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 half year results for the 2022 financial year, writing days before Russian troops had entered Ukraine, we stated that "the shared, albeit staggered recovery pattern of the prior half has given way to highly idiosyncratic trends within the energy and non-ferrous commodity clusters, as well as within the steel making raw materials complex. Nevertheless, and extreme volatility notwithstanding, most of our major commodities are trading at prices that are close to, or above, our estimates of long-term equilibrium". As we release full year results for the 2022 financial year today, both statements remain valid. Prices in general remain close to or above forward-looking estimates of equilibria, while differentiation across commodity clusters has increased.

Over the last five months, energy², food and fertilizer markets have been dominated by the direct and indirect impacts of the Russian invasion of Ukraine. Non-ferrous metals and the steel-making value chain have also been impacted by former Soviet Union (FSU) supply uncertainty, but China's dynamic zero-Covid policy and the financial market turbulence that has emerged under escalating inflation, multi-region central bank tightening and recessionary speculation have been more influential. In parallel with these trends, global logistics and manufacturing bottlenecks that were evident prior to the invasion have improved modestly, labour markets are arguably even tighter, the Chinese authorities are attempting to stimulate their economy in contrast to the global trend towards tightening, and pent-up services demand is still being released, funded in part by the substantial savings pools accumulated over the pandemic.

Table of contents

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

The global economic outlook is significantly more complex and multi-faceted now than a year ago, as the above series of observations makes clear. Little is certain in the face of such complexity beyond the fact that the overall rate of economic growth will decelerate - ex-China - as the impact of global monetary tightening is progressively felt over the next 6-18 months.

Beyond the obvious directional trend, the degree of the slowdown is unclear. A recession in the United States and other developed markets is within the range of shorter-term possibilities that we consider. Our base case for calendar 2023 is that for the US, avoiding a sharp rise in involuntary unemployment - the key marker of a recession - is a manageable task. Europe on the other hand faces a more troubling constellation of negative factors, including sovereign debt risks as bond yields rise, as well as an energy crisis. In the developing world ex-China, tighter financial conditions alongside rising prices for food and fuel presage challenges - especially for those regions where depreciated exchange rates, high foreign debt and balance of payments challenges have led to a loss of monetary independence³.

In China itself, the picture is mixed, with both upside and downside risks to consider. On the downside, the possibility of further lockdowns interrupting growth cannot be counted out whilst there is an immunity gap in the population and the zero-Covid stratagem remains in place. Exports are also likely to slow. On the positive side, substantial policy support for growth has been put in place, dating back to late in calendar 2021, and this is already showing through in sectors like autos and infrastructure. As ever though, the test will be how the real estate sector responds. On balance, we feel confident enough to say that at a minimum China will be a source of stability over the coming year. And perhaps something much more than that if the supply side of the property industry is effectively de-bottlenecked.

See additional commentary on global economic growth here.

For the 12 months of financial 2023, we assess that weighted directional risks to annual average prices across our diversified portfolio are balanced or tilted modestly downwards, a view that relies in part on the lower starting point created by substantial price depreciation already observed in the financial year to date. These developments have highlighted the intrinsic vulnerability of "fly-up" pricing to modest improvements in supply conditions or material changes in demand conditions - whether actual or expected.

Beyond the slowdown in ex-China demand, the observed turn in the Chinese policy cycle, ongoing two-way uncertainty as to FSU trade flows, a range of operational challenges across key mining jurisdictions and the fact that operating cost curves have moved higher and steepened amid the global inflation shock, are all relevant considerations for thinking about how near-term prices might develop. Notably, industry-wide cost inflation has raised real-time price support well above pre-pandemic levels in many of the commodities in which we operate.

The lag effect of these inflationary pressures is expected to remain a challenge in the 2023 financial year, with labour market tightness and energy markets now edging ahead of manufacturing supply chain and logistics constraints as the most pressing forward-looking concerns.

We expect the supply-demand balance to move out of deficit in both copper and nickel, with supply conditions improving (more so in nickel) in both commodities just as demand in the ex-China world is coming off the boil (more so in copper) - and the ex-China slowdown is occurring before Chinese policy easing has fully delivered its intended impact.

Iron ore moved into a considerable surplus in the first half of financial year 2022, before tightening somewhat in the second half. On balance, it seems likely to be in surplus across financial 2023. On the supply side, that view assumes a stronger aggregate operational performance by the seaborne majors than we have observed in recent history, as well as a pick-up in the availability of ferrous scrap.

Metallurgical coal prices achieved all-time records in the second half of financial year 2022 on strong ex-China demand and multi-regional, multi-causal supply disruptions. These "fly-up" prices partially unravelled early in financial 2023, as some sources of disruption faded and ex-China steel markets softened noticeably in the face of broader macroeconomic headwinds. Chinese import policies remain a key uncertainty for both metallurgical and energy coal. The latter commodity also ascended to record highs in financial 2022, with supply constraints in the major export nodes coinciding with strong demand conditions. The balance is expected to remain tight at least through the forthcoming northern hemisphere winter, with energy security issues paramount.

Potash prices escalated rapidly in the second half of financial 2022 on the credible threat of outright physical scarcity. Strong farm economics coupled with the loss of shipments from Belarus and (to a lesser extent) Russia created the veritable perfect storm. The regional price structure at the close of financial 2022 is obviously susceptible to any sign of a return to more normal levels of total FSU exports. Even so, with crop prices also elevated, potash affordability, while stretched, is nowhere near as bad as it was at the peak of the last major price upswing.

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 COVID-19, the war in Ukraine, and the global inflationary shock, we anticipate that geologically higher-cost production will be required to enter the supply stack in our preferred growth commodities as the decade proceeds.

The projected secular steepening of some industry cost curves that we monitor, which may be amplified as resource nationalism, supply chain diversification and localisation, carbon pricing and other forms of "greenflation" (which we define below) become more influential themes in both demand and supply centres, can reasonably be expected to reward disciplined and sustainable owner-operators with higher quality assets featuring embedded, capital-efficient 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 steel, non-ferrous 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 population⁴ 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 $83 trillion to $ 171 trillion and capital spending to expand by $16 trillion to $39 trillion⁵. Each of these 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.

In line with our purpose, we firmly believe that our industry needs to grow in order to support efforts to build a better, Paris-aligned world⁶.

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 whole⁷.

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 is likely to be a net beneficiary of deep decarbonisation, albeit not quite 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 scenario⁸, 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 the commodity landscape.

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 the pace at which these ambitions crystallise into tangible action⁹. Our key Asian customer centres of Japan and South Korea (2050), China (2060) and India (2070) are among the nations that now have carbon neutral commitments. Less positively, the share of global emissions that are "priced" has much lower coverage, at 23%, 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 met¹⁰.

Against this backdrop, "clean energy" investment, as defined and estimated by the IEA, is expected to reach $1.44 trillion in calendar 2022, a 10% increase from the prior year and about 40% higher than in 2015. Easier-to-abate sectors - renewable energy and electrified transport - are expected to attract $582 billion in calendar 2022, while complementary outlays on electricity networks, nuclear generation and energy storage were just short of $400 billion. A separate dataset from Bloomberg NEF shows that technologies with the potential to unlock gains in harder-to-abate corners of the energy system - Carbon Capture, Utilisation and Storage (CCUS) and hydrogen - attracted just over $4 billion collectively in calendar 2021. The aggregate and sectoral figures are both promising (in terms of growth) and underwhelming (in terms of the gap between actual spending and the levels required to jolt the world onto a Paris-aligned pathway) 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 some hope that the current wave of economic nationalism that we observe - which represents a headwind for long term global prosperity regardless of whether the origin of that sentiment is political populism or geopolitical competition - may also retreat in time¹¹.

Investment that seeks to abate greenhouse gas (GHG) emissions and/or adapt to, insure against, and mitigate the risks 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 trust¹².

Now: add each of the generally constructive foregoing themes to the fact that the resources industry has been disciplined in its allocation of capital since the middle of the 2010s. With this disciplined historical supply backdrop as a starting point, any sustained demand surprise(s) to the upside seem likely to flow almost directly to tighter market balances.

That last observation should not be taken to imply that the industry will suddenly become exempt from the cycles that have characterised its history. Cyclical swings of considerable magnitude will continue to occur, in line with core fundamentals that sponsor volatility: fluctuating demand from traditional end-use sectors, very long lead times for project delivery and the lumpy nature of supply additions when they do occur. Even so, with the secular underpinnings of those commodities that are positively leveraged to the decarbonisation mega-trend so firm, the depth and duration of future cyclical price corrections might reasonably be expected to be shorter and shallower than some of those seen in the past, while upswings may prove more enduring.

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.

Global economic growth

The world economy contracted around -3% in calendar year 2020 before bouncing back by a little less than +6% in calendar 2021. Calendar 2022 is on now on track for a modest outcome around 3½%. The global economy has been weighed down by China's June quarter lockdowns, a softer than expected first half in the US, the wide-ranging impacts of the Russian invasion of Ukraine, and aggressive central bank tightening ex-China in response to rapidly accelerating inflation. Our early take on world growth in calendar 2023 is +3¼%, with improvement in China offset by a wholesale softening elsewhere. The IMF's latest projections for 2022 and 2023 are roughly -¼% and -½% below our forecasts, partially reflecting what we see as overly pessimistic projections of just 3.3% and 4.6% for China in calendar 2022 and 2023 respectively¹³. That said, China will have to avoid material lockdowns between now and the end of calendar 2023 to achieve our forecasts. If China is not able to do so, world GDP would likely be roughly -¼% lower in calendar 2023 than in the absence of new lockdowns.

