron ore concentrate production (implied) reached 273 Mt in calendar year 2019, 308 Mt in 2020 and the same figure in 2021. Power rationing, safety concerns and environmental restrictions prevented a further increase in production in 2021, as the very attractive price environment might have predicted.²⁶ Going forward, we expect that in addition to structural market based drivers, potential policy initiatives that seek to increase China's self-sufficiency in ferrous units, as well as safety and environmental inspections are likely to have a material influence on the average level and seasonal volatility of Chinese domestic iron ore production.

On the topic of differentials, the lump premium (LP) narrowed on average in the second half of calendar 2021, to US$0.23/dmtu, amid considerable volatility. The LP hit its low point of US$0.03/dmtu in September-2021, on rising port stocks and a reduced productivity imperative as steel mills recalibrated their procurement strategies in the face of the steep production cuts. The LP recovered in the December quarter on heightened environmental restrictions.

Fines differentials to the 62% index for the 65% and 58% indexes widened considerably half-on-half (higher premiums for higher grade, much larger discounts for lower grade) following the improved average steel margin and the rapid escalation of coking coal prices, which higher quality iron ore helps to offset via furnace efficiency.

In the medium to long-term, as described in our steel decarbonisation blogs (episodes 2 and 3 in our Pathways to Decarbonisation series) higher quality iron ore fines and direct charge materials such as lump are important abatement sources for the blast-furnace steel making route during the optimisation phase of our three-stage Steel Decarbonisation Framework. In China of course, the BF-BOF route represents roughly 90% of steel-making capacity, with the average integrated facility being just 10-12 years old. BHP's South Flank project, which achieved first production in May 2021, will raise the average iron ore grade of our overall portfolio by around 1%, in addition to increasing the share of lump in our total output from around one-quarter to around one-third.

Our analysis indicates that the long run price will likely be set by a higher-cost, lower value-in-use asset in either Australia or Brazil. That assessment is robust to the prospective entry of new supply from West Africa, the likelihood of which has increased. This implies that it will be even more important to create competitive advantage and to grow value through driving exceptional operational performance.

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Metallurgical coal

Metallurgical coal prices²⁷ have been extremely volatile. In the half financial year just concluded, the PLV index ranged from a low of $198/t FOB Australia to a high of around $409/t. The $409/t was an all-time record that has since been surpassed in January 2022. MV64 has ranged from $171/t to around $346/t; PCI has ranged from $145/t to $290t; and SSCC has ranged from $138/t to $294/t. Three-fifths of our tonnes reference the PLV FOB index, approximately.

For the half year overall, the PLV index averaged $316/t, up by 139% compared to the prior half and by +183% YoY. The differential between the PLV and MV64 indexes averaged 17% in the first half of financial year 2022, +8 percentage points wider than in the previous half and +4 percentage points above the five-year average.

The contrast with the conditions that prevailed through the financial year 2021 has been stark. Multi-region, multi-causal supply disruptions, both inside China and in the major export nodes, at a time of strong Chinese demand and recovering import demand in the ROW, from a starting point of low stocks, produced fly-up pricing across the metallurgical coal industry.

The spread between PLV FOB· pricing, China CFR equivalent and China domestic PLV varied wildly against this backdrop. Quoting in the form of China CFR minus FOB, the differential ranged from +$192/t to -$39/t, versus the average in the four previous financial years (FY17-20) of -$8/t. The upward extreme of the range was associated with the drive towards unimaginable China CFR pricing above $600/t as Chinese end-users scrambled for tonnes without having recourse to the production of the major exporter, Australia. It was only the combination of direct interventions by the Chinese authorities, the reality of declining pig iron production in China (as discussed elsewhere), an uplift in Chinese domestic production coming into calendar year-end , and the release of some stranded import cargoes by Chinese customs, that saw the CFR benchmark fall into the low $300s. From that point forward, ongoing tightness in the seaborne trade, with the additional headwind of wet weather in Queensland to deal with, saw the FOB price move back above China CFR.

Six months ago, we provided a detailed discussion of the impact of trade distortions, including the historical background required to process the analysis effectively. That discussion can be reviewed here.

This is the new status quo on the destination of Australian shipments, with the first figure being the 2021 share of Australian exports, and the second being the average from the previous five years. China (zero vs 23%), Developed Asia (44% vs 36%), India (32% vs 24%), Europe (11% vs 9%), South-east Asia (8% vs 4%) and Brazil (plus other, 5% vs 4%).

Demand recovery in ROW and strong operating conditions for the steel industry helped accommodate this abrupt redirection of trade. Blast furnace operating rates have normalised across ROW as a whole. Despite a devastating second wave of COVID-19 infections, India's metallurgical coal imports increased by +24% YoY, to a record 70 Mt. Europe and Developed Asia both witnessed strong rebounds in pig iron production, with a consequent uplift in metallurgical coal import requirements. A third factor assisting the placement of Australian tonnes was the redirection of North American shipments from ROW to China, seeking the very attractive arbitrage opportunity that emerged.

In terms of volume, Australian shipments were adversely impacted by safety concerns at some mines in Queensland, weather and some production curtailment decisions that were taken when prices moved deep into the cost curve in financial 2021. Exports were down -1% YoY in the calendar year-to-November (noting calendar 2020 volume was at a seven year low), versus the five-year average they are down almost -6%. Versus calendar 2019 they are -8% lower.

Elsewhere on the supply side, the Chinese and Mongolian coal industries struggled for most of the calendar year. The COVID-19 situation in Mongolia deteriorated starkly from early May 2021, and alongside the "zero tolerance" approach to the virus in China, the trade never picked up momentum. Coking coal truck flow was roughly 720 trucks per day in calendar 2019 - the year when Mongolia was China's largest source of imports. That slowed to a mere trickle around the middle of the year, according to data from MonCoal. The peak for the year was 300-400 trucks per day on November, but the rate collapsed again going into calendar-year end, falling below 100 in December. Separately, a series of domestic mining accidents in China had an impact on higher quality coking coal production too.

Chinese domestic PLV prices surged to record levels just above $600/t in September, double the price as of June-July, as local fundamentals tightened quickly. This set off an immediate chain reaction in the seaborne trade, similar to the slower moving trends seen earlier in the year, but compressed into weeks. These events highlight that even though Australian exporters and Chinese importers are not transacting bilaterally at present, the China CFR and Australian FOB markets are still directly influenced by each other via the overlap of ex-China demand and ex-Australian supply.

While on the subject of industry financials, as an aside we note that the aggregate liability-to-asset ratio for all coal mining companies (energy and metallurgical, as reported by the NBS) reached 64% in calendar 2021, -6 percentage points from the 70% peak that was reached in 2016 just after the Supply Side Reform (SSR) of the sector was launched. That compares to steel, who as discussed above, have reduced the equivalent ratio by -9 percentage points.

Given the relative price situation faced by the two industries, the protection from import competition afforded to the domestic coal industry since 2017, and the fact that the steel industry added capacity and underwent a mini M&A boom under the capacity swap regime, it is somewhat counter-intuitive that coal has lagged behind in this balance sheet cleansing project.

To understand the gap, it is important to remember that coal producers have been strongly encouraged by policymakers to sell under fixed price contracts in recent times, therefore limiting their exposure to the record high spot prices we have observed. Second, many listed producers have increased their dividend payout ratios, and have decided to de-prioritise debt retirement while servicing rates are low: and they have apparently done so without encountering administrative roadblocks. Third, vertically integrated coal miners with power generation businesses have been encouraged to boost their investment in renewable capacity, adding to their capex bill. Four, anecdotally, larger producers have been active in providing short term financing to coal traders, which of course absorbs some balance sheet.

Going forward, despite the recent exuberance, while natural trade flows are inhibited the met coal industry faces a difficult and uncertain period ahead.

Longer term, we argue that the continued policy focus on environmental considerations and financial sustainability in Chinese coal mining, in addition to the intent to embark upon a decarbonisation path for steel making, should highlight the competitive value of using high quality Australian coals in China's world class fleet of coastal integrated mills. As we argued here, China's steel industry is still in the optimisation phase of its decarbonisation journey, in which higher quality raw materials make a clear difference to the energy and emissions intensity of the BF-BOF²⁸ route, which accounts for 90% of Chinese and 70% of global crude steel production.

In coming years, most committed and prospective new metallurgical coal supply is expected to be mid quality or lower, while industry intelligence implies that some mature assets are drifting down the quality spectrum as they age.

The relative supply equation underscores that a durable scarcity premium for true PLV coals is a reasonable starting point for considering medium terms trends in the industry. The advantages of the highest quality coking coals with respect to GHG emissions are an additional factor supporting this overarching industry theme: an advantage that will be increasingly apparent if carbon pricing becomes more pervasive.

The flip side of the burgeoning advantages of PLV, as derived from the fundamentals discussed above, is that the non-PLV pool of the industry could face fundamental headwinds for an extended period in the disrupted post COVID-19 world.

On the topic of technological disruption, our analysis suggests that blast furnace (BF) iron making, which depends on coke made from metallurgical coal, is unlikely to be displaced at scale by emergent technologies this half century. The argument hinges partly on the sheer scale of the existing stock of long-lived BF-BOF capacity (70% of global capacity today, average fleet age²⁹ of just 10-12 years in China - the major producer - and around 18 years in India - the key growth vector). It also highlights the lack of cost competitiveness and technological readiness (or both) that is expected to inhibit a wide adoption of potentially promising alternative iron and steel making routes, or high-cost abatement levers such as hydrogen iron making and carbon capture and storage, for a couple of decades at least in the developing world. Notwithstanding the current sweet spot in profitability under record pricing in many regions, steelmaking is a low margin industry where every cent on the cost line counts.

We certainly acknowledge that (a) PCI could be partially displaced in the BF at some point by a lower carbon fuel, and (b) the well-established electric arc furnace (EAF) technology, charged with scrap and without any need for metallurgical coal, will be a stern competitor for the BF at scale to the extent that local scrap availability allows. In a decarbonising world, EAFs with reliable scrap supply running on renewable power should be very competitive. We assess that emerging technologies that are expected to feature in a low carbon end-state for the industry, such as green hydrogen enabled DRI-EAF, are some decades away from being deployed at scale. Accordingly, we expect that the industry will need to be a purchaser of carbon offsets (as required to meet regulatory or voluntary commitments) for a considerable period of time even as it positions itself to pursue long run carbon neutrality.

Information on our four Scope 3 MOUs with China Baowu, HBIS, Japan's JFE Steel and South Korea's POSCO is available on our website.

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Copper

Copper prices ranged from $8,776/t to $10,652/t ($3.98/lb to $4.83/lb) over the first half of the 2022 financial year, averaging $9,534/t ($4.32/lb).³⁰ The average was around +5% higher than in the prior half and +39% versus the equivalent half of financial year 2021. The average for the full financial year 2021 was $7,944/t.