Against this backdrop exchange rate volatility has picked up alongside rising interest rates and falling equity markets, after a surprisingly calm six months for currencies in the first half of financial year 2022. Compared to the levels prevailing at the time of our half-year results, the US dollar index (DXY) was roughly +8% stronger as financial year 2022 closed. In real trade weighted terms, as of June-2022 the US dollar has increased in value by roughly +4.4% from December-2021, and had surpassed the level reached in the COVID-19 panic of April-2020. US dollar strength was expressed broadly, with pronounced gains against both non-China emerging markets and the G3. USD/JPY approached levels not seen since the Asian Financial Crisis and EUR/USD traded towards parity: a level not breached from above since the Greenspan era Tech Bubble. The US dollar appreciated by a more modest +¾% against the Chinese yuan in the second half of financial 2022, or around +5% point-to-point.

International merchandise 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 calendar 2021 up around +10%, and calendar 2022 year-to-date tracking at +4.4%% YoY. Unit prices of world exports are up around +13% year-to-date, on top of a gain of +14.4% in calendar 2021.

As global policymakers increasingly focus their attention on cost-of-living concerns and the related questions of food and energy security, it is worth highlighting that the act of deepening trade integration tends to suppress inflation while the opposite action tends to amplify it. Trade is the essential lubricant of the global economy, and any agenda seeking to reinstate a healthier balance between growth and inflation 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. Remaining open to the cross-border flow of people, goods, capital, and ideas is vital to this end: unrestricted trade based on comparative advantage, competition, productivity and innovation and an affordable cost-of-living are close companions. Much of the "bad" inflation we have referred to frequently throughout this mini cycle is the direct or indirect result of natural cross border flows of physical production inputs and people 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 for both growth and inflation.

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.

The global inflationary curve was steepening even before Russian troops entered Ukraine. We have been flagging an inflationary upswing since the second half of calendar 2020, noting an expected combination of strong demand, constrained supply elasticity in a range of goods-producing and distributing sectors, and the fact that 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 drove the underlying cost base of some of the world's most essential end-to-end value chains sharply higher - for example petroleum products, construction materials, electronics, automobiles, and food - along with the associated distribution industries (principally land, sea, and air logistics).

And then came the invasion.

As of June 2022, consumer and producer prices in the US were tracking around +9% and +11% YoY respectively, with a modest decrease to 8.5% for CPI in July. The most recent updates on producer price inflation in the EU, Japan, China, and India are distinctly elevated at +30%, +9%, +6% and +15% YoY respectively (rounded). Major commodity producing countries such as Chile, Canada, Brazil, and Russia are seeing equivalent or even higher outcomes. Australia is presently at the lower end of the field with PPI at "just" +5.6% YoY and CPI at +6.1% YoY in the June quarter.

We anticipate that elements of the "bad" inflation created by known bottlenecks prior to the invasion of Ukraine will remain challenging in financial 2023: the lag effect of which may influence our business well into the following reporting period.

However, at the margin, improvement is evident in some important areas¹⁴. Indeed, some of the key value-chains referenced above - such as electronics and construction - are now exhibiting reduced supply chain pressure. The bad news is that this is not a pure productivity effect: supplier delivery times are still poor relative to normal, and the observed rundown of backlogs and the rise in value chain inventories has partially been due to the increase in macroeconomic uncertainty.

The sectors of most concern in terms of higher future inflationary pressure are those where labour availability and energy supply are the key constraints, rather than manufactured or basic material inputs. What we described as the "energy situation" six months ago is now a crisis.

This crisis has been sparked by the direct and indirect impacts of the Russian invasion, which has revealed some of the frailties of regional power and energy networks. The potential for further price spikes in energy commodities and power prices, as well as outright shortages and rationing, remain very real. Labour is a more complex question, with a mix of idiosyncratic local and common global factors at play.

We maintain our long-held view that "good" demand-led inflation, which is presently obscured amidst the tremendous difficulties of the here and now, will re-emerge and then endure for some time. This will contribute to higher average inflation outcomes across the 2020s than what we experienced across the 2010s - even after abstracting from the peak of calendar 2022.

Higher inflation on average across the decade will assist with the passive repair of strained public sector balance sheets. The extra 1 per cent on the average global inflation rate that we envisage for the 2020s will increase the size of the nominal global economy by around $18 trillion by 2030, or 21% of 2019 GDP¹⁵.

The phenomenon of secular "greenflation" is also a genuine force 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 decarbonisation and climate change adaptation 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 permeate the dynamics of price formation in all corners of the economy.

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China

China's economy has been nothing if not turbulent in the 2020s to date. First, we saw a spectacular V-shape across calendar 2020, with strong momentum carrying over into the first half of calendar 2021, giving China "first-in, first-out" status in the global pandemic. The positive momentum was then arrested - abruptly - in the September quarter of that calendar year. The "dual control" framework for energy policy, the "zero-growth" steel mandate and the desire to constrain macro-financial risks in the property market were all fierce headwinds for the growth trajectory. The reality of the resulting 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. Calendar 2022 started with promise, partly due to the tilt towards easier policy settings - but then came the COVID-19 lockdowns in the June quarter: a period in which the economy suffered a sequential contraction. Roughly two months into the recovery period from the lockdowns, the flow of data has been somewhat mixed.

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. Obviously, the blunt force of the lockdowns in the June quarter, and the omnipresent threat of snap civic restrictions that will persist while a material immunity gap in the population remains, complicate the analysis. So too does the present state of the all-important real estate sector.

China's housing market has often been at the centre of counter-cyclical policy shifts. It is also the biggest wild card in the remainder of calendar 2022 and into calendar 2023. Our current diagnosis is that what ails Chinese housing is not a demand problem - it is a supply-side problem.

More specifically, the resolution of the current issue lies within the nexus of developer balance sheets, macro-prudential controls on the same, and risk-averse financiers, who have lost confidence over the last twelve months or so in the face of high-profile defaults.

It is instructive to compare the present situation to the extended real estate downturn of the mid-2010s. The earlier cycle was characterised by an excessive inventory of unsold properties, with substantial over-building in lower tier cities intersecting with tightening purchase controls on out-of-town investors against a backdrop of policy uncertainty under the anti-corruption drive, property tax pilots and the national housing ownership registry. Such was the depth of the issue that "housing de-stocking" that it became a macroeconomic priority in parallel with the execution of President Xi's signature Supply Side Reform (hereafter SSR) initiative.

The excess inventory problem at the national level was also the collective expression of hundreds of demand-supply mismatches across China's various city tiers. The resolution required a transfer of real assets from the balance sheet of developers to the balance sheet of households, and that in turn required an increase in purchasing power and regulatory forbearance on the out-of-town investor question. The transfer was ultimately unlocked through a considerable expansion of mortgage loans and a more lenient approach to investors.

The upswing began tentatively, with the average historical lag relationship between the leading indicators and building activity comfortably exceeded, but ultimately an enduring upswing in sales and starts was put in place. It had a lower peak but a longer tail than prior cycles. The shadow of this cycle is still visible in the pipeline of work under construction today - which is part of the problem. Developers have been incentivised to start multiple projects but not to complete them in timely fashion. This oddity stems from the fact that buyers need to compete for access to developments by paying very large down-payments - 100% up front - a practice that has evolved due to the extraordinarily high demand for property assets in China which has historically put developers in a very advantageous bargaining position. If they choose to, developers have been able to dawdle their way through projects after the initial phase without repercussion - prioritising the majority of their capital instead for the acquisition of land and the initiation of new projects.

The authorities have progressively recognized that this issue was creating unhealthy imbalances in the real estate market. For some years, the response was to tread relatively softly, reflecting the sector's central role in employment, the credit-collateral system, and the storing of wealth. National level housing policies have been directed towards limiting speculation, modest direct interventions via public housing and shanty town reconstruction and the building up of rental markets. These measures did not tackle the root causes of the starts/completion imbalance, one of which was of course the incentive matrix faced by developers. The enormous wedge between the volume of starts and completions that opened across 2016-2019 made this abundantly clear. The response was to place developers into a traditional SSR template, with specific macro-prudential guardrails now known as the "three red lines" introduced in August 2020¹⁶.

These regulations, finally, increased the incentive for leveraged developers to complete projects in timely fashion, as running down their liabilities to off-the-plan buyers counts towards the -10 percentage point reduction in the liability-to-assets ratios required of the sector. This has seen completions out-perform starts. But with most of the sector coming under financing pressure since Evergrande's problems came to light roughly a year ago, even working capital has become an issue for some developers. That has led to a very slow supply response to the easier policy measures enacted to boost the demand side of the housing market; a distinct lack of progress on many semi-finished projects; and disgruntled purchasers in multiple locations threatening mortgage servicing strikes.

This latter factor may have been the final straw that forced the authorities' hand to intervene directly on the supply-side. Not long after this story created a local media stir, it was made known that a state-backed vehicle would be created to backstop financially distressed developers and get liquidity flowing to the sector again. The Politburo meeting of late July released some high-level details, alongside a resolute statement to "stabilise the real estate market" and "ensure housing delivery".

This episode shows yet again that 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.

Turning to the specifics now, this is how the major housing data stood as of June 2022 (year-to-date, YoY unless otherwise stated). The volume of housing starts - the key indicator for contemporaneous steel use in real estate - have declined by -34.4%. Sales volumes declined -22.2% (weighed down by pre-sales at -27%: existing home sales rose +16%). The equivalent comparisons for housing completions - the key indicator for contemporaneous copper use in real estate - was -21.5%. Floor space under-construction was tracking at -2.8%; land area sold was -48.3% YoY and developer financing was -25.3%.

A final observation on housing: the scaled inventory of unsold dwellings is close to historical lows as we move into this next cycle phase. A sustained period of weak starts has diminished the pipeline of work, and the needed focus on completions has been delayed. That implies that despite the challenges on the supply side of the industry, risks for housing prices are not skewed downwards. In fact, the reverse may well be true.

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.

That case can still be made. For one thing, alone among the major economies and despite its very large exposure to imported commodities, China does not have an economy wide inflation problem. Even so, there is also a case to be made that the increasing urgency to spur activity towards the 5.5% GDP for calendar 2022¹⁷, even as the June quarter lockdowns made that very unlikely, means that a considerable amount of additional policy support is sitting in the system waiting to unfurl (to the degree that the zero-COVID mandate permits). Policymakers the world over are highly susceptible to this kind of mistake - a failure of patience. Policy packages are generally well calibrated in their first iteration. But then comes the gnawing doubt - the slow wait for confirmatory data, the worry about leads and lags, and the temptation to do a little more before you have any genuine evidence of the impact of the first wave. Just as there is a case for an underwhelming performance over the next 6-12 months should the real estate sector fail to bounce despite pervasive encouragement to do so, there is also an upside case where real estate moves into a clear recovery phase and it turns out that the non-housing sectors have been over-stimulated. Food for thought. Our P50 case sits between these two bookends.

Moving on to those non-housing end-use sectors now, and fixed investment in infrastructure has emerged as a bright spot in calendar 2022 to date, as expected, with 9.2% growth June year-to-date, YoY, and 12% YoY in the month of June itself. This pick-up has been financed by aggressive front-loading of local government bond issuance.

The overall infrastructure sector has had a mediocre run over recent years, with annual growth for every year from 2018 to 2021 falling between 0.2% and 3.4%. The subsector that has most obviously held infrastructure back prior to the current year is water conservancy and related areas, where spending had expanded at a two-year compound growth rate of just +2% at the time of our half-year results six months ago, despite periodic entreaties from Premier Li for local governments to boost outlays in this area. At roughly 40% of spending in the broad infrastructure category (yes, it is larger than either transport or power generation), this uplift is impactful for overall end-use demand trends. Elsewhere in the infrastructure space, in the month of June power outlays were tracking at a strong 24% YoY [led by renewables, as discussed in more depth in the copper chapter] while transport was at around -1.2%.

For auto production, this is what we wrote six months ago: "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." The reality is that lockdowns made things difficult for a time, but the introduction of time-limited tax incentives for buyers (June-2022 to December-2022) saw sales jump sharply in the month of June. As for New Energy Vehicles (NEVs), they continue to leapfrog the most bullish of expectations, with China experiencing triple digit percentage growth in production and sales in the first half of calendar 2022 after 168% growth in 2021.

Elsewhere in the domestic end-use story, machinery has come back to earth after a very strong run up in recent years, with transport, construction and agricultural machinery all weakening in the year-to-date. Power machinery has been resilient within the broader category slowdown. The overall segment is -5% YTD YoY as of June. Consumer durables have been a little firmer than machinery in the domestic market, but they have seen export markets tailing off.

Exports increased by around 30% in calendar 2021, and somewhat against expectations managed to expand rapidly again in the first half of calendar 2022 (+14.2% YTD YoY, +18% YoY in July itself) despite that high base and ongoing tariff protection in the US. Chinese manufacturers have been arguably the leading beneficiaries of the global boom in goods consumption observed over the last two years or so, gaining around 2 percentage points of global market share (from around 13% to around 15%)¹⁸.

The data implies strongly that claims of the demise of the Chinese manufacturing export machine have been greatly exaggerated.

There are of course some special or short-term cyclical factors behind this on-going strength that will unwind in due course: (1) The global boom in consumer durables (including IT hardware for WFH), played to China's existing strengths. Latest data shows this has topped out. (2) The invasion of Ukraine has created some extra space for Chinese exporters to fill, for instance in steel and other metals. (Steel and aluminium exports up 18% and 39% YoY respectively in July).

Balancing that, the latest data show an emerging source of secular strength beginning to come through: China is the major manufacturer of the decarbonisation hardware that the world needs to meet its climate goals. In July-2022, exports of EVs rose +151%, solar panels +15% YoY, and wind turbines 58%, YoY YTD).

Major economies are increasingly buying into the doctrine that decarbonisation and energy security go together, and that should extend to the manufacturing and critical minerals supply chains that support them. China made this strategic connection some time ago, established an industrial policy framework and has invested heavily and consistently on the manufacturing side. That consistency has enabled Chinese firms to achieve a strong incumbent position in the manufacture of backbone green technologies such as solar cell modules, EV batteries, hydrogen electrolysers and wind turbines, and the processing of critical minerals.

Staying with the longer-term, our view remains that China's economic growth rate should moderate as the working age population falls (noting new estimates from the UN released on July 11th indicate that the total population is peaking now - rather than around 2030 as in the previous vintage) 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 well 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 considerable further improvements in the domestic innovation complex as the transfer of foreign technology is not expected to be as straightforward as it was earlier in China's development drive. Notwithstanding the emphasis now being placed on the more introspective thematics of "dual circulation" and "common prosperity"¹⁹ , we anticipate that the concerted move outwards of the 2010s is likely to continue, with an emphasis on South-South cooperation, regional trade agreements²⁰, and the Belt-and-Road corridors, with China seeking both markets and resources in these ongoing endeavours. 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 a 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 economic outlook is delicately poised.

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."

Many of those tailwinds are still in evidence - as will be discussed below. But major headwinds for growth have emerged since the Russian invasion of Ukraine, with the nexus of rising inflation, rising interest rates, and falling equity markets hurting both business and consumer confidence and denting the interest rate sensitive (and previously booming) housing market. Against this backdrop, the practical application of the Fed's new average inflation targeting framework is undergoing a very stern test, with headline consumer price inflation reaching 9.1% in the month of June, having held above 7% through the first half of calendar 2022. Fed rhetoric has shifted from modest unease as calendar 2021 closed to doing "whatever it takes" in calendar 2022. That approach has lit a fire under the US dollar.

Countering the proximate reasons for pessimism listed above are the ongoing presence of tailwinds. The list of potentially positive factors for the outlook includes (1) the very large household cash saving pools accumulated during the pandemic (2) considerable wealth accumulation besides [albeit financial asset prices have now corrected abruptly and wiped out some of this gain] (3) the tight labour market that is producing strong growth in jobs and nominal labour income, especially for households where marginal propensities to consume are high²¹ (4) the solid capex outlook as companies and all levels of government continue to play catch-up on three fronts - (a) in traditional capital stock after the relative neglect of the 2010s, (b) to accelerate decarbonisation efforts, (c) to accelerate digitisation and automation efforts to confront the pressing concern of labour shortages, and (5) the further release of pent-up household demand for discretionary services.

That is quite a list. Even so, with house building no longer on it, and the major headwinds blowing at gale force, realistically they can only be a partial offset. Much now depends on when the Fed decides to pause and survey the landscape. That in turn depends upon the month-by-month inflationary trajectory and what it tells us about calendar 2023.

First things first, if the global economy does slow down considerably, substantial pressure will be removed from supply chains, and that will flow into a weaker inflationary pulse in non-energy raw materials and (some) durable goods relatively promptly. There was arguably a preview of that in the July US CPI outcome. Wages though move more slowly and are a critical factor in any medium-term forecast of aggregate inflationary pressures in services, which dominate inflation index weights. Six months ago, we argued the following: "Even with the recent acceleration, 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%. 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 of June-2022 (63.4% versus 62.2%), this story feels like it is a long way from its conclusion." In this regard, we note that wage increases for those changing jobs have accelerated to 6.4% YoY, and wage outcomes for those staying in jobs are also on the move (4.7% YoY). The preceding figures are 12 month moving averages. The 3 month moving averages are more dramatic at 7.9% (switcher) and 6.1% (stayer)²².

Will the slowing economy crack the labour market? The unemployment rate is presently 3.6% and the participation rate is unchanged from six months ago at 62.2%. Total employment has reclaimed its pre-pandemic level (just), but the economy is almost 15% (or $3.2 trillion) larger. The Richmond and Atlanta Fed's joint June quarter CFO survey indicated that "labour quality and availability" is the single most pressing concern for the C-suite, overtaking inflation, with more than 11 million job vacancies across the nation, while "quits" and "layoffs" are still running around all-time highs and all-time lows respectively. Labour availability was cited three times more frequently than the health of the economy as a pressing concern by these survey respondents. Once again, the refrain that this story feels like it is a long way from its conclusion still seems apt.

Closing out this line of argument, we note that the fact that the US economy has already contracted in real terms across the first half of calendar 2022. This has opened a Pandora's Box of technical (and mainstream and social media) debate as to whether this means that the US is already in recession. The first point in this regard is that a recession officially occurs when the National Bureau of Economic Research's (the NBER) "Business Cycle Dating Committee" says so, and the NBER takes a much broader view than the GDP figures alone. Our view is that until the unemployment rate increases in a material way, claims of a recession and the pronounced and widespread economic hardship that term entails, are misplaced. Jobs are still growing nicely, thank you very much, with non-farm payrolls expanding by +528k as recently as July-2022. You grow the economy to create income and jobs, and the US has been doing precisely that - GDP is not an end in itself.