Both industry specific fundamental factors and swings in broader macro sentiment have been influential factors in price formation. Volatility was somewhat reduced though in the most recent half, with the range more than $1000/t narrower than the second half of the financial year 2021. Prices were stable in trading ranges for considerable stretches of time, and speculative movements to the downside were quickly recovered by the physical trade given the underlying deficit conditions. That is reflected in the fact that while the high end of the range in the two periods were broadly similar, the low for the most recent half was in the high $8000s, whereas in the prior half the low was in the high $7000s. All of these prices are of course very elevated relative to both history and the position of the operating cost curve.

The size of the wedge that opened up between copper demand in China (roughly half of refined production) and the ROW in calendar 2020 narrowed in calendar 2021. Chinese semis production was up by 1.8% in calendar 2020 (upwardly revised), while ex-China markets declined by around -8%, for a global figure of -3.5%. We estimate that growth came in at around 6% and 8% for China and ROW respectively in calendar 2021, with global production around 7%, a comfortable margin above growth in world GDP. The volume of world copper demand surpassed 2019 levels by around 3¼%. Obviously, these figures are strong, reflecting a synchronised bounce in copper consumption. It is notable though that within the ROW detail, it was the mature customer centres of the US and Europe that produced the most upside, while some developing world lagged somewhat behind. This divergence, in our opinion, was partly due to lesser capacity in the developing world to both manage the pandemic in a narrow sense and partly due to their finite ability to cushion their economies from the shock through aggressive expansion of public sector balance sheets. We anticipate that those parts of the developing world that have not yet ascended to 2019 levels will do so in calendar 2022.

Turning to Chinese demand first of all, six months ago we indicated that demand conditions had firmed and broadened noticeably in the first half of calendar 2021, as expected. The momentum continued in the second half, leading to the strong growth across the full calendar year reported above. On an end-use basis, most major sectors recorded growth of 5% YoY or above in calendar 2021, with considerable strength in multiple segments. Power sector demand for copper, which declined YoY, was the major exception. This broad-based strength allowed copper to turn the tables on steel, where end-use had out-performed copper by a large margin in calendar 2020 (2.4% growth versus around 6% for steel).

White goods, transportation, machinery and electronics have all enjoyed favourable operating conditions, with export sales a considerable support. Where white goods are concerned, customer intelligence indicates that this is more of a volume boost than a genuine profit boom for downstream manufacturers, as rising input costs are difficult to pass on in this highly competitive, price-sensitive market. Perhaps reflecting this, the equity market performance of listed consumer durables manufacturers was poor in calendar 2021.

Construction managed to post solid growth of 5% in calendar 2021, leveraging the upswing in copper-intensive housing completions even as steel-intensive new starts fell away in the second half. (See the extended discussion under the Chinese economy above). While we were surprised by the way the real estate sector evolved through the second half of calendar 2021, the resilience of copper vis-à-vis steel was in line with our expectations. Six months ago with wrote that: " … with a housing completion upcycle underway even as new starts flatten out copper demand growth from real estate is likely to out-perform the leading and coincident indicators for the sector (e.g. housing sales and under-construction) for some time to come."

To quickly recap the key Chinese housing parameters, the volume of housing completions expanded by +11.4% across the calendar year and +1.9% YoY in the month of December. Housing starts - the key indicator for contemporaneous steel use in real estate - declined by -11.4% and -31.1% on the same basis.

Still in China, power infrastructure (comprising both grid spending and power generation projects) slowed down in calendar 2021. Anecdotally, high prices may have led to some project delays, with State Grid reportedly working within a relatively steady nominal budget for the calendar year. Power generation investment was strong in the first half on the back of renewables, but tailed off in the second amidst considerable turbulence in the power industry under both the "dual control" policies and energy security issues coming into winter. Overall investment rose 4.5% YoY. Low carbon technologies are an increasingly important element of this component of demand, with China's boom in offshore wind capacity in particular expected to be a long-term boon for copper. Wind's share of power source investment in China has doubled in recent years to reach around 50%.

State Grid has set their nominal budget for calendar 2022 at 501.2 billion yuan, +6% YoY. Upgrade of the power grid will be a major focus, after nominal outlays rose just 1.1% YoY.

In the ROW, developed regions have led the way, with North America and Europe in the vanguard.

If the definition of a robust rebound is the full reclamation of the calendar 2020 percentage point loss in semis production in 2021 (i.e. Europe was -7% in 2020 and up by +8% in 2021), then only minor producers Africa and Latam meet the criteria beyond these two. North East Asia was flat at -6/+6, India was behind at -23/+19, while other emerging Asia and the Middle East (both medium sized producers), came in at -16/+13 and -5/+3 respectively. That implies that the recovery still has further to run in many regions.

On the supply side of the industry, the copper concentrate balance has recovered from the extremes of tightness in the first half of calendar 2021, when spot treatment and refining charges (TCRCs) moved down (in the producers' favour), towards decade lows.³¹ The absolute trough occurred in April-2021, from which point we saw an initial swift rebound that ultimately fell short of the calendar 2022 benchmark of $65/dmt & US 6¢/lb, agreed in December 2021.

While the localised risks from COVID-19 and other forms of potential disruption (for example community protests or labour negotiations) remain elevated, industry-wide operational performance was sound across the calendar year. As of January 31, 2022 (i.e. with the benefit of many December quarter operational reviews), Wood Mackenzie had identified 1.1 Mt of disrupted production in calendar 2021, or roughly 5% of initial production expectations. Concentrate operations contributed 0.84 Mt of the 1.1 Mt total. The 5% estimate for calendar 2021 compares to realised outcomes of 5.4% for calendar 2020 and 4.8% for calendar 2019.

Turning to the outlook, a cluster of in-development projects (including in Peru, Chile, central Africa and Mongolia) are expected to come on-stream somewhere in the 2022-2024 window, even as the scrap share of copper units moves higher. The scrap uptrend is supported by the increasing size of the end-of-life pool in China, high prices and fewer physical constraints from social distancing.³² There have also been some expansion announcements at existing operations, including in the DRC, no doubt encouraged by both attractive copper prices and strong by-product fundamentals.

The industry must navigate the entry of this supply over the next few years, which is likely to produce periods when the demand-supply balance is in surplus. Once this phase of the decade is navigated, a durable inducement pricing regime is expected to emerge from the mid-to-late 2020s.

A "take-off" of demand from copper-intensive easier-to-abate sectors (renewable power generation, the electrification of light duty transport, and the infrastructure that supports them both) is expected to be a key feature of industry dynamics from the second half of the 2020s forward: if not earlier.

A series of copper foil project announcements in calendar 2021, including equity participation from the EV value chain, indicate that the green tech uplift for copper in the transport space is no longer abstract.³³

Looking even further out, long term demand from traditional end-uses is expected to be solid, while broad exposure to the electrification mega-trend offers attractive upside. Grade decline, resource depletion, water constraints, the increased depth and complexity of known development options and a scarcity of high-quality future development opportunities are likely to result in the higher prices needed to attract sufficient investment to balance the market.

On this latter point, it is notable that while there has been some activity in the project space, the response has been timid when you consider both the very strong prices of today and copper's future-facing halo effect. That underscores the idea that the option set of the industry as a whole is constrained. It may also reflect policy and political uncertainty, with both Chile and Peru (together about two-fifths of world mine supply and one-third of reserves³⁴) presenting a fluid regulatory picture to would-be explorers, project developers and asset owners.

In terms of hard numbers, according to data assembled by Standard & Poor's, global capex by majority copper producers among the world's top 80 mining companies (excluding diversified operators) is expected to decline between calendar 2022 and calendar 2024. Total outlays in 2024 are expected to be exactly half of the peak spending levels of calendar 2014.

It is these multiple parameters that are critical for assessing where the marginal tonne of primary copper will come from in the long run and what it will cost.

Working off a 2019 operating asset baseline, we estimate that grade decline could remove approximately -2 Mt per annum of mine supply by 2030, with resource depletion potentially removing an additional -1½ and -2¼ Mt per annum by this date, depending upon the specifics of the case under consideration.

Note that resource depletion depends in part on decisions to close or extend the life of aged assets, which in turn will depend upon, among other things, price expectations and the regulatory environment.

Our view is that the price setting marginal tonne a decade hence will come from either a lower grade brownfield expansion in a lower risk jurisdiction, or a higher grade greenfield in a higher risk jurisdiction. Neither source of metal is likely to come cheaply. Under an optimistic but not extravagant demand case, we estimate that the cumulative industry wide capex bill out to 2030 could be close to a quarter of a trillion dollars.

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Nickel

LME nickel prices ranged from $17,800/t to $21,135/t over the second half of financial year 2022, averaging $19,470/t. That is 11% higher than the prior half. Prices finished the half with positive momentum, closing at $20,925/t, in advance of a sharp rally early in the current half, with a decade high print of $24,208/t recorded on the 21st of January.

Nickel first-use is dominated by the stainless steel sector. It comprises more than two-thirds of primary demand today. Nevertheless, with a rapid and prolonged drive towards the electrification of transport in prospect, we contend that there are plausible long run paths where the battery supply chain and stainless steel become equally important consumers of nickel, in a much bigger global market.

Nickel end-use is diverse, with broad sectoral exposure to construction, consumer durables and electronics, engineering, metal goods and transport, in addition to finished batteries.

The refined nickel market was in surplus to the tune of around 120 kt in calendar 2020. Our view of six months ago was that we expected "… the balance will flip to a small deficit in calendar 2021, with a rebound in ROW demand the primary difference, given overall supply growth and Chinese demand are both expected to be solid once again."

That was directionally correct, but much too conservative. The refined deficit in calendar 2021 is estimated to be around -100 kt. Supply growth slowed from 6.2% YoY in 2020 to a still respectable 3.8% YoY in 2021, albeit disruptions were a recurrent feature of the narrative. But the key story of the year was the double digit expansion in global demand, with all regions recording positive growth from calendar 2020, with China in the unaccustomed position of laggard at just 2% YoY.

The demand break-out in calendar 2021 was fuelled by both traditional uses (stainless steel 13.7% global, 21.2% in ROW) and the battery-EV complex (48% global, 55% in ROW). All in all, global primary nickel demand (incorporating also non-stainless, non-battery demand not referenced above) increased by 13.1% YoY and 28.6% YoY in ROW. The demand story finished the calendar year with a flourish, with full year estimates of EV sales hitting a stunning 6.7 million (see dedicated EV section).