In the wake of the Biden inauguration, eighteen 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 determination to treat China as a rival, and to pursue a nationalistic line on trade more broadly. The lack of action (to date) to rollback tariffs on Chinese goods despite an acknowledgement of their contribution to inflationary pressures has been an interesting test of resolve on this score.
• The current situation in Ukraine has galvanised NATO, the G7 and the broader democratic movement. Prior to this emergency, there have also been clear efforts by the US to re-engage constructively with both immediate allies and with the multilateral architecture.
• Climate action has entered the Administration's everyday domestic and foreign policy discourse, and the US clearly attempted to lead constructively at COP26. That said, the initial congressional failure of "Build Back Better", and the trimming back of some climate-related elements of the Bipartisan Infrastructure bill, are reminders that politics is ultimately local. And as the mid-term elections loom, the results of which may increase the complexity of delivering the announced agenda, we note that the Inflation Reduction Bill includes around $370 billion for core elements of Build Back Better. Swings and roundabouts.
• On macroeconomic policy innovation, six months ago we wrote that "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." With gasoline averaging more than $5.03 per gallon in June-2022 and $4.68 per gallon in July, alongside general inflation of around +9% YoY, countering cost-of-living pressures obviously now predominate in the political calculus. It remains to be seen if the "high pressure economy" experiment returns in the medium term, once there is some assurance that the supply side of the economy is ready to keep up.

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 S&P Global (formerly 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. This normalisation will be accelerated by softer consumer demand.

Common to the US experience, upstream inflation is painfully evident, while business surveys that had been implying generally favourable operating conditions with respect to demand (if not supply), have taken a notable tumble in recent months. 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.

Coming out of that winter, spring weather was unable to alleviate energy stress, which has been amplified by the invasion of Ukraine, actual sanctions and self-sanctioning, summer heatwaves, nuclear outages, low river levels, record LNG and energy coal prices and erratic pipeline gas supply. These adverse forces have gripped Europe's power sector and parts of its heavy industrial sector in a tightening vice. We are approaching the winter of 2022/23 with a sense of foreboding.

Against this backdrop, the ECB waited until July to move interest rates for the first time, kicking off the cycle with a 50 bp increase. The ECB must tread more warily than the US Fed on rate hikes, with the region's soft underbelly of indebted sovereigns a constraint on freedom of action. The euro has weakened considerably in the face of this differentiation. In stark contrast to the "currency wars" and failed austerity of the 2010s, a weaker euro is not a desirable outcome. Indeed, exchange rate appreciation is the desirable outcome in the scramble to alleviate cost-of-living pressures for households. The ECB faces some very difficult trade-offs in areas where it does have agency and some unpalatable uncontrollables that add considerable complexity to its policy calculus.

In developed North Asia, the manufacturing PMIs ended the 2021 calendar year around 54 in Japan and 52 in South Korea: six months later they are tracking just 1 point lower, at 53 and 51 respectively. Both nations have faced mixed conditions, with a material decline in the terms of trade co-existing with a solid export performance, led by capital goods. There are some cracks emerging in the edifice though, as export markets in the US and Europe have begun to weaken, and the Chinese recovery is not yet fully-fledged.

Japan and South Korea are at the epicentre of the global chip supply chain. They are both expected to benefit directly and indirectly from the ongoing resolution of the global semiconductor supply bottleneck, and progress towards this end has been positive. The semiconductor shipment-to-inventory ratio in developed North Asia is clearly in an expansionary phase, with sales and stocks both advancing apace. While the consumer facing auto and electronics supply chains rightly receive a lot of attention in this space, and these are obviously strategic sectors for both Japan and South Korea, 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.

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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 was a major swing factor in short term forecasts of global growth across calendar 2020 and 2021. 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 was tentatively back on a firmer footing as calendar 2022 opened. Of course, another jolt was waiting at this point as Russian troops entered Ukraine: steep inflation in India's import bill, principally via high energy, food, and fertiliser prices, with the financial pain amplified by a weakening rupee.

The key takeaway from all these rapid reversals is that India's recovery trajectory and the associated release of pent-up consumption demand has further to run, rather than being heavily concentrated in calendar 2021 as would have been the case without the June-2021 quarter wave. The question now though is how this release will interact with the challenges presented by tighter global financial conditions, balance of payments deterioration and higher prices for essentials at home. A secondary question is how the corporate sector will respond with their investment plans, noting India is a positive outlier in terms of both services and manufacturing survey data at present, while profitability and credit availability have both improved. Total domestic credit growth has moved steadily higher to around 9.5% YoY, with bank credit running a little faster than the total. Surveys describe a resilient growth picture, with the new orders and output sub-indices in India's manufacturing PMI recording robust outcomes around 60 in July.

In terms of the numbers, the economy shrank around -7% in calendar 2020 and rebounded around +8% in calendar 2021. Our calendar 2022 estimate is for 8¾% growth.

Indian inflation has lifted sharply, in line with the global trend. The wholesale price index moved into double digit territory in the June quarter of 2021 and has edged higher since. Consumer prices have been holding in the 5-6% YoY range for much of the last year, but have recently breached 7%.

Beyond the short-term uncertainties, 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 are sensible. Labour law reforms passed in 2019/20 are a significant positive for flexibility and simplicity. That should complement the focus on attracting foreign direct investors.

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 economy²³. 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, new or green 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. India's ambitious plans to build an independent renewable energy value chain at home - behind a protectionist wall - as it pursues its newly minted carbon neutrality target of 2070, are a case in point. This choice plays to India's historical nationalistic economic instincts, but it also fits the post-Ukraine zeitgeist that blends the themes of energy security and decarbonisation. Notably, Indian domestic demand alone is big enough that this introspective effort will not lack for economies of scale. Sub-optimal scale is one factor that can prevent a protected industry from ever reaching the level of standalone competitiveness that allows import substitution to metamorphose into export market gains.

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Steel and pig iron

Global steel production was a record 1.95 billion tonnes in calendar 2021, representing growth of 3.7% YoY. China's production declined abruptly in the second half, with the full year finishing at 1033 Mt, roughly -3% versus the 2020 figure of 1065 Mt. Ex-China production rose 12.3% YoY to 922 Mt, with a broad-based uplift led by India (+17.8%), North America (+16.6%) and Europe (13.6%). 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). Ex-China pig iron increased by 11.4%.

The first half of calendar 2022 has seen YoY growth rates between China and the ROW (rest of world: interchangeable with "ex-China") converge, after smoothing for the lumpy base effects that afflict YoY calculations. WorldSteel estimates that global steel production achieved a run-rate of 1915 Mtpa in the first half of calendar 2022, or -5.5% YoY. China recorded a run-rate of 1062 Mt (almost the same figure as full-year 2020), or -6.5% YoY. For pig iron, WorldSteel puts the global and Chinese outcomes at 1313 Mtpa (-5.5% YoY, the same rate as crude steel) and 885 Mtpa (-4.7% YoY, firmer than crude steel) respectively.

Six months ago, we wrote that "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." Since we penned those words, the authorities have moved the goalposts on the annual production target, shifting from "zero-growth" to a "net reduction", while remaining silent on the scale of said reduction. There have also been moving parts to reconcile across end-use sectors, feedstock availability and disrupted trade flows, among others. The net impact of these forces on the statement above is that it still feels broadly valid, but the ultimate route to those ends will be a circuitous - and volatile - one.

Broad-based strength across the majority of Chinese 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, and they have remained that way in calendar 2022 to date. Infrastructure has been the lone true bright spot, with other major non-housing sectors (transport and machinery) experiencing shallow contractions. Knowing that information and adding it to the reality of the record run-rates seen in the same half a year ago, it would be reasonable to guess that steel production would have been deeply negative YoY in the first half of calendar 2022.

As a secondary deduction, it would be just as reasonable to assume that China's blast furnace (BF) utilisation rate would have been pegged at a subdued level. In fact, the opposite has been the case. China's blast furnace (BF) utilisation rate averaged a robust 84% in the first half of calendar 2022, peaking at 90.2% early in the month of June. And the 84% was achieved despite heavy controls around the time of the Winter Olympics, when nation-wide utilisation hit just 75.4%. Modest demand and strong BF utilisation would tend to point towards rising inventory levels and weak profitability: and this has certainly been the case. However, BF production was partly occupying space vacated by electric-arc furnace (EAF) mills, whose utilisation rates declined by a spectacular -20 percentage points YoY, averaging just 45% versus 65% in the corresponding half of calendar 2021.

The weakness in EAF production was driven by two key factors (1) poor scrap feedstock availability, with collection rates collapsing during the lockdowns, and (2) weak demand for commodity construction steels amidst the downturn in housing activity. These trends combined to hit EAF profitability hard. The difficulties faced by Chinese EAFs saw a reversal of the relative growth rates of pig iron and crude steel seen in calendar 2021, when pig iron lagged crude steel by more than 1 percentage point.

Realised margins for Chinese steelmakers have been poor for most of the half year just concluded, with loss-making widespread at times.

We estimate that spot margins opened the half around +$50/t, but closed it in negative territory, around -$20/t, leading to an average for the period that was very close to break-even. While on the subject of industry financials, as an aside we note that the aggregate liability-to-asset ratio reached 61% in the March quarter of 2022, -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 account for slightly more than 10% of Chinese apparent steel demand. 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 is exported directly. The direct trade surplus in steel has fluctuated widely since the pandemic began. It fell into deficit in the middle of calendar 2020, and then rebuilt quickly back towards pre-pandemic levels in the middle of calendar 2021. 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 recorded a +41 Mtpa outcome for the whole year, with a run-rate of 31Mtpa in the second half. The surplus then jumped again in the first half of calendar 2022, aided by the disruptions in the FSU, with the month of June-2022 recording a sizeable surplus of 84 Mtpa (+68% YoY), and the whole first half coming in at 52 Mtpa.