The fundamental tightening described above manifested in a consistent rundown of visible inventories, with LME briquette stocks breaching some important physical and psychological levels in the second half of the calendar year. As of February 2, 2022, briquette stocks had declined by -137.7 kt, or -66%, since April-2021. We estimate that China absorbed a great deal of this metal. The relationship between stocks and prices in exchange trade metals cease to be linear when stock levels move to the extremes. In other words, when stocks fall beyond a certain low threshold, prices tend to respond (much) more aggressively to any further change than they do from a more normal starting point: in other words they fly-up, leaving the anchor of the operating cost curve well behind them.

In this regard, it is noteworthy that even with the latest rally, nickel prices are still well short of the previous cycles peaks of around $50,000/t and $29,000/t of 2007 and 2011 respectively, while copper and iron ore (to name just two adjacent commodities) have established all-time highs over the last 12 months. That illustrates two things: (1) the disruptive force of the nickel pig iron [NPI] innovation on the industry's fundamental cost base still casts a long shadow. (2) If nickel prices were to really fly-up, historical precedent indicates there is lot of headroom.

While demand has certainly been exceptionally strong, it is also important to recognize that while supply disruptions have been multi-regional in calendar 2021, they have impacted class-one material disproportionately: major producers in Russia, Canada and New Caledonia among them. Power supply and cost issues in Europe and China also constrained energy-intensive refining activity in the second half of calendar 2021. Overall, class-one supply declined -4% YoY to 995 kt (a little less than two-fifths of total nickel unit supply) in calendar 2021. We also estimate that the 90th percentile of operating cost curve has lifted appreciably under these circumstances.

In contrast to developments in class-one, supply of class-two material was able to keep pace with traditional demand. Indonesia's ongoing NPI (nickel pig iron) build up (+42% YoY to 870 kt) was more than enough to offset China's non-discretionary ramp-down (-21% YoY to 405 kt). Total NPI supply increased 13.3% YoY to 1275 kt (a little less than half of total nickel unit supply). Ferro-nickel (FeNi) supply fell -3.7% to 370 kt.

Six months ago we discussed the announcement that Chinese NPI pioneer Tsingshan had invested in a NPI-to-matte conversion facility in Indonesia, with first supply expected to come in October-2021. This was the first commercial effort to go from NPI - a low nickel content class-two product - into a high nickel intermediate (~75%) material acceptable in the battery supply chain. The first units from this facility came a little later than expected, but trial volumes Indonesian matte were produced before the end of the calendar year.

The differential between NPI and nickel sulphate (NiSO4) prices is the key metric to watch as this embryonic sub-industry evolves. Indonesia's ongoing efforts to use policy levers to increase the proportion of value-added captured onshore is a second important watch point. The latest "trial balloon" from a senior official indicated that export taxes could be applied to products with nickel content below 40% - something that would capture all NPI and some FeNi. Converting NPI to matte onshore would have a double benefit of avoiding the tax and servicing the battery value chain directly. The environment footprint of the process though, whether that footprint is measured narrowly or broadly, remains problematic in absolute terms and highly uncompetitive versus an integrated sulphide operation. To wit:

Longer term, we believe that nickel will be a substantial beneficiary of the global electrification mega-trend and that nickel sulphides will be particularly attractive. This is due to their relatively lower cost of production of battery-suitable class-1 nickel than for laterites, as well as the favourable position of integrated sulphide operations on the GHG emissions intensity curve.³⁵

There are four key questions for the nickel market in the longer run. The first is how fast will electric vehicles (EVs) penetrate the auto fleet? The second is what mix of battery chemistries will power those vehicles? The third is what will be the "steady state" marginal cost of converting the abundant global endowment of laterite ores to a high grade nickel product suitable for use in battery manufacturing? The fourth question is related to the third: how will the cost curve evolve in the face of ever-increasing consumer and regulatory demands for transparency with respect to the sustainability of upstream activity?

Our views on the first two questions are both well-known and uncontroversial: EVs are taking off, and ternary nickel rich chemistries will be the leading technology that powers them. Leading of course does not mean that this technology has to completely monopolise all applications across all segments. LFP (Lithium-iron-phosphate) has a role at the low end of the cost and performance spectrum, and other chemistries (for example those that thrift on cobalt and/or accommodate more manganese) are also likely to find their niche as EV penetration broadens across all segments.

The recent increase in LFP share in China is noteworthy, as discussed in the EV section. There is a nickel specific point to be made here as well. The 3.4 million EV units China sold in calendar 2021 required 87 kt of nickel. The 2.4 million EV units sold in Europe required 95 kt of nickel and the 730 thousand EVs sold in North America required 48 kt. The big picture here is that the electrification of transport mega-trend is a major stimulant for nickel any way you cut the data. The secondary story is that the ultimate size of the prize is a function of both the number of EV units and the nickel multiplier associated with the choice of battery.
There has been a lot of information flow on the third and fourth questions. The NPI-to-matte developments were discussed above. There is still considerable uncertainty as to HPAL (high pressure acid leaching) costs, and the ability to ramp-up to nameplate, which has been a recurring issue in the past. Signals from Obi Island seem positive on the latter point thus far, but it remains early days. On the cost side, an increasing recognition among nickel customers and the wider investor community of the broad biodiversity and environmental impacts of Indonesian mines (from land-use to tailings management), in additional to the very carbon intensive nature of the local electricity supply, will - rightly - add to the cost base of supply from this region in due course. We range the quantum of this uplift in our long run scenario analysis.

The nickel value chain is placing a high value on security of supply as well as provenance and traceability. Both themes are encapsulated by our partnership with Tesla, while the many formal backward and forward linkages emerging up and down the value chain are a good illustration of the degree of urgency and excitement we observe from customers. The carbon-equivalent footprint of a typical integrated sulphide operation is between one-fifth and one-quarter of the NPI-to-matte route to battery acceptable material. With the integration of more renewable energy into our Nickel West operations, we will move even further to the left on the industry operational GHG emissions intensity curve.

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Crude oil

Crude oil prices (Brent) ranged from a low of around $65/bbl to a high of around $86/bbl in the first half of financial year 2022. West Texas Intermediate (WTI) Cushing ranged from $62/bbl to $85/bbl. Brent was up by around 17% from the average of the prior half and 72% from the corresponding half of financial year 2021.

The front-month Brent minus WTI spread narrowed on average to $2.93/bbl in the first half of the financial year 2021 from $3.12/bbl in the prior half. The WTI minus MARS³⁶ spread averaged $1.82/bbl for the last six months (i.e. MARS at a discount to WTI), versus a mild premium in the prior half. This is the first discount over a full half year since financial year 2017.

The fundamentals in the oil market have been tight, with the demand and supply sides of the ledger both contributing to that status. As we suspected it would be, demand has, in general, been progressively more resilient to each successive COVID-19 wave. And the rebounds that we have observed from these progressively shallower demand dips have been consistently robust. Trucking, light duty miles and Asian petrochemical demand have produced particularly strong performances. Even with only a partial rebound in aviation to date³⁷, the industry is on track for record-high demand in calendar 2022, easily surpassing pre-pandemic levels. Allied to supply discipline on behalf of both OPEC+ and US shale producers, this has produced a consistent rundown in global inventory to the point where barrels are starting to look scarce. Boiling that down to a single figure, visible stocks are approaching their lowest level this century in days of demand. In other words, there is less scaled inventory today than before China entered the WTO, when global demand was roughly three-quarters of the 2019 level.

Given that striking observation, the next logical question is where does the industry look for extra barrels should demand continue to grow in calendar 2022 and 2023? Half of the barrels that OPEC+ curtailed during the lockdown peak have returned, and aggregate spare capacity will soon be back to pre-pandemic levels. In the US, there are no signals yet that independent producers in the US are on the cusp of reverting to the capital ill-discipline of previous cycles. In fact, there is evidence that some of the traditional hedging policies that supported high supply elasticity in shale in the past are being altered in favour of higher acceptance of price risk. Furthermore, general labour shortages in the US are pronounced, and given the violence of the 2020 contraction in oil field services employment, drawing workers back into the sector at a reasonable cost may prove challenging.

Six months ago we highlighted that the IEA was projecting that total upstream investment would come back a modest 8% in calendar 2021. That led to the striking realization that if the IEA forecast were to eventuate, total upstream spending in calendar 2021 would be 44% below the level of 2015, but with a higher price backdrop.

In a sector subject to the perpetual tyranny of field decline, with (conservatively) a third of on-stream barrels needing to be replaced on a rolling ten-year cycle, that is also coming off a relatively unsuccessful decade for exploration, an investment and exploration crunch of this magnitude is expected to have major ramifications for supply for some time to come. The markedly higher levels of upstream activity from NOCs versus the IOCs as the industry embarks in earnest on the energy transition era, also imply that the current imbalance between sovereign and non-sovereign controlled oil reserves (the former control around two-thirds of the total³⁸) will only get wider in coming years.

Our base case remains that demand will rise modestly above pre-COVID levels in the coming years, before reaching a plateau in the medium run. In the phase that precedes the plateau, the twin disruptive levers of efficiency and electrification that are operating on the road transport segment are more than offset, from a total liquids demand perspective, by the impact of rising living standards in the developing world.

But these circumstances are not expected to last forever. Beyond the plateau, we foresee a steady erosion of demand as the disruptive forces gain ascendancy over the traditional economic development drivers, assisted by policy changes and, just as importantly, technological progress and voluntary decarbonisation effort by individuals, business and government. The ability of developing countries to leapfrog in their technology choices as cost relativities evolve (subject to infrastructure availability), and heightened discretionary effort in line with stated aspirations, is expected to ensure that their future pathways of oil use per head track lower than the historical pathways pursued by the major OECD economies. Future patterns of urban infrastructure design and country specific population density and agglomeration characteristics also play a role in this assessment.³⁹

Bringing this bottom-up analysis of demand together with the systematic decline rates that the supply side of the industry is subject to, points to an expected structural supply-demand gap through the 2020s and into the 2030s. This analysis indicates that considerable investment in conventional oil is going to be required to fill that gap and maintain market balance. If that investment is not forthcoming in a timely way, the possibility of oil prices flying-up aggressively cannot be ruled out.

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Liquefied natural gas

The Japan-Korea Marker (JKM) price for LNG has been extraordinarily volatile over the last eighteen months. Spot prices hit record lows as COVID-19 demand destruction hit a market already facing excess supply and large storage builds in the first half of calendar 2020. The market then reversed course sharply during the northern winter, printing what were then record high prices in January 2021. Following a short reprieve for shoulder season, prices moved higher again going into the northern hemisphere summer and spiked upwards to yet another new record in the lead-up to the European winter ($56.33/MMBtu in October-2021), as that region's energy crisis unfolded.

The average price for the half year just concluded was $27/MMbtu, +168% higher than the prior half and +362% versus the corresponding half of financial year 2021. And for a truly astonishing comparison, JKM increased more than 30-fold from the pandemic low of $1.83 to the October 2021 high. Equivalent volatility in iron ore would have produced a high point of around $2400/t, not $236/t.

The fundamental starting point for the second half of financial year 2022 features a lean storage position and constrained supply that is stretched to service robust demand coming from power and non-power sources in both East Asia and Europe. Geopolitics is also a considerable influence on the industry at present: Russian pipeline supply to Europe was down -29% YoY in December-2021 and more than -40% YoY in January-2021. High carbon allowance pricing in Europe, and elevated energy coal prices, are also relevant considerations for the near-term outlook. Notwithstanding the array of reasons why prices are high today, the situation seen in the winter of 2021/22 is a genuine "fly-up" that is quite disconnected from the cost base of the industry, and therefore prices are susceptible to a rapid correction if/when positive supply signposts emerge.

Looking further ahead, within our generally constructive outlook for LNG demand growth, the key uncertainties include energy mix and decarbonisation policies in Japan, China and Korea in the wake of their net zero pledges. At the national level, the scale of competing supply of indigenous and pipeline gas in (and into) China⁴⁰; the level of investment in new gas infrastructure in India; and the timing and scale of nuclear restarts in Japan are also potential swing factors in the outlook. Outside Asia, the amount of Russian pipeline gas supplied to Europe, plus energy mix and decarbonisation policies in the EU are all material sources of uncertainty.

Beyond the mid-2020s, new projects are expected to be required in a global gas market where the marginal supply looks likely to come from North American LNG exports under a range of scenarios. The project queue looking to target this window has thinned out rapidly during the pandemic, with the capex discipline of the petroleum majors on display in LNG as well as in upstream liquids.

In the longer term, we see LNG as a commodity that has an opportunity to operate under inducement economics, at times, given the combination of systematic base decline and an attractive demand trajectory. Global gas is also a big market that is getting bigger, with LNG expected to almost double its share of that expanding pie. However, gas resource is abundant and liquefaction infrastructure comes with large upfront costs and extended pay backs. There is though considerable heterogeneity in terms of the full lifecycle carbon-equivalent footprint of different resources. The answer to this complicated equation is that, in our view, only assets that are advantaged by proximity to existing infrastructure, or customers, or both, with competitive carbon intensity, are fundamentally attractive.

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Energy coal

Energy coal prices started financial year 2022 strongly on robust power demand due to both accelerating industrial activity and the hot northern summer driving cooling demand. Ongoing supply disruptions carried over from the latter part of financial 2021, record high gas prices and energy security anxiety in major importing regions in advance of the northern winter (which was projected to be harsh) kept the rally going.

The gCNewc 6000 kcal/kg FOB Newcastle index (hereafter 6000kcal, or "high CV") averaged around $176/t over the first half of financial 2022, up from around $98/t in the prior half. Prices ranged from a high of around $254/t to a low of around $140/t.

The 5500kcal index (alternatively an element of "low CV") averaged around $59/t over the first half of financial 2022, with a high of around $164/t and a low of around $78/t.

The spread between the spot indexes for gCNewc 6000kcal and 5500kcal was volatile, continued to be influenced by Chinese import policies, the unintended spillover effects of the same with respect to distorted trade flows, the rapid turnaround from lagging to surging supply in China's massive domestic industry, erratic availability of Mongolian coals, multiple supply outages in high CV regions and relative rates of demand recovery across low and high CV importers. On average, the spread was pretty stable around 39-40% in the two halves of calendar 2021, versus the historical average of around 32%.

Longer-term, we expect total primary energy derived from coal (power and non-power) to plateau initially, and decline thereafter, with power generation (about two thirds of total demand) peaking much earlier than non-power applications, where GHG emissions are generally harder to abate.

Coal currently has an approximate 36% share of the global power generation mix. Our range of business-as-usual cases has that declining to as low as one-fifth in 2035. Within those cases, there is very large regional variation. Europe is projected to come down from around 15% to as low as 5% in 2035, Japan from 33% to as low as 12%, China from around 64% to as low as 31% and India from around 72% to as low as 47%.

Stepping back for a moment though, even under the most aggressive decarbonisation scenario we run internally - the 1.5 degree scenario discussed in our Climate Change Report 2020, as described above - while the cumulative requirement for energy coal in the coming thirty years would be less than in the thirty years just gone: the industry would still need to produce around three-quarters of its historical volume to meet demand in this scenario. That obviously doesn't make energy coal "future-facing" or attractive for organic growth: but it does highlight that this commodity could still play a role in coming decades as a source of affordable energy in the world's developing regions, even under deep decarbonisation scenarios.

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Potash

The recovery in potash prices that began in the second half of calendar 2020 gathered pace in calendar 2021, with a dramatic acceleration emerging in June. Some regional price benchmarks have hit levels not seen since 2009, although there are some very large variances between regions. The gaps between the (mainly granular grade, hereafter gMOP) benchmarks in the Americas and the (mainly standard grade, hereafter sMOP) benchmarks in Asia remain extremely stark.

Strong demand in calendar 2020 was partly met by a rundown of producer inventories. These were accumulated under the weaker demand conditions observed in the second half of calendar 2019. With robust demand again in calendar 2021, inventories being lean and little succour as yet from expected greenfield start-ups in Belarus and Russia, the industry has been struggling to meet demand from its active capacity. Prices have accordingly "flown-up" - a circumstance we flagged in our potash and Jansen briefings as something that may well recur as this industry evolves in the coming decades.⁴¹

Mosaic has announced that the earlier-than-planned closure of inflow-affected mining areas at its Esterhazy site in Canada (K1 and K2) will reduce output by 0.7 Mt between July-2021 and March-2022, even though it is going to restart its Colonsay facility, which has been idle since September 2019, and Esterhazy K3 is expected to reach full capacity in the current quarter. Nutrien has also announced that it will produce 1 Mt more than originally planned in calendar 2021 by increasing staffing levels at several of its under-utilised operations. Sales the first three quarters of the calendar year rose 4% YoY. Nutrien has also intimated that capacity in calendar 2022 will be 1 Mt higher than in 2021. Uncertainty regarding the status of Belarus, the source of approximately one-fifth of internationally traded potash, has deepened over the last six months. The impact and duration of sanctions on Belaruskali and its marketing arm BPC, plus BPC's loss of rail access to the Lithuanian port of Klaipeda, are a considerable sources of uncertainty for potash buyers, as well as incumbent producers.⁴²

While supply has certainly been constrained, this upswing has also been characterised by very strong demand. Shipments jumped sharply to a record high of 71.6 Mt in calendar 2020, from 63.3 Mt in calendar 2019, according to CRU. We estimate that global shipments again on track to reach the 71-73 Mt area in calendar 2021. Strong demand from centres where pricing is prompt has offset a decline in imports in regions with annual contracts, where a standoff between buyers and sellers limited trade through much of the year.

Looking at price developments by region across calendar 2021, within the steep overall uptrend, the timing and pace of gains has varied greatly. The price of gMOP⁴³ into Brazil opened the year at $245/t CFR and closed the year at $795/t, leapfrogging the US around mid-year, and then carrying on. gMOP into the United States (at NOLA) initially led the global rally, opening the year at $273/t FOB Barge, and closed the year at $750/t. In contrast, spot prices for sMOP in South-East Asia didn't rise above $300/t CFR until early July-2021, but they had reached $600/t by calendar year end. Contract prices with China and India have been set much lower, at $247/t CFR and $280/t CFR respectively, although only two suppliers (BPC and ICL) have publicly announced commitments to sell at this level.

Realised prices tend to reflect developments in prompt benchmark pricing with a multi-quarter lag which is partly dependent on the timing of new annual contacts catching up with spot markets. At present a producer with higher gMOP exposure in the Americas is enjoying vastly superior pricing than a producer geared more towards sMOP under contract into Asia. We estimate that approximate realised prices for Canadian producers (FOB Vancouver equivalent) as of the week of Jan-24, 2022, were just short of $530/t.

Turning to the major consumption regions, Brazil, the most reliable growth destination in recent years, has recorded import volume growth of +14% YoY in calendar 2021, despite the big price increases. Earlier in the year, the strong soybean price had kept the barter ratio - the number of 60kg bags of soybeans required to buy one tonne of MOP - in check. However, the ongoing lift in MOP prices and a levelling off in soybeans has now driven the barter ratio to decade-long highs of 28, which is almost a three-fold decrease in affordability since early calendar 2021. That explains the inability of Brazilian prices to push beyond $800/t, in our view.⁴⁴ Imports into China and India were down, partly due to the fact these destinations were unattractive to producers due to stale contract prices.

With domestic production weak, and imports not flowing, the Chinese government released some of its strategic reserve late in the calendar year. South-east Asian imports have rebounded sharply in calendar 2021, with the full year estimated at a record 8.2 Mt, up from 6.4 Mt in calendar 2020. Strong prices for crude palm oil allowed affordability to remain manageable even as MOP prices escalated.⁴⁵ Demand from the US was also at record levels (10.8 Mt), up from 8.4 Mt in calendar 2020.

Export volumes from Canada (Jan-Nov) are up +2% YoY, though this has been driven by strong US demand rather than offshore sales. Instead, much of the global demand growth has been met by exports from Russia have increased 28% YoY year-to-date, while Belarus has not published export data since May 2021. Reviewing imports attributed to Belarus in key destinations, significant growth seems to have been achieved, including in China and India. Note that it was Belaruskali that settled the head-scratching contract price with India in January of 2021. This deal went stale very fast as other regions with prompt pricing took off.

On the supply side of the industry, construction and commissioning of greenfield mines continues. Belaruskali's Petrikov project was commissioned in August 2021. EuroChem's Usolskiy expansion in Russia is expected by calendar 2023. New mines under construction by Slavkali (Belarus) and Acron (Russia), plus two replacement mines at Uralkali (Russia), are due to reach full production by the mid-2020s. The tightening of the sanctions net on Belarus, and the medium term geo-economic ramifications of the tense stand-off between Russia, the Ukraine and NATO (not to mention the combustible geopolitics of energy in the region at present), cast considerable uncertainty over future potash trade flows.

Longer-term, we see potash as a future-facing commodity with attractive fundamentals. Demand for potash stands to benefit from the intersection of a number of global megatrends: rising population, changing diets and the need for the sustainable intensification of agriculture.

That latter point includes both the need to improve yields on existing land under cultivation, in the face of depleted native soil fertility, but to also begin factoring in the long run land-use implications of large scale bio-fuel production and nature-based solutions to climate change. To be clear though, the impact of deep decarbonisation on potash demand is best characterised as attractive upside on top of an already compelling demand case.