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% 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, industry structure, economic geography, and demography, have even higher stocks than the US.

The exact trajectory of annual production run-rates that will achieve this near 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 (with 1065 Mt in 2020 being the "clubhouse leader" in golfing terms).

Strategically speaking, it is the plateau concept, not the peak concept, that matters now. Having attained and sustained 1 billion tonne plus run-rates for three years going on four, defining the literal peak year and/or level is no longer anything more than a tactical question.

There was of course a time in the early to mid-2010s when the peak steel question was at the core of the strategic debate for the entire value-chain. No longer.

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, notwithstanding the fact it 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 major 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 steel 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 expectations²⁵. In addition, a guidance document for the steel industry's "high-quality development" has been jointly issued by three official entities: the MIIT, NDRC and MEE.

The document restated 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, we expect that steel will be included in China's ETS before the conclusion of the 14th 5YP period.

Steel production outside China (hereafter ROW) recovered strongly from the mid-2020 collapse, with robust growth (albeit inflated by base effects) of 12.3 percent YoY to 922 Mt in calendar 2021. That compares to 882 Mt in calendar 2019. During the 2021 recovery phase, ROW capacity utilisation rate tracked very mildly above normal pre-pandemic ranges (72-75%) throughout the year. This positive impetus flowed through to the early months of calendar 2022, with utilisation still registering at 74.1% in February, with attractive margins across multiple regions. With hindsight, that month looks like the mini-peak for this cycle, with utilisation trending lower sequentially in the remainder of the half, with June-2022 hitting an underwhelming 68.5%. That was the first reading below 70% in 20 months. The run-rate for the full half (852 Mtpa) is -4.2% YoY.

India's crude steel sector has recovered strongly from the pandemic, and it has also exhibited resilience amidst the current slowdown. After growing by +18% to 118 Mt - a record - in calendar 2021, year-to-date output in calendar 2022 has lifted a further 8.8% to a run-rate of 127 Mtpa. Pig iron has increased by a lesser +3.5% YoY to 81 Mtpa on the same basis. Output in Japan, Europe and South Korea has decreased by -4.3% (pig iron -6.2%), -5.9% (pig iron -6.7%) and -3.9% (pig iron -7.7%) YoY respectively. The US has been somewhat more resilient, backed by generally strong profitability behind its tariff wall, with crude production falling only -2.2% YoY.

The turnaround in fortunes has been swift. In the immediate aftermath of the invasion of Ukraine, according to Platts, benchmark prices in India (ex-tax), Europe, and the US had surpassed US$1000/t, US$1,500/t, and US$1,600/t respectively. These figures have since retreated to below $800/t, $900/t and $1000/t respectively as of July-2022: all below the levels prevailing in February just prior to Russian troops crossing the border.

The abrupt ending to the strong run of profitability across calendar 2021 and the March quarter of 2022, which had provided a fillip to a number of struggling mills after some very tough few years both prior to the pandemic and then in calendar 2020, could have far-reaching consequences. Improving cash flow had enabled a tangible acceleration of deleveraging efforts and boosted shareholder returns. It may also have sparked more ambitious decarbonisation efforts, the financing of which has always been a question mark in this traditionally low margin sector. If the profitability sweet spot is over - and this is a point of uncertainty - we are back in a world of significant trade-offs.

Protectionism remains a feature of the ROW industry landscape, with both export and import disincentives in play, with the latter persisting despite elevated inflationary concerns. There is also an emerging theme at the nexus of decarbonisation and protectionism: scrap nationalism.

There is speculation that the EU may be contemplating a scrap export ban. Mandated circularity of local waste generation, including scrap metals, or establishing stringent conditionality on trade in waste, are other potential levers²⁶. 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 low stocks of steel in use²⁷), 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 zero or low emissions 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 for Eurocentric views - 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 research and development partnerships in steelmaking on Asia, where our five MOU partners to date represent around 13.4% of reported global steel production, almost 6 percentage points more than EU production combined. Unsurprisingly, their share of global pig iron production is even higher. Looking at our partners via the nations they represent rather than as standalone entities, around 70% of crude steel production is covered and around 80% of pig iron.

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 the infrastructure of decarbonisation [+]
• Lower demand from the fossil energy 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 based on projected climate change 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) traded a reasonably wide range over the second half of financial year 2022, with the spot index ranging between $110/dmt and $160/dmt, averaging around $140/dmt. Even so, that represents a considerable reduction in volatility from the prior half, when the range was $223/t to $87/t. Half-on-half average prices were quite close (a $3/dmt difference), but versus the corresponding half of financial year 2021, they were -$44/dmt lower. As for fines, lump premia traded in a narrower range in the second half of financial year 2022 ($0.09 to $0.45/dmtu, averaging $0.30/dmtu, seaborne).

Six months ago, we recounted the abrupt correction in the iron ore market that occurred in the face of steep cuts in Chinese steel production in the second half of calendar 2021. This negative demand shock had a major impact on the balance of the seaborne trade, which flipped from deficit to surplus essentially overnight. Chinese port stocks of all iron ore products²⁸ 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. At the opening of calendar 2022, with seaborne supply expected to increase and demand expected to be constrained by both special factors like the Winter Olympics and the overall zero-growth mandate for steel, there was a general view that even with firmer end-use conditions, port stocks were likely to rise further.

As it so often does, the invisible hand of the market chose a different course to the one dictated by careful logic. Rather than building up, port stocks trended downwards for four straight months after peaking around 160 Mt in February 2022. At the end of this run, port stocks hit 126 Mt, close to the year-end positions for calendar 2020 and 2021. How did this happen? Three main factors drove the surprisingly firm iron ore fundamentals: (1) stronger than expected demand on the back of elevated BF utilisation rates in China, partly due to scrap shortages that hindered the EAF fleet; (2) lower than expected aggregate seaborne supply from low-cost majors; (3) lower than expected aggregate seaborne supply from junior and swing suppliers, including India [export tariffs] and Ukraine [military conflict].

Against this backdrop, Chinese domestic iron ore concentrate production (implied) has been steady. It reached 308 Mt in both 2020 and 2021. We anticipate a similar or slightly higher figure across calendar 2022, although there will need to be some catch-up in the second half to achieve that after COVID-19 disruptions in the first half.

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 period-on-period volatility of Chinese domestic iron ore production. In this regard, we note that fixed investment in iron ore mining surged 76% YoY from Jan-June 2022. This is presumably in part a response to the ambitious targets in CISA's "Cornerstone Plan" for 2025, which aims to lift both domestic iron ore and overseas equity-controlled volumes by 100 Mt versus a 2020 baseline. Our take on the domestic component of the goal is that it will be challenging to achieve, based on a bottom-up review of potential projects²⁹.

Moving to differentials, the lump premium (LP) was firm in the March quarter, supported in part by sintering restrictions in northern China. The LP then trended lower from the mini-peak of $0.45/dmtu in mid-March. The lifting of sintering restrictions, weakening steel margins, and rising seaborne supply all contributed. The LP closed financial year 2022 around $0.10/dmtu.

Fines differentials to the 62% index for the 65% and 58% indexes narrowed across the second half of financial year 2022 (lower premiums for higher grades, smaller discounts for lower grades) following the deterioration in steel margins and the consequent move by mills to procure lower cost raw materials on average.

Looking ahead, the key near-term uncertainties for iron ore are the pace of steel end-use sector recovery in China, how the Chinese authorities will administer steel production cuts in the remainder of the 2022 calendar year, and the performance of seaborne supply: mostly but not exclusively with regards to the seaborne majors.

Lower steel run-rates than seen in the first half of the 2022 calendar year seem assured. That is based on the administrative guidance of a "net reduction" for the full year, and the first half run-rate having tracked well above the 2021 full year outcome of 1.033 Bt. With that demand backdrop, if major producers all hit their shipment guidance, then an increase in port stocks is a likely outcome. In terms of swing supply, there could well be a resumption of Ukrainian exports and Indian miners are reportedly lobbying to reduce the export tariff that has abruptly cut off seaborne supplies from this source since May.

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 BF 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 11-13 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 coalprices³⁰ have been extremely volatile. In the half financial year just concluded, the PLV index ranged from a low of $302/t FOB Australia to a high of around $671/t. The $671/t was an all-time record since the Platts PLV FOB index was established in the early 2010s: remarkably, this is almost $300/t higher than the previous record achieved during the Queensland floods of 2011. MV64 has ranged from $268/t to around $642/t; PCI has ranged from $245/t to $655/t; and SSCC has ranged from $216/t to $575/t. Three-quarters of our tonnes reference the PLV FOB index, approximately, with that percentage being higher than six months ago due to the divestment of our BMC operations during the second half of financial year 2022.

For the half year overall, the PLV index averaged $467/t, up by +48% compared to the prior half and by +253% YoY. The differential between the PLV and MV64 indexes averaged 9% in the second half of financial year 2022, -8 percentage points narrower than in the previous half and 5 percentage points below the five-year average.

The contrast between the conditions that prevailed through financial year 2022 and the year that preceded it could not be starker.

Financial year 2021 was a grind for most of the period, with prices nailed to the cost curve as the industry grappled with the ramifications of China's ban on Australian origin coals. Escape from these circumstances came by way of a synchronised uplift in pig iron production across China and the ROW that kicked into gear in the June quarter of calendar 2021: and the demand impulse happened to coincide with multi-region, multi-causal supply disruptions, allowing the FOB and China CFR segments to tighten simultaneously. That produced an initial wave of fly-up pricing across the metallurgical coal industry. Then came the invasion of Ukraine, which drove panicky precautionary stocking of non-Russian coal, which in turn drove the entire metallurgical coal complex skywards. The spot PLV FOB price hit its all-time high in this phase. Record prices unravelled late in the June quarter, as a turn in ROW steel market conditions intersected with the re-opening and ramp-up of suspended operations in Queensland.

The spread between PLV FOB pricing, China CFR equivalent and China domestic PLV swung wildly against this backdrop. Quoting in the form of China CFR minus FOB, after adjusting for freight, the differential ranged from +$192/t to -$273/t across financial 2022, versus the average in the four previous financial years (FY17-20) of -$7/t. Extraordinary.

We have analysed the impact of trade distortions in detail previously. That discussion can be reviewed here.

Here is the status quo on the destination of Australian shipments, with the first figure being the Jan-May 2022 share of Australian exports, and the second being the average from the five years prior to the Chinese ban. China (zero vs 18%), Developed Asia (44% vs 37%), India (30% vs 26%), Europe (13% vs 9%), South-east Asia (8% vs 5%) and Brazil (plus other, 5% vs 4%).

In terms of volume, Australian shipments have been 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. In calendar 2022 to date (Jan-May), exports are down -5% YoY, which is also -9% versus the five-year average. Versus calendar 2019 they are -14% lower. Any way you present the data, volumes are soft.

Elsewhere on the supply side, the Chinese and Mongolian coal industries have both struggled to lift (and/or deliver) volumes in the pandemic era. 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 as financial year 2022 opened, according to data from MonCoal. There was a momentary peak around 300-400 trucks per day in November 2021, but the rate quickly collapsed again, falling back below 100 in December. It was only in June-2022 that truck flow reached and then surpassed the 500 per day threshold.

Separately, a series of domestic mining accidents in China had an impact on higher quality coking coal production in calendar 2021. More recently though, with a more intense focus on domestic supply security, the authorities have apparently moved in a pragmatic direction with respect to the penalties associated with safety incidents. In the recent past, a fatality at one mine would result in county-wide suspensions, with an obvious deleterious impact on output. Recently we have observed that it is only the "guilty" mine that is suspended in the wake of serious safety incidents, and their "innocent" neighbours are allowed to continue to operate normally.

This change has been one contributor to a solid 2% YoY increase in hard coking coal output in calendar 2022 to date. Within that though, the relatively small domestic PLV proportion has declined (-6% YoY). So, while overall metallurgical coal supply has been at a reasonable level, with falling domestic PLV production and no access to Australian PLV imports, we can safely deduce that the average quality blend in Chinese steelmaking has been trending lower. Chinese domestic PLV prices have generally been extremely firm against this tight fundamental backdrop, although the decline in steel margins in recent months has necessitated a move towards thriftier procurement strategies.

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. Fourth, 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 export 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-BOF³¹ route, which accounts for around 90% of Chinese and around 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. Additionally, the regulatory environment has become less conducive to long-life capital investment in the world's premier PLV basin - Queensland. 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 headwinds for an extended period in the

On the topic of technological disruption, our analysis suggests that blast furnace 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 size of the existing stock of long-lived BF-BOF capacity (70% of global capacity today, average fleet age³² of just 11-13 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 sweet spot in profitability over the last year or two 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 the 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 five Scope 3 MOUs with China Baowu, HBIS, Japan's JFE Steel, South Korea's POSCO and India's Tata Steel are available elsewhere on our website.

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Copper

Copper prices ranged from $8,245/t to $10,730/t ($3.74/lb to $4.87/lb) over the second half of the 2022 financial year, averaging $9,761/t ($4.37/lb)³³. The average was around +2% higher than in the prior half and +7% versus the equivalent half of financial year 2021. The average for the full financial year 2022 was $9,645/t ($4.37/lb), +21% versus the previous financial year.

Zeroing in on the second half of the financial year, there were three distinct phases of price evolution. Prices started out trading near historic highs, with an additional step up to a new record price of $10,730/t ($4.87/lb) on the 7th of March, with supply risks related to potential Russian sanctions combined with already uncomfortably low visible inventories. Supply risks then gave way to demand concerns in the June quarter. The initial trend reversal came in response to China's COVID-19 lockdowns. Sentiment then soured further as speculation on recessionary risks heightened. The price closed the financial year on its low for the period: $8,245/t ($3.74/lb). The sell-off intensified in the month of July, with the price testing $7000/t mid-month, before consolidating as risk aversion receded slightly. All these prices are of course very elevated relative to both history and the position of the operating cost curve.

Both industry specific fundamental factors and swings in broader macro sentiment will remain influential factors in price formation.

Turning to Chinese demand first of all, six months ago we noted that 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 (+1.9% growth versus around +6% for steel). That momentum did not carry over to the first half of calendar 2022. Some of that was expected - but any nuance in the forecast was obscured by the blunt force of the June quarter lockdowns and the slowdown in global consumer goods demand, which came earlier and faster than anticipated.

Year-to-date (Jan-May 2022) production of air-conditioners, refrigerators and washing machines have all declined, and exports of these products are falling at a faster rate than is production.

Construction demand has been soft, as copper-intensive housing completions have struggled to sustain momentum, even if they are in somewhat better shape than steel-intensive starts. (See the extended discussion of the housing cycle in the Chinese economy chapter). To quickly recap the key Chinese housing parameters, the volume of housing completions - the key indicator for contemporaneous copper use in real estate - contracted -21.5% across the first half of the 2022 calendar year, after rising +11% in calendar 2021. Housing starts - the key indicator for contemporaneous steel use in real estate - declined by -34.4% and -11% in the equivalent time periods.

The positive story for Chinese copper use in calendar 2022 to date is in power infrastructure (comprising both grid spending and power generation projects), which was the sole laggard in the broad-based upswing of calendar 2021. That is consistent with the general macroeconomic picture, where the aggregate infrastructure segment (also including transport and non-power utilities such as water) is the major pillar of growth right now. Within the power generation segment: grid spending is +9.9% YoY in the first half of calendar 2022; power generation is +14% YoY; newly installed wind power is +19% YoY; and newly installed solar capacity is up 137% 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. In the more prosaic area of traditional grid outlays, State Grid has set their nominal budget for calendar 2022 at 501.2 billion yuan, +6% YoY, and they are on track to disburse those funds. Southern Grid (about 10% of spending versus State Grid's 90%) has also announced higher capex in calendar 2022.

The auto sector had a patchy start to calendar 2022, but conventional vehicle sales are picking up momentum under generous, time-limited tax breaks. NEV sales continue to surge, with +168% growth in calendar 2021 followed up by another triple-digit growth pace in calendar 2022 to date. (See additional commentary in the nickel and EV chapters).

In the ROW, developed regions led the way in calendar 2021 and the early part of calendar 2022, with North America and Europe in the vanguard. There was though a trend break in the growth trajectory in the June quarter.

Those regions where the release of pent-up demand still has further to run, a category that covers most of the developing world, are likely to see more resilient growth this year and next versus the regions where growth was stronger a year ago.

On the supply side of the industry, copper concentrate supply has gone from "extremely tight" to "regularly tight" over the last five quarters. The situation was at its most stretched in the first half of calendar 2021, when spot treatment and refining charges (TCRCs) moved down (i.e., in the producers' favour), towards decade lows³⁴. The absolute trough occurred in April-2021, from which point we saw an initial swift rebound that ultimately fell short of the calendar 2022 TCRC benchmark of $65/dmt & US 6¢/lb, agreed in December 2021. More recent settlements covering calendar 2023 have been higher, with TCs in the mid $70s. As of July-2022 (i.e. with the benefit of many June quarter operational reviews), Wood Mackenzie had identified 490 kt of disrupted production in calendar 2022, or roughly 2.2% of initial production expectations. At the same point a year ago, disruptions were running at 1.9%, on their way to a 5.1% outcome for the full calendar year. The pattern of backloading the identification/recognition of disruptions is common, as producers on calendar year reporting schedules tend to hold off on revising guidance until they are absolutely certain they cannot catch up. If the historical pattern repeats, then the industry is on track for a fourth consecutive year of average or above average disruptions, following 5.1% in calendar 2021, 5.4% in calendar 2020 and 4.8% in calendar 2019.

Turning to the outlook, a cluster of projects (including in Peru, Chile, central Africa and Mongolia) have either recently come on-line or are expected to do so within the 2022-2024 window. There have also been some expansion announcements at existing mine operations, including in the DRC, no doubt encouraged by both attractive copper prices and strong perceived by-product fundamentals. Rising primary supply is expected to coincide with an increase in the availability of copper scrap. 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 distancing³⁵.

The industry must navigate the entry of this supply over the next few years, which is likely to produce periods when the supply-demand balance is in surplus.

Once this phase of the decade is transited, 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. Rapid growth in renewable power generation and EVs in China (as discussed above) are already making a material contribution to growth, at the margin.

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 we have observed and copper's future-facing halo effect. That underscores the idea that the collective option set of the industry 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 reserves³⁶) presenting a fluid regulatory picture to would-be explorers, project developers and asset owners.