Further, conventional potash mining and processing has the lowest upstream environmental footprint among the major fertiliser nutrients, and beyond the mine gate potash does not generate some of the negative environment impacts associated with nitrogen and phosphorus. The major issues here are leaching into and polluting waterways and the release of GHGs in the application process. Excess nitrogen and phosphorus flows to the biosphere and oceans have been identified as critical "planetary boundary" parameters.⁴⁶

With respect to the outlook for the demand-supply balance, we anticipate that trend demand growth will progressively absorb the latent excess capacity currently present in the industry. That, in turn, is expected to create an opportunity for new supply by the late 2020s or early 2030s. When that process has played out, with the market very likely to continue expanding in the following decades, a durable inducement pricing regime centred on solution mining in the Canadian basin is the most likely operating environment for the industry in the 2030s and beyond. Accordingly, Canadian greenfield solution mines, which tend to have higher opex, require more sustaining capex and consume more energy and water than conventional mines, are expected to set the industry's long run trend price. From an operating cost perspective, higher carbon pricing would amplify the advantages of conventional mining vis-à-vis the solution mining method. We estimate that a price in the mid-$300/t range would be required to incentivise a material portion of Canada's solution mining "supply bench" into production.

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Maritime freight

The maritime industry as a whole has confronted monumental logistical challenges throughout the pandemic. Demand for tonnage has been elevated and the effective supply of tonnage has been constrained, leading to high levels of volatility in both chartering costs and operational reliability. The container industry has emerged as one of the key bottlenecks driving the global inflation shock.

In the dry bulk segment, immediately prior to the pandemic, the industry was actively transitioning from an era of austerity towards a heightened focus on sustainability. While to some extent COVID-19 has interrupted the idea of a clean break from the recent past, the trend towards sustainability is inexorable: and BHP is taking a leadership role.

There have been a number of key signposts marking the rise of the sustainability era. These include the upcoming IMO mandated technical and operational efficiency measures coming into force in 2023, numerous charterer and ship-owner goals (including BHP's⁴⁷) to achieve net zero emissions by 2050 (or earlier), as well as the advent of a number of research and innovation collaborations and consortia to trial future fuels and accelerate the commercialisation of innovations.

We are proud to have awarded the world's first LNG-fueled bulk carrier tender, with the Mount Tourmaline officially welcomed at Jurong Port in Singapore in early February 2022. We anticipate that our LNG breakthrough will catalyse investments along the value chain in advance of the major fleet replacement that is due in the mid-2020s. LNG of course, is a transitional technological option for shipping, and the green end-state will be different. As we seek to anticipate that end-state, in calendar 2021 we concluded (along with partners⁴⁸) a successful trial voyage of a sustainable biofuel vessel bunkered in Singapore. We have been in active discussions since with biofuel providers and other members of the value chain to gain a clearer commercial picture and pathway on sourcing and using biofuels in South-east Asia. We are also partnering with Class Society DNV to improve the measurement of our Scope 3 footprint, and we are a founding member of the Global Centre for Maritime Decarbonisation in Singapore.

Our decarbonisation initiatives, such as these, have undeniable "public good" characteristics for the maritime industry as a whole. Each pioneering step or successful demonstration represent critical milestones on the global maritime industry's decarbonisation long-term path, which the IMO has defined (for now) as a 40% reduction in carbon intensity by 2030 and a 50% reduction in total emissions by 2050 (versus a 2008 baseline).

On the topic of safety and welfare, as the pandemic rolls on, we remain highly supportive of measures to ensure the physical safety and mental well-being of the seafarers that pursue their livelihood on our chartered vessels. As one of the world's largest bulk charterers, we embrace our responsibility to engage collaboratively with maritime operators and the wider industry to support these crews. BHP has worked with vessel owners, customers, port authorities and relevant national and global agencies, to support critical crew changes despite the logistical challenges of the times we live in.

Turning to the recent history of the bulk freight market, the key C5 WA-China route averaged $14.20/t in the first half of financial year 2022, a 43% increase over the second half of financial 2021. That is also 94% higher than the average achieved across the three calendar years prior to COVID-19. In the full calendar year 2021, both C5 and C3 (Brazil-China) increased by around 80% over calendar 2020. C5 averaged $12.07/t and C3 (Brazil-China) $26.74/t in calendar year 2021, with highs for the period being $23.60/t and $50/t respectively.

This substantial move higher in rates reflects the impact of respectable growth in the bulk trade, but it is arguably developments on the supply side that have had more influence. Available Capesize tonnage has been tight, with modest growth in the fleet "nameplate" discounted by a drop in "effective" capacity due to lengthy vessel queues in some locations (COVID-19 issues and controls in many jurisdictions, but also Chinese import policies in the coal trade). As an aside, we note that the drop in effective capacity has been most pronounced in the container segment of maritime, but the Capesize fleet has also been heavily constrained at times. Capesize orders are currently equivalent to just 7% of the existing fleet, while the same metric for containers is 23%.

According to Maritime Strategies International, Capesize fleet growth is estimated to have been around 13 million dwt (mdwt) in calendar 2021, with around +18 mdwt in deliveries offset by approximately -5 mdwt in deletions. Deletions basically ground to a halt under the favourable conditions for ship-owners that emerged in the second half of calendar 2021. Ship-owners are incentivised to keep their older vessels on the water a little longer while profitable rates are on offer.

The demand for bulk tonne-miles will remain uncertain while Brazilian exports of iron ore are constrained, and while natural trade flows in energy and metallurgical coal are distorted by Chinese import policy uncertainty.⁴⁹ On the supply side of the sector, which offers firm leading indicators on a two-year horizon, we anticipate fleet growth will slow sharply across calendar 2022 and 2023. A relatively stable demolitions run-rate and a material slowdown in deliveries are expected. Deliveries are, at this stage, expected to be low in calendar 2022. Given that starting point, and making some allowance for congestion to be reduced progressively through the year, projected deletions will have to be delayed further to prevent a further rise in utilisation rates towards the sort of thresholds where rates can again "fly-up", as they did in the September quarter of 2021. Even if deletions stayed at the current low level, an upside surprise on Brazilian iron ore exports could tip the tonne-mile balance.

In the container market, the logic is similar but amplified, with a thin delivery schedule projected for calendar 2022 and a higher initial rate of congestion to unwind (about 3-5 percentage points above average in containers versus 1-2 percentage points in Capesize). Some relief on the nameplate tonnage side is expected in calendar 2023, with an increase in deliveries anticipated. Developments in congestion will depend in part upon the way the major trade hubs evolve their attitudes towards the pandemic. Given the container trade represents one of the key supply bottlenecks in the current global inflation picture, this is a significant series of statements.

As we move into the middle and then latter half of the current decade, an intense period of dry bulk fleet replacement is scheduled to occur. This is the 'demographic shadow' of the shipbuilding boom that coincided with the China-fuelled commodity super cycle. This replacement wave offers a unique opportunity to dramatically alter the technological and environmental profile of the dry bulk fleet within a little over half a decade. If the participants in the industry get this right, the steep task of the IMO's goal of halving shipping emissions by 2050 (let alone going further) may not seem as far off as it does today.

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Inputs and inflation trends

Just a year and a half removed from the COVID-19 induced trough in uncontrollable cost pressures, operating cost inflation has emerged as a major element of the resource industry narrative, echoing the macroeconomic concerns emanating from the global inflation shock (see discussion above). We have been arguing that an industry cost upswing was in the works, going back at least a year, with an emphasis on raw-material linked uncontrollables. The direction of change we are observing is therefore no surprise, but the scale and breadth of the uplift, which now unambiguously encompasses labour, has exceeded expectations.

This is what we wrote at the time of our full year results for financial year 2021: "Looking ahead, the period-on-period change in costs may be quite variable for some time. The ultimate duration of this volatility will likely reflect macroeconomic forces (as discussed elsewhere in this report), uncertainty as to the flexibility of cross-border labour supply (international and domestic, where such controls exist) and idiosyncratic issues specific to individual industries in our value chain."

Like the broader economy, the mining industry is experiencing a combination of "good" [demand-led] and "bad" [supply bottleneck] inflation.

When a bout of "good" inflation breaks out with raw material linked prices such as diesel and steel rising due to robust global demand conditions, diversified resources companies have natural, albeit imperfect hedges on their revenue line for some, but not all of the change in costs faced. Commodities are, after all, essential upstream inputs to many of the world's most important value chains. That is a major reason why resource company equities, and commodities themselves, are widely regarded as effective financial hedges against inflationary episodes in the global economy.

"Bad" inflation due to supply bottlenecks, on the other hand, tends to offer no such protection: hence the name.

Our updated perspective on the duration of the "bad" inflation shock is that it seems clear that inflation due to global supply bottlenecks will remain challenging in calendar 2022, and we expect only tentative signs of easing pressure by the end of the period, with some carry over into 2023 in certain instances. Movements in prompt pricing are reflected in our realised costs with a lag: therefore developments this calendar year will still be impacting our cost line in calendar 2023.

The major localised supply bottleneck we face - constraints on the free movement of parts of our workforce due to COVID-19 controls - increases both labour costs and operational risk, which can potentially manifest in abrupt changes in unit costs with both the numerator and denominator of this ratio potentially moving adversely. This awkward combination has cropped up in the operational reports of some of our industry peers in the December quarter of 2021. In terms of the outlook for this factor, it is difficult to be adamant about anything on the topic of border controls under the pandemic, least of all specific timing.

It is instructive to compare what is currently going on with costs to the super-cycle experience. The inflationary forces hitting the resource industry cost base (opex + capex) during the super-cycle were partly "self-inflicted" in the scramble for tonnes and barrels, leading to extraordinary blowouts on project budgets due to competition for the same pools of talent and for critical inputs, like earth moving tyres. Exchange rates were also a major driver, with the Australian dollar rising above parity to US dollar. The broader economy was strong as well, leading to intense competition for labour across industries. There was also a "good" inflation element to the picture, with key raw-material linked uncontrollables like steel, diesel and power elevated, helping to drive opex higher even as margins widened.

The contemporary cost upswing is very different in the Australian context. It has some elements of "good" inflation on the uncontrollable side lifting opex, but global supply constraints and artificial labour shortages have been more influential to date, and it is "capex lite", especially in petroleum. Capex delivery though is challenged by all of the above, which can be seen in the performance of those projects that found themselves trying to either complete work or to ramp up tonnes under the conditions the pandemic has created.

Resources project activity (minerals and petroleum combined) in Australia is currently only one-third of the super-cycle level. It is likely to top out at less than half of the 2013/14 peak.

For iron ore, activity has arguably already peaked for this cycle in financial year 2021, when three major WA projects, including our now-operational South Flank mine, were underway at the same time. Importantly, petroleum capex is in a deep thaw right now, whereas in the super cycle, we had LNG mega projects on the east, west and northern coasts, alongside the major mine and infrastructure expansions in minerals. And the Australian dollar is around 40% lower than it was during the super-cycle, despite broadly equivalent commodity pricing.