In terms of hard numbers, our internal estimates show that in a plausible upside case for demand, the cumulative industry wide capex bill out to 2030 (which will be here before we know it) could reach one-quarter of a trillion dollars. Yet according to data assembled by Standard & Poor's, global capex by the majority copper producers among the world's top 80 mining companies (i.e., excluding diversified operators) is expected to decline between calendar 2022 and calendar 2024. Total outlays in 2024 are expected to be roughly half of the peak spending levels of calendar 2014. That is a very substantial disconnect.

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.

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Nickel

LME nickel prices ranged from $20,480/t to $45,795/t over the second half of financial year 2022, averaging $27,746/t, with a spectacular short squeeze in the wake of the Russian invasion of Ukraine, and its eventual unwinding, generating enormous two-way volatility³⁷. The average is +43% higher than the prior half. Averages though are not the same thing as momentum: prices finished the first half of the financial year 2022 with positive impetus, but they were under downward pressure as the financial year closed. By the middle of July-2022, nickel had given back all the gains made under the uniquely bullish conditions in place just four months earlier.

We estimate that the refined nickel market was in surplus to the tune of around +114 kt in calendar 2020. In calendar 2021 that flipped to a large deficit of -106 kt, with a steep associated rundown in visible stocks. That set the stage for the dramatic events that unfolded in the aftermath of Russian troops entering Ukraine.

It is important to recall though that the pre-conditions for fly-up pricing were arguably already in place prior to the invasion, and that was just the spark that set the tinder box ablaze. Consider for example our not-so-subtle bullish hints of six months ago, obviously written without foreknowledge of what would happen in Ukraine:

"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 2021 calendar year. As of February 2, 2022, briquette stocks have declined by -137.7 kt, or -66% since April-2021."

"The relationship between stocks and prices in exchange trade metals ceases 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 cycle 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."

To summarise, there was very little buffer in the system should a new supply shock emerge, or demand were to surprise sharply to the upside, especially if either development was centred on the minority of nickel products that are eligible for physical delivery to the LME³⁸. When the shock did come, these vulnerabilities came directly to the surface. The shock was magnified by the presence of large, over-the-counter [i.e., not visible to other market participants] short positions that had been accumulated prior to the invasion. It became clear that a great deal of LME deliverable metal would be required to cover those shorts. With the existing stocks very tightly held, and the over-the-counter short holder(s) apparently unable to physically supply eligible products from their own operations, prices went into an unmitigated upward spiral. The circuit was only broken via the suspension of trading.

This episode has damaged the global price discovery mechanism for this critical building block of the energy transition: and reform of the exchange infrastructure seems to be in order. BHP is constructively engaged with the broader industry to help find a way forward.

When the veracity of benchmark price discovery comes into question, that flows directly through to the veracity of differentials that price off that benchmark, or prices that correlate closely with it even if the relationship is one or two steps removed. There is a very practical reason for raising this general theme. It is the gap between two nickel products [NPI and nickel sulphate (NiSO₄)] that has become the key metric to watch as technological innovation plays out in the sprint to service the battery value chain.

Twelve months ago, we discussed the announcement that Chinese NPI pioneer Tsingshan had invested in an NPI-to-matte conversion facility in Indonesia. 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 subsequent export volumes have exceeded expectations. Other operators have now followed Tsingshan's lead. The return on these investments will of course rely in large part on the differential we discussed above³⁹. With LME nickel lacking liquidity in the aftermath of the suspension, NPI was trading at a deep discount to the base price, thereby incentivising the construction of these conversion facilities. It is debatable whether any relative price point taken in the wake of the short squeeze was a reasonable guide to assess the medium-or-long term economics of any capital project.

Indonesia's ongoing efforts to use policy levers to increase the proportion of value-added captured onshore remains an important watch point. Senior officials have floated "trial balloons" that export taxes could be applied to products with nickel content below 40% - something that would capture all NPI and some FeNi. There has been no policy announcement yet, but a government taskforce is apparently considering the optimal design for an export tax. If the 40% cut-off were to be introduced, converting NPI to matte onshore would have a double benefit of avoiding the tax and servicing the battery value chain directly. The environmental footprint of the process though, whether it 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.

There are four key questions for the nickel market in the longer run⁴⁰. 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 nickel products 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 are expected to be the leading technology that powers them. Leading of course does not mean that this technology must 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 elsewhere. There is a nickel specific point to be made here as well, with battery chemistry choices driving different nickel intensity per unit across the major consumer regions. The 3.5 million EV units China sold in calendar 2021 required around 95 kt of nickel. The 2.3 million EV units sold in Europe required around 90 kt of nickel: just 5kt less despite selling 1.2 million fewer units. The 792 thousand EVs sold in North America required 50 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 capacity, which has been a recurring issue in the past. Signals from both Obi Island and the Morowali project seem positive on the latter point thus far, while the pace of new project announcements seems to signal increasing levels of confidence. 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 (for example land-use, biodiversity and 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 high importance on security of supply as well as provenance and traceability.

Both themes are encapsulated by our relationships with Tesla and Ford, among others, while the ever growing 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 expect to move even further to the left on the industry operational GHG emissions intensity curve⁴¹.

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Energy coal

Energy coal prices started and finished financial year 2022 strongly. Prices closed the financial year around all-time highs.

The gCNewc 6000 kcal/kg FOB Newcastle index (hereafter 6000kcal, or "high CV") averaged around $321/t over the second half of financial 2022, up from around $176/t in the prior half. Prices ranged from a high of $436/t - a record - to a low of around $202/t.

The 5500kcal index (alternatively an element of "low CV") averaged around $184/t over the second half of financial 2022, with a high of around $284/t and a low of around $110/t.

The spread between the spot indexes for gCNewc 6000kcal and 5500kcal was volatile. In the second half of financial 2022, some carryover factors from calendar 2021 remained influential: Chinese import policies, erratic availability of Mongolian coals, and constrained supply in high CV regions. New forces also emerged, with the direct and indirect impact of the invasion of Ukraine - most notably the European energy crisis - foremost among them. At one point the spread widened to a historical high of 54% against this backdrop, versus the average 39-40% in the two halves of calendar 2021, and 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 have 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 2% in 2035, Japan from 34% to as low as 9%, China from around 61% to as low as 31% and India from around 72% to as low as 49%.

Stepping back for a moment though, even under the most aggressive decarbonisation scenario we run internally - our 1.5-degree scenario discussed in BHP's Climate Change Report 2020 (available at bhp.com/climate) - 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 tragic events in Ukraine have left an indelible imprint on the global commodity markets. The immediate impact on potash has been larger than most - and the reverberations of the history-shaping events we are living through will certainly continue for years, and plausibly, perhaps decades.

The combined shock of sanctions on Belarus and loss of port access for its exports, and profound uncertainty over the near-term status of Russian exports, drove potash buyers into scarcity mode in the March quarter of 2022. Similar to the situation in many other commodities that we monitor, in potash the FSU supply shock occurred at a time when the industry was already stretched to meet robust demand. The potash price recovery dated back to the second half of calendar 2020, it had gathered pace through the first half of calendar 2021, and then really accelerated from June-2021.

This is how we described the jumping off point just in advance of the invasion: "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"⁴².

So, a strong price upswing was already in place, with a tight supply-demand balance to match, and value chain inventories were depleted, reducing buffers should a shock occur. And that was the jumping off point for the industry when, suddenly, around two-fifths of global supply was put into question. It is difficult to fathom that scale of risk. In copper, that would be the same as putting a question mark over the total supply of Chile and Peru. In oil, that would be the same as putting a question mark over all of OPEC, plus Canada and Texas. In short, this was near enough to unthinkable.

The glass half full reality is that seen through the lens of global food security, the catastrophe of a sudden and comprehensive stop for all FSU exports did not occur. While land-locked Belarus has been severely limited, without official sanctions on Russian products or producers, their export volumes have continued flowing at a reduced but still reasonable rate. The glass half empty reality is that global availability of potash for crops planted in calendar 2022 will certainly be constrained by the inability of shipments to get close to the level of the prior year, and that could well have a long shadow in terms of global crop prices. More directly for potash, the reality of a market where a portion of unconstrained demand is left systematically unrequited for an extended period should keep prices reasonably high and affordability at elevated (i.e., less comfortable for the farmer) levels.

Six months ago, we reported that Canadian producers were seeking to increase production in the bullish price environment, but these efforts were signalled as tentative and temporary. In this regard it is worthwhile to note that it was already known about a month in advance of the Russian invasion that Belaruskali and its marketing arm BPC had lost rail access to the Lithuanian port of Klaipeda, opening the period of uncertainty for potash buyers, as well as incumbent producers. As the conflict in Ukraine has dragged on, non-FSU incumbents have been signalling a more open-ended attitude to what is now a deeper and more likely prolonged issue regarding the FSU. The non-FSU signals have broadly confirmed our views, as described in our potash briefing, on the scale and likely availability of excess capacity in Canada, and the sequence in which all forms of potential supply will be brought on-line.

Looking at price developments by region, within the steep overall uptrend, the timing and pace of gains has varied greatly. According to assessments in CRU's Fertilizer Week, the price of gMOP⁴³ into Brazil opened the second half of financial year 2022 at $795/t CFR and closed the year at $1,025/t. gMOP into the United States (at NOLA), which initially led the global rally before ceding that place to Brazil, opened the year at $750/t FOB Barge, and closed the year at $810/t. Spot prices for sMOP in South-East Asia opened the second half of financial year 2022 at $600/t CFR, but by financial year end they had leapfrogged the US and were closing in on Brazil, at $938/t. Annual contract prices with China and India were set at $590/t CFR, just in time to make our previous update in February-2022, which was serendipitous timing from the customer point of view, given a new spike in prompt prices was imminent.