Moving to the global canvas, if we narrow the discussion to the capex outlays of the top 80 listed miners, as tracked by Standard & Poor's, investment in calendar 2022 is expected to reach 69% of the super cycle peak of $130 billion (calendar 2012). However, projected capex for 2024 (analyst consensus) is lower than 2022, at 54% of peak.

Diversified miners are investing a little more than others, proportionally, but there is no sign of an investment breakout on any score. The capital discipline the industry has demonstrated in the last half decade or so remains steadfast on this evidence. Even specialist copper miners, facing fly-up pricing, a very attractive longer term outlook and a supportive shareholder community, are projected to reduce outlays to just half of super cycle levels in 2024, 16% lower than in 2022.

So, to date this feels like an opex upcycle led by uncontrollables, amplified by special factors like state border controls, a sudden stop in skilled migration, and global supply bottlenecks in key value chains.

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Operational jurisdictions and labour markets

The Australian dollar depreciated in the first half of financial year 2022, with a -5.1% move from the previous half year, on average, to around US 73¢. Point-to-point over the half (end of December-2021 versus end of June-2021), the Australian dollar depreciated mildly by around US 2¢ to US 72.5¢. The Chilean peso weakened by -10.8% to around 800 pesos per dollar on average, but it declined by a larger -15.6% point-to-point to 850.

For Chile specifically, we note that there is a wide gap between where the currency is actually trading and its fundamental fair value based on historical empirical relationships, most notably very favourable copper prices. This gap opened up prominently with the rise in political and policy uncertainty associated with the opening of the Constitutional Assembly and the congressional debate on proposed changes to mineral royalties. While the CLP is back to trading somewhat in line with changes in fundamentals in terms of direction, a significant wedge to fair value remains.

The Australian economy fell into a deep but relatively short-lived recession under COVID-19. The subsequent rebound in economic activity and employment was one of the strongest in the world. As of December-2021, the unemployment rate had declined to 4.2%, the lowest since August 2008. That is no ordinary comparison: August 2008 was the crest of the pre-GFC credit and commodity boom that had pushed the RBA's cash rate up to 7.25% with CPI inflation running at 5% YoY.

The low unemployment figure is partly due to remarkable rates of job creation during the recovery and partly due to the crimping of national labour supply under restricted international migration conditions, and a reduction in the effective supply of local workers due to state border controls. Net overseas migration was a staggering net outflow of -88,800 in financial year 2021, the largest since World War One. The preliminary estimate for skilled visas (permanent and temporary) was a net outflow of 4.7k in calendar 2021, compared with a net gain of 25k in calendar 2019.

Mining has been one of the sectors contributing strongly in terms of job creation, reaching an all-time high of 280 thousand jobs in the June quarter of 2021. The coal mining PPI, the only resource sub-sector which has a dedicated input price index from the ABS, picked up to 7.9% YoY in the December quarter, versus the national average of 3.7%. Competing sectors such as construction have not yet attained pre-pandemic levels of employment, being some -50k or so below the all-time highs of around 1.2 million workers. However, with the boom in residential building and the considerable pipeline of potential civil infrastructure work, construction employment is expected to continue improving through calendar 2022, public health restrictions permitting.

The immediate impact of restricted labour movement inside the country under the COVID-19 lockdowns has been to create artificial scarcity of workers in some localities, with areas of South Australia and Western Australia prominent on that list.

This is producing upward pressure on all-in labour costs, especially for skilled and trade workers and "prompt" labour hire, which can de-link from traditional wage indexes at the margin. In addition, maintaining business continuity in the face of Omicron requires considerable vigilance. While we continue to manage these challenges effectively, operational risk will be heightened while these conditions pertain.⁵⁰

Mining wages have been growing at a rate close to the national average, despite the relative out-performance of the sector since the beginning of the 2020 calendar year. Six months ago, we discussed a series of signposts that indicated that national wage growth was likely to re-set at pre-pandemic levels relatively soon, including: developments in minimum wages; an uptrend in newly approved federal enterprise agreements; and a steep decline in the share of firms reporting wage freezes under the RBA's business liaison program. Since that time, state border controls have created artificial scarcity in some sectors and locations, a rapid rebound in employment growth has ensued in the wake of the Delta lockdowns and the cost of living element of wage formation has picked up.

The national average wage price index (WPI) for the December quarter will not be released until after our financial results, but it was still tracking at a moderate +2.2% YoY in the September quarter. Higher frequency indicators such as the weekly payrolls report show that the national wage bill took a step higher late in calendar year 2021.

The Chilean economy has faced difficult circumstances since October 2019. First civil unrest, and then a series of COVID-19 waves, have restrained the economy in a number of ways. The good news is that some of the pent-up demand that was built up over this difficult period has begun to escape, assisted by the release of pension savings and government support programs, pushing economic activity upwards and unemployment down. Inflation though is a looming issue, with the Banco Central de Chile responding by initiating an interest rate hiking cycle.

In December-2021 the unemployment rate had fallen to 7¼%, only modestly above the level of two years ago, and roughly 2 percentage points lower than at the time of our full year results for financial 2021. A little over three-quarters of the job losses attributed to the pandemic have now been recouped. Low levels of labour force participation though remain a constraint on the economy's productive potential. The employment to population ratio and the labour force participation rate are both 4-5 percentage points below the levels of June 2019 (before the pre-pandemic recession began).

Six months ago we noted that while Chilean consumer price inflation was presently unthreatening at 3.6% in the June quarter 2021, upstream inflation was very high: in excess of 30% YoY. Risks of downstream pass-through were obviously elevated. Subsequently, consumer price inflation has lifted to a more troubling 7.2% YoY in December-2021. Chile's dependence on maritime trade, and on imported petroleum products and many other key industrial raw materials, in addition to the weakness of the currency relative to fundamentals, are all elements contributing to these pressures. These unique conditions can lead to significant differences in rates of change versus other jurisdictions for the same basic input. The gap between Australian and Chilean explosives feedstock over the last six months is one example (see commentary below).

Nominal wages for the general population increased 6.8% YoY in December-2021: a decent figure in nominal terms, but one that has been leapfrogged by inflation. Mining wages increased by 7.9% YoY in December-2021. Mining wages are expected to continue to do somewhat better than non-mining, reflecting the strong relative performance of the sector at present: and potentially through the decade as Chile leverages its future facing commodity endowment. That said, a heavy round of multi-year industrial relations settlements were concluded in calendar 2021, so employment conditions are relatively set for the mining sector in the short run.

More broadly, and independent of COVID-19, Chile remains in a period of political, economic and social instability of indeterminate length.

The impacts and likely success of the reforms to political and economic institutions that will be necessary to make Chile a more egalitarian society, without impacting the foundations of the nation's international competitiveness, which have driven its regional exceptionalism status in recent decades, are still not clear. The newly elected President Gabriel Boric was backed by a Leftist coalition that supports an ambitious social agenda, but the recent appointment of former President of the Central Bank, renowned moderate economist Mario Marcel, as new Finance Minister, has given some relief to the markets.
The next few years remain highly uncertain. Arriving at a new constitution that is acceptable to a very diverse set of constituencies is still the major item on the national agenda. Add to this the transition of presidential power in calendar 2022, pending mining royalty legislation, the lingering pandemic and the challenging macroeconomic trade-offs that must be faced, and it should be no surprise that measured policy uncertainty⁵¹ spiked to unprecedented levels late in calendar 2021.

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Trends in uncontrollable costs

Industry wide inflationary pressure has been pronounced, lifting and steepening operating cost curves and challenging timely project delivery. Many commodity-linked uncontrollable costs have moved noticeably higher, in some cases to record highs.

Benchmark indices for ammonium nitrate (AN) - a proxy for explosives costs - increased around +47% over the previous half in Australia and +51% in Chile.

The ammonia supply deficit we discussed six months ago has widened further. Constrained supply, strong fertilizer demand (a much larger market for ammonia feedstock than AN based explosives) and steeply escalating natural gas feedstock costs have all contributed to upward pressure on prices. Point-to-point over the second half of the financial year, the Australian AN benchmark was up +67%. The Chilean AN benchmark increased by +105% on the same basis. As we finalised this document, Russia announced it was banning AN exports for two months: a new source of uncertainty in an already tight market.

Earth-moving tyre raw material costs (weighted) increased by 2.2% in the first half of financial 2022 versus the full 2021 financial year. Natural rubber has the highest weight in our index, and it peaked in the middle of calendar 2021 after a strong run-up, thereby offsetting sizeable increases in steel and petroleum derived inputs.

Sulphuric acid prices for Chilean end-users, sourced from Argus, have moved up sharply. CFR Chile pricing ranged from $226/t to $257/t over the first half of the 2022 financial year. Point-to-point Japan-Korea FOB prices increased +48% to around $135/t, with sharply higher ocean freight rates explaining the remainder of the price uplift for Chilean end-users. The global sulphuric acid market has been characterised by tight supply availability, a broad-based demand uplift from fertilizers, metals and industrial markets, higher sulphur feedstock costs and limited availability of vessels. The strength in demand coupled with productions curtailments in Europe due to that region's power crisis have sustained acid prices around these extreme highs.

Power prices were volatile globally in the first half of the financial year 2022. However, both of our main operating jurisdictions saw less dramatic price changes than, say, Europe, where electricity price hikes have been extreme.

Chilean spot power prices in the Northern grid (SING) increased +7% in the first half of financial 2022 versus the prior half year, averaging US$75/MWh. Severe drought conditions have adversely impacted hydro output, thus increasing the grid's sensitivity to fuel costs, coal plant availability and also to global gas price dynamics, where LNG has surged to record highs. In an attempt to mitigate hydrological inflow uncertainty (and optimize generation cost), Chile has delayed the mothballing/retirement of two plant units (combined 556 MW), and mobilised the previously mothballed 114 MW Ventanas U1 earlier this financial year.

Australian NEM spot power prices opened the first half of financial 2022 in mean reversion mode following the price spike brought about by the explosion at the Callide C plant in Queensland in late May-2021. Swift restoration of three of the four units at the plant saw prices normalise quite quickly, allowing average prices to decline half-on-half and stay relatively flat versus financial 2021 as a whole. The ability of the Eastern Australian gas price to stay relatively independent of the global surge in LNG spot prices also helped contain power prices in Australia relative to countries with exposure to imports delivered on prompt pricing. In the current half, prices spiked in Queensland in early February, with a searing heatwave coinciding with lower availability of coal generation units.

The renewable capacity pipeline for the NEM stands at 6.8 GW (committed and probable), with that influx expected to arrive within three years. We have also seen a rising focus on storage capacity additions. The higher frequency of NEM settlement (now 5 minutes since October-2021 down from 30 minutes previously), is expected to improve price signals and may help speed the deployment of fast response technology (including battery storage).