Realised prices for producers tend to reflect developments in prompt benchmark pricing with a lag that is partly dependent on the perpetual dance between prompt and fixed price contract 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 annual contract into Asia. We estimate that approximate realised prices for Canadian producers (FOB Vancouver equivalent) as of the week of Jul-21, 2022, were just short of $720/t.

Turning to the major consumption regions, Brazil, the most reliable growth destination in recent years, has recorded import volume growth of +37% YoY in Jan-June 2022, 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 topping out at 32, which is almost a three-fold decrease in affordability since early calendar 2021. Just prior to the invasion, we had noted the apparent inability of Brazilian prices to push beyond $800/t, as a sign that affordability was getting stretched at that time⁴⁴. It seems likely that some of the growth in Brazilian imports in the last two quarters was purely precautionary as a hedge against a sudden stop in the availability of FSU product.

US importers have taken the opposite approach to their Brazilian competitors. They have backed right off in the calendar year to date, with shipments down by one-third YoY in Jan-May 2022.

Imports into China (-11% YoY Jan-Jun) and India (+2% YoY Jan-May) have been mixed. With domestic production weak, and imports not flowing under stale contract pricing, the Chinese government released some of its strategic reserve late in calendar 2021. That is another sign of the very thin buffers that were in place prior to the Ukraine shock.

South-east Asian imports have increased by a solid +8% YoY, with the full year now estimated to reach a record 8.2 Mt, up from 6.4 Mt two years ago. Strong prices for crude palm oil (CPO), which reached a record $1800/t in March, allowed affordability to stay manageable even as MOP prices escalated, although with CPO back at $1500/t in June, the affordability vice has been tightening again⁴⁵.

On the supply side of the industry, FSU greenfield mines are (were?) a core pillar of the potential supply stack for the 2020s. Belaruskali's Petrikov project was commissioned in August 2021. EuroChem's Usolskiy expansion in Russia was expected by calendar 2023. New mines under construction by Slavkali (Belarus) and Acron (Russia), plus two replacement mines at Uralkali (Russia), were due to reach full production by the mid-2020s. We estimate that around 5 Mt of this supply could potentially be delayed as a result of the tightening of sanctions on Belarus and the schism between Russia and the West.

With respect to the outlook for the supply-demand balance, our careful pre-Ukraine calculus that was partly based on the FSU project pipeline described above, clearly needs revisiting.

To recap the view that helped motivate our investment in Jansen stage 1, we anticipated that trend demand growth over the course of the 2020s would progressively absorb the latent excess capacity present in the industry. That, in turn, was expected to create an opportunity for new supply by the late 2020s or early 2030s. When that process had 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 was deduced as 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. Higher carbon pricing should amplify the operating cost advantages of conventional mining vis-à-vis the solution mining method. We estimate that a price in the mid-to-high $300/t range would be required to incentivise a material portion of Canada's solution mining "supply bench" into production.

How does the new geopolitics of the FSU impact upon this? The most honest answer is that it is too early to tell. The secondary answer is that at a minimum it is reasonable to expect a delay of some years from the original timetable for new mines in the FSU. That then creates either an earlier balance point for the market, a potential reshuffling of the theoretical inducement queue, with non-FSU latent capacity release and projects coming forward and FSU projects moving backward, or some combination of the above. It is important to note here that this would not necessarily change the long-term price we have in mind - but it could alter the timing by which it emerges as a durable trend. There are many, many possible permutations here, and against this backdrop it is strategically prudent for us to accelerate studies of our own capital-efficient organic options beyond Jansen Stage 1, as we argued here.

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 mega-trends: 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 biofuel production, giga-industrial scale renewables 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" parameters⁴⁶.

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Maritime freight

The maritime industry 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. We are, however, tentatively past the worst, with bulk rates having settled down somewhat in calendar 2022 to date, and container rates also off their highs.

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.

Financial year 2022 was a full and satisfying one on the maritime sustainability front.

We are proud to have officially welcomed the world's first LNG-fueled Newcastlemax bulk carrier, the Mount Tourmaline, 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 carbon neutral end-state will be different. As we seek to anticipate that end-state, in calendar 2021 we concluded (along with partners⁴⁷) 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 define a clearer pathway on sourcing and using biofuels in South-east Asia. Very recently, we have initiated an exciting wind-assisted propulsion partnership with Pan Pacific Copper, Norsepower and Nippon Marine. We are also partnering with Class Society DNV to improve the measurement of Scope 3 emissions associated with our maritime transportation requirements; joined the US Government's First Mover's Coalition, launched at COP26 in Glasgow, as a founding member in the shipping sector; formed a consortium to analyse and support the development of an iron ore maritime green corridor fuelled by green ammonia; and we are a founding member of the Global Centre for Maritime Decarbonisation in Singapore.

Turning to the recent history of the bulk freight market, the key C5 WA-China route averaged $10.70/t in the second half of financial year 2022, down -25% from $14.20/t in the first half, which represented a 43% increase over the $9.90/t seen in the second half of financial 2021. The half-on-half decline was registered despite considerable upward pressure on fuel costs in the wake of the Russian invasion of Ukraine, with very-low sulfur fuel oil prices increasing 54%⁴⁸. Over the last three and a half years, C5 has thus traced a crudely symmetric "head and shoulders" formation, with the "head" being the peak period of tightness.

Lower port congestion has increased the effective supply of Capesize tonnage, with the change in vessel quarantine conditions in Western Australia being one important step. Alongside lower than expected iron ore exports from Brazil (and from the seaborne majors overall), this took some of the heat out of time charter rates.

According to Maritime Strategies International, Capesize fleet growth is estimated to have been around 13.6 million dwt (mdwt) in calendar 2021, with around +18.6 mdwt in deliveries offset by approximately -5.0 mdwt in deletions. Deletions basically ground to a halt under the favourable conditions for shipowners that emerged in the second half of calendar 2021. Shipowners 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 and the redirection of trade that is required to achieve Europe's goal of energy independence from Russia⁴⁹.

On the supply side of the sector, which offers firm leading indicators on a two-year horizon, we anticipate Capesize fleet growth will slow sharply across this calendar year and next. Deliveries are expected to be at a multi-year low in calendar 2022. A steadily increasing demolitions run-rate and a material slowdown in deliveries are jointly expected from 2022-2026, with nameplate tonnage moving lower after 2023. Remarkably, every year between 2022 and 2026 is current slated for deliveries that are lower than any year from 2017 to 2021. While order books could well start filling up at the back end of the forecast period, the current profile makes for uneasy reading, and we still need to transit the next couple of years at least with glacial fleet growth as a cornerstone assumption.

Given this starting point and making some allowance for congestion to be reduced progressively through the year, projected deletions will still have to be delayed further to prevent a further uplift in fleet 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, with a considerable jump in calendar 2024. Underlining the different medium term supply response in the container and bulk markets, container tonnage on order has surpassed bulk tonnage on order for the first time in history, according to data from Clarksons.

Developments in container 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 fleet turnover "right", it can provide a springboard for the aspiration of a fully carbon neutral end state for the global maritime fleet in the fullness of time. Equally, we note that the sparse order book we currently observe may partly be due to the technological and regulatory uncertainty that shipowners are facing.

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Inputs and inflation trends

Just two years removed from the COVID-19 induced trough in uncontrollable cost pressures, operating cost inflation has emerged as a central element of the resource industry narrative, echoing (and endogenous to) the pressing macroeconomic concerns discussed elsewhere. We have been arguing that an industry cost upswing was in the works, going back at least 18 months, with an emphasis on raw material linked uncontrollables and artificial shortages of labour under the unique circumstances of the pandemic. The direction of change we are observing is therefore no surprise, but the scale and breadth of the uplift, hugely magnified by the massively disruptive conflict in the Ukraine, continues to exceed expectations.

Like the broader economy, the mining industry has been experiencing a combination of "good" [demand-led] and "bad" [supply bottleneck] inflation. Unfortunately, the balance between the two has been skewed heavily towards the "bad" since the Russian invasion of Ukraine.

As we stated in the preamble: "The lag effect of inflationary pressures is expected to remain a challenge in the 2023 financial year, with labour market tightness and energy markets now edging ahead of manufacturing supply chain and logistics constraints as the most pressing concerns."

Our updated perspective on the duration of the "bad" inflation shock is that there is now emerging differentiation between manufacturing and logistics, on the one hand, and labour and energy on the other. The first two categories are now in the camp of "past the worst, but still considerable work to do before we can declare normality has resumed". Labour and energy, especially power, remain pressing issues where it is unclear if conditions may yet deteriorate further. Europe's energy crisis and Australia's east coast power crisis are cases in point.

We see signs that global manufacturing bottlenecks are on an easing trend, while logistics, especially in the maritime space, appear to be past the worst as well. The ending of China's June quarter lockdowns has helped, no doubt, but the global trend in supplier delivery times, order backlogs and inventory accumulation are all moving the right direction whether China is included or excluded from the analysis. Semiconductor prices are off their peaks and restocking has commenced. Key construction materials prices, such as those for steel and lumber, have also come down. Freight rates have come off their highs and effective capacity is improving as port congestion gradually declines, partly due to eased COVID-19 restrictions around the world. Softer demand is also taking