The rate of increase in the US producer price index (PPI) for mining machinery and equipment manufacturing escalated rapidly in the first half of financial year 2022 (+6.9% on a 12-month smoothed basis, 15.1% YoY for the month of December). Two of the four largest monthly increases in the history of the index, which dates back to 1970, occurred in the half (July and November 2021). Given the scale of economy wide inflation in the 1970s, and the scale of the super-cycle capex boom that was specific to the mining sector in the early 2010s, that is a most remarkable fact. So remarkable that it has us questioning the time series dynamics and overall veracity of this indicator as a suitable metric for inclusion in rise and fall contract clauses.

The heavy machinery sector is now clearly back in recovery mode after the sharp contraction seen in the first year of the pandemic. According to Parker Bay, deliveries of surface trucks were down by -37% YoY in calendar 2020. Data for calendar 2021 point to a sharp bounce back in excess of +70% for the full calendar year. Excavator deliveries are estimated to have risen by a lesser +26%, to be 10 units short of reclaiming calendar 2019 levels. Individual OEM reporting supports the high level messages in the Parker Bay data. The major swing factor in surface equipment orders has been the resuscitation of the global coal industry (where volumes are dominated by energy coal), which was distressed in calendar 2020, but was experiencing boom time pricing by the June quarter of calendar 2021. Coal accounts for around two-fifths of global material moved, so swings in the profitability of this sector in its entirety (i.e. not just the seaborne trade) are vital for comprehending the heavy equipment cycle.

Scaling the circumstances of today to super-cycle levels, which was the last time so many mineral commodity prices were experiencing fly-up pricing simultaneously, the upswing in equipment investment looks timid. Our estimate of total truck deliveries (above 200 tonne) in calendar 2021 is just 47% of the super-cycle peak - 745 units versus almost 1600 back in calendar 2012. Looking just at very large trucks, deliveries in the 290 tonne bracket are sitting around 45% of the peak, while deliveries in the 308-363 tonne bracket are around 40% of peak levels.

Bringing all of the above back to the industry-wide replacement cycle, we continue to believe it will be staggered, rather than compressed: and we are unconvinced that it will be substantially concluded in the first half of this decade. The exact timing on a company basis will continue to depend in large part upon the pace at which each producer converges upon the technical and cultural productivity frontiers.

There is a final point to note in this context and it is a profound one.

Just as the next major fleet turnover will be critical for the global maritime industry to meet its decarbonisation objectives, the desire to displace diesel, and the associated emissions from mining operations also puts an incredible onus on decisions made on the replacement of the trucking fleet for the remainder of this decade.

In this regard, we are an enthusiastic founding member of both the "Charge On" Innovation Challenge (whose members run around 12% of the global mining truck fleet, carrying roughly 16% of the total payload, according to our estimates based on Parker Bay data) and Komatsu's GHG Alliance, while simultaneously advancing our bilateral collaboration with Caterpillar on zero-emissions mining equipment.

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Electric vehicles (EVs)

EVs had their best year on record in calendar 2021, despite the headwinds confronting the conventional light duty vehicle (LDVs) industry. EV sales reached 6.7 million in calendar 2021, more than double the 3.1 million of 2020, and almost triple the 2019 figure of 2.4 million. Europe passed the 2 million sales mark for the first time (70% YoY) and China comfortably passed 3 million (159% YoY), with both achieving total LDV sales of 15-16%. Globally, the EV sales share reached 8.8%, exactly double calendar 2020, with the US' share lifting from 2.0% to 4.3%.

This is what it feels like to be on the steep initial slope of a technology S-curve destined for saturation.

Previously, we have discussed the Chinese approach to running down EV subsidies, and the decision that was made to extend support for longer with the industry facing difficult operating conditions after the most recent subsidy reduction. An unintended consequence of the subsidy cuts has been to incentivise producers to look for ways to lower production costs to be more competitive with ICE vehicles now, but are not actively progressing long term competitiveness in the international arena. This has led to a much larger than expected increase in the number of models using low cost LFP (Lithium-iron-phosphate) batteries, with the share increasing from 5% in calendar 2019 to 15% in calendar 2020, with much higher 45% rates in 2021 to date. As an aside, we note that escalating lithium carbonate prices are narrowing the raw material cost gap between LFP and higher nickel chemistries.

Within our battery chemistry framework, LFP chemistries are not competitive with nickel based chemistries in the area of vehicle performance, but they have advantages in terms of lower cost, decent cycle life and thermal stability. This is a competitive mix of characteristics for intra-city buses and light passenger compacts, and some trucking, where we have always had LFP playing an important role: less so for most other passenger car segments. We will continue to monitor this trend. Our customer intelligence and other soundings taken from the battery eco-system imply strongly that this is a China-specific matter in a specific customer segment: not a "back to the future" moment for the EV revolution globally.

Our research collaboration with ADC, a subsidiary of China Automotive Technology and Research Centre (CATARC) is expected to provide us with the best technical insights on this topic over time, and many others related to the electrification of transport mega trend in China. CATARC is a central Chinese SOE engaged by the Ministry of Industry and Information Technology (MIIT) to conduct research on the roadmap for the evolution of automotive industry towards carbon neutrality, aiming to map out a comprehensive low-carbon transition trajectory for the auto sector, covering policies, standards, markets, technologies, and industry dynamics.

As discussed in the nickel section, battery chemistry choices by OEMs led to European EVs consuming a higher volume of nickel than Chinese EVs in calendar 2021, despite China selling 1.1 million more units.

Policy and corporate signposts for rapid EV adoption were distinctly favourable over the course of the last 12 months, although the spectacular sales figures are eloquent enough on their own. An especially notable development is that the traditional OEMs in the US have answered the President's call (delivered via Executive Order) to raise EVs to half of all LDV sales by 2030. GM is targeting 100% EV sales by 2035, with Ford and Stellantis (the poly-marque that now houses Fiat-Chrysler-Peugeot-Dodge-Jeep-Dongfeng, among others) targeting 50% by 2030. Ford's F-150 "Lightning", the electric version of the archetypal American pickup that will be powered by a 94% nickel chemistry, has reportedly received 200k reservations, more than double its current capacity for delivery.⁵² Volkswagen owned supercar maker Lamborghini has also announced that it will transition to all-electric cars by 2024.

Staying with the OEMs, we also note that some major heavy duty vehicle (HDV) producers have begun to signal aggressive zero-emission vehicle sales targets, with Daimler, Volvo, Scania, Hino, FAW and Hyundai all doing so, along with major fleet operators DHL, FedEx and Walmart. Also in the HDV space, there were two interesting pro-battery, anti-hydrogen in transport signposts. Swedish HDV giant Scania abandoned its fuel cell program to concentrate on battery electric powertrains exclusively.⁵³ The French city of Montpellier cancelled its plans for 51-strong hydrogen bus fleet, citing operating costs that were projected to be 6 times higher than going electric, in addition to significantly more expensive fleet. The extravagant opex bill would have included a standalone electrolyser, solar infrastructure, hydrogen storage plus refuelling stations.⁵⁴

At the national level, India's 2070 net zero emission national target is another important milestone as a key marker of decarbonisation ambition in the developing world, which also likely pulls forward EV adoption in this current and future mega market. Sri Lanka and Indonesia's ICE bans (2040 and 2050 respectively) do likewise.

The signposts have a cumulative force, backing a move to even more aggressive penetration forecasts than those we released in the wake of Biden's election win. In our central case, EVs are now expected to constitute around 45% of the global light duty vehicle fleet by 2035 and around 80% of annual sales. The 45% fleet share we project in 2035 translates to around 860 million EVs on the road worldwide.

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Important Notice:

This article contains forward-looking statements, including regarding trends in commodity prices and currency exchange rates; supply and demand for commodities; plans, strategies and objectives of management; assumed long-term scenarios; potential global responses to climate change; and the potential effect of possible future events on the value of the BHP portfolio. Forward-looking statements may be identified by the use of terminology, including, but not limited to , "intend", "aim", "project", "see", "anticipate", "estimate", "plan", "objective", "believe", "expect", "commit", "may", "should", "need", "must", "will', "would", "continue", "forecast", "guidance", "trend" or similar words, and are based on the information available as at the date of this article and/or the date of BHP's scenario analysis processes. There are inherent limitations with scenario analysis and it is difficult to predict which, if any, of the scenarios might eventuate. Scenarios do not constitute definitive outcomes for us. Scenario analysis relies on assumptions that may or may not be, or prove to be, correct and may or may not eventuate, and scenarios may be impacted by additional factors to the assumptions disclosed. Additionally, forward-looking statements are not guarantees or predictions of future performance, and involve known and unknown risks, uncertainties and other factors, many of which are beyond our control, and which may cause actual results to differ materially from those expressed in the statements contained in this article. BHP cautions against reliance on any forward-looking statements, including in light of the current economic climate and the significant volatility, uncertainty and disruption arising in connection with COVID-19. Except as required by applicable regulations or by law, BHP does not undertake to publicly update or review any forward-looking statements, whether as a result of new information or future events. Past performance cannot be relied on as a guide to future performance.

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Footnotes

¹ Data and events referenced in this report are current as of February 9, 2022. All references to financial years are June-end, as per BHP reporting standards. For example "financial year 2021" is the period ending June 2021. All references to dollars or "$" are US dollars unless otherwise stated. The data is compiled from a wide range of publicly available and subscription sources, including national statistical agencies, Bloomberg, Wood Mackenzie, CRU, IEA, ILO, IMF, Argus, CREIS, Fertecon, FastMarkets, SMM, Parker Bay, MySteel, Platts, LME, COMEX, SHFE, ICE, DCE, SGX, and I.H.S Markit, among others.

² Our preliminary analysis of the impacts of an escalation of this situation to the point where Russian exports were reduced markedly, indicates that the largest impacts would likely be in petroleum, potash and nickel, with medium-level disruptions in steel, iron ore pellets, copper and non-premium metallurgical coal.

³ Data comparisons are between 2019 and 2030 and reflect our latest central case forecasts, which incorporate aspects of the physical impacts of climate change and responses to them for these global indicators, the projected green investment boom and the likely impact of expected climate policies. GDP is in nominal US dollars, on a base of $87 trillion in 2019, with changes being the absolute difference between the 2019 actual and the 2030 projection. Capital spending is estimated based on the share of gross capital formation (GCF) applied to this measure of GDP. In PPP terms, the 2019 GDP base is around $135 trillion.

⁴ "Paris-aligned" means a societal pathway aligned to the Paris Agreement goals. The central objective of the Paris Agreement is its long-term temperature goal to hold global average temperature increase to well below 2°C above pre-industrial levels and pursue efforts to limit the temperature increase to no more than 1.5°C by 2100.

⁵ We note, of course, that there are an almost infinite array of technical, behavioural and policy assumptions that can achieve this end in combination, and our 1.5 degree scenario is just one of the many. Each unique pathway produces a unique call on commodity demand and presents a unique incentive matrix vis-a-vis supply. This highlights the need to avoid treating any single pathway as the sole source of "truth". That is too heavy a burden for any one scenario to carry. As the common knowledge base of publically available Paris-aligned scenarios continues to grow, we will continue to learn from this invaluable collective resource to improve the work that helps to inform our strategic deliberations. The statement in the text is explicitly based on the commodity demand and price impacts of our 1.5 degree scenario, a technical pathway modelled in consultation with Vivid Economics. Demand figures derived from the pathway are shown in our Climate Change Report, available at bhp.com/climate.

⁶ Available from https://www.iea.org/topics/net-zero-emissions

⁷ The average price will fluctuate as market-based mechanisms such as EUAs move day to day. This estimate dates to January 26, 2022. A combination of WRI and World Bank data was utilised to make the estimates in these paragraphs.

⁸ Proprietary research surveying individuals in multiple jurisdictions. The definition of Millennials is those born between 1981 and 1996 (aged 24 to 39 in 2020) and Gen Z are born after 1996.

⁹ The Edelman Trust Barometer for 2021 documents a material decline in the degree of societal levels of trust across a range of themes and in various institutions in 27 countries.

¹⁰https://www.imf.org/en/Publications/WEO/Issues/2022/01/25/world-economic-outlook-update-january-2022

¹¹ See the two forecast vintages at https://www.rba.gov.au/publications/smp/2021/nov/forecasts.html
And https://www.rba.gov.au/publications/smp/2022/feb/forecasts.html . An analysis of RBA forecasts in 2021 can be found here

¹² The 6-9 month lead-lag cited above is with respect to macro policy settings (an exogenous variable) and housing starts: not the more often cited lead-lag between sales and starts (an endogenous relationship).

¹³ Natural increase in 2021 was just 0.03%, with the birth rate dropping from above 1% to around 0.75% (a blip such as this is common in pandemics, but is usually made up later) while the death rate increased slightly. Natural increase was 0.15% and 0.33% in the two prior years.

¹⁴ Dual circulation refers to an inner domestic core "circuit" and an outer circuit comprising various selective avenues of international cooperation. The domestic core is where the future lies. Common Prosperity is a more complex concept to grasp, both in the abstract and in practice, but at its base is a desire to reduce inequality of opportunity and improve the income distribution mechanism.

¹⁵ China is a major sponsor of the RCEP (Regional Comprehensive Economic Partnership) and has formally expressed interest in joining the CPTPP (Comprehensive and Progressive Trans-Pacific Partnership).

¹⁶ See https://www.atlantafed.org/chcs/wage-growth-tracker

¹⁷ The 13 sectors are automobiles, aviation, medical devices, renewable energy, chemicals, electronic systems, food processing, metals and mining, pharmaceuticals, telecom, textiles and apparel and white goods.

¹⁸ The "Farm Bills" sought to deregulate agricultural commerce, which is still governed by a range of antiquated restrictions that constrained farmers' options for selling their produce. In the end, the potential upside from accessing larger and more diverse markets and changes to hoarding laws were not enough to offset the fear that mandated floor prices would disappear and large purchasers would take advantage of their perceived market power.

¹⁹ DCE traders took collectively large long met coal/short iron ore positions during the phase of iron ore weakness that emerged in the face of escalating production cuts.

²⁰ We continue to see Chinese urbanisation as an opportunity rich trend for our Company. The next revision of the UN's 2100 population projections, due in March 2022, will incorporate the estimated long term impact of China's new three child policy. We will build these new projections into our own forecasts when they become available.

²¹ The raw material industry 5YP broadly confirmed most of our positions on the sectors involved, as did the steel industry guideline released on February 8, 2022. The guideline is a joint document produced by three Ministries/Commissions: MIIT, NDRC and MEE.

²² As an aside, we note that when Russia has applied export taxes to copper cathode in the past, the response has been to switch to the export of wire rod instead. Preliminary evidence suggests something similar has occurred in the second half of calendar 2021.

²³ See the EU's updated waste management directive, issued in late 2021. https://ec.europa.eu/environment/topics/waste-and-recycling_en

²⁴ We estimate that the current steel stock per capita in India and other emerging Asia is about 2 tonnes - roughly one quarter of Chinese levels today. China can internally "finance" a scrap to steel ratio of around one-fifth with its stock. With an actual scrap-to-steel ratio similar to China's, India is the second largest importer of scrap today, after Turkey.

²⁵ All data in this paragraph is sourced from Mysteel.

²⁶ Note that source data from Mysteel on domestic iron ore production was revised upwards prior to our financial year 2021 full year results. As a result, the levels reported here are not directly comparable to those quoted in vintages of BHP commentary prior to August 2021.

²⁷ The abbreviations used in the metallurgical coal section are as follows - PLV: Premium Low-Volatile, MV64: Mid-Volatile 64, PCI: Pulverised Coal Injection, SSCC: Semi-soft Coking Coal, as published by Platts. Unless specified otherwise, figures are rounded to the nearest dollar and are quoted in free-on-board (FOB) terms. The terms "coking" and "metallurgical" coal are used interchangeably throughout the text.

²⁸ A BF-BOF operation is an integrated process with "hot metal" (molten pig iron) produced in the BF then transferred to the blast oxygen furnace (BOF) for conversion into steel.

²⁹ These approximations are based on a sample of mills, not a census. Note a BF is relined every 20 years or so.

³⁰ LME Settlement basis. Daily closes and intra-day lows and highs may differ slightly.

³¹ Spot TC rates from FastMarkets. A sharp reversal in sulphuric acid prices (in smelters' favour) was a factor keeping smelter utilisation rates high through this period, despite the unattractive TC rates.

³² Scrap availability rebounded solidly in calendar 2021 to around 31% of semis production, a fraction above the pre-pandemic share. We expect scrap use to grind upwards as a structural trend in the 2020s due to both supply and demand drivers.

³³ Electrodeposited copper foil is the key form in which copper is utilised in EV batteries. See Bhavya Laul and Jonathan Barnes "Copper demand prospects are strengthening as EV take-up gathers pace", https://www.woodmac.com/reports/metals-copper-demand-prospects-are-strengthening-as-ev-uptake-gathers-pace-how-is-the-semis-industry-responding-150000247

³⁴ Reserves from USGS, https://pubs.usgs.gov/periodicals/mcs2021/mcs2021-copper.pdf

³⁵ The 2019 operational GHG emissions intensity curves for our major commodities were depicted in our Building a better world Climate change briefing, 10 September 2020, available at https://www.bhp.com/-/media/documents/investors/annual-reports/2020/200910_climatechangebriefing_presentation.pdf?la=en

³⁶ MARS is a Gulf of Mexico (GOM) oil and gas asset owned by Shell and BP that has grades that are somewhat similar to our GOM assets. The 'commodity' contract for MARS barrels is the closest public domain analogue for our GOM pricing. Source: Bloomberg.

³⁷ Analysis presented by Morgan Stanley suggests that scheduled flights imply an uptick of 1.5Mbpd of jet fuel demand by the northern hemisphere summer. Under the pandemic, those barrels are not exactly "in the bank", but the aviation recovery is an asymmetric risk to the upside for this commodity.

³⁸ This figure is derived from IEA data for 2018, with the two-thirds share incorporating both NOCs (56%) and the INOCs (Iran and Iraq, 9.7%). https://www.iea.org/reports/the-oil-and-gas-industry-in-energy-transitions

³⁹ Our integrated view of the land transport system takes account of these factors when assessing how transport services will be provided in various regions/countries/cities. The future size of the vehicle fleet, EV penetration, ride sharing and autonomous mobility all depend to some extent on the physical realities of urban geography, in addition to technology and living standards.

⁴⁰ Pipeline gas imports are mainly from Central Asia and eastern Russia. Russian pipelines are more competitive (Shanghai city gate basis) than Turkmenistan, and have optionality to increase flow.

⁴¹ See slide 15 of the Jansen Briefing presentation, and page 13 of the Potash Briefing speech. Both are available from https://www.bhp.com/investors/presentations-events

⁴² At the time of writing, there is considerable uncertainty as to what extent volumes can be redirected and on what timeframe. The range of potential outcomes from this starting point is very wide indeed.

⁴³ Fertilizer-grade MOP is commonly sold in powder ("standard") or compacted "granular" forms, abbreviated as sMOP and gMOP respectively. gMOP typically sells at a premium of US$10-25/t. Major demand centres for sMOP include China and India, while gMOP is prevalent in the Americas. Pricing data sourced from Fertilizer Week and public filings.

⁴⁴ Having spent roughly three months frozen at the $795/t price point, Brazilian CFR finally edged lower in the first week of February-2022, -$15/t to $780/t.

⁴⁵ Trade data is from I.H.S Markit.

⁴⁶ For more on the Global Boundaries framework, see W. Steffen et al., Science 347, 1259855 (2015).

⁴⁷ Refer to page 8 of BHP's Climate Transition Action Plan 2021, available at bhp.com/climate, for a full description of BHP's Scope 3 target for the shipping of our products, including its assumptions and definitions.

⁴⁸ Oldendorff, GoodFuels and the Singapore Maritime Port Authority.

⁴⁹ To simplify, if for example more South African energy coal and North American metallurgical coal is dragged out of the Atlantic trade into the Pacific, while Australia coal moves from the Pacific to the Atlantic, for the same volume of imports, the tonne-mile will be higher than under the optimised model that pertained prior to the altered import environment in China.

⁵⁰ The latest NAB survey of Australian businesses showed that labour availability was the number one constraint on output, with four in five businesses indicating that this was the major reason they were not able to operate at capacity. See commentary in https://www.afr.com/policy/economy/businesses-shackled-by-shortages-everywhere-20220203-p59thu

⁵¹ "Policy uncertainty" indexes track the language in media publications through time to quantify the fluctuations in the level of certainty/uncertainty prevailing in a country. The method was pioneered by academics at Stanford University and the University of Chicago. For the Chilean version see https://www.policyuncertainty.com/chile_monthly.html

⁵² https://seekingalpha.com/news/3778859-electric-trucks-ford-stops-taking-f-150-lightning-reservations-gm-shoots-for-early-2023-for-all-electric-silverado. The specific battery is NMC 955.

⁵³ https://cleantechnica.com/2021/01/30/scania-ditches-fuel-cell-trucks-to-focus-on-full-electric/

⁵⁴https://cleantechnica.com/2022/01/11/french-city-cancels-hydrogen-bus-contract-opts-for-electric-buses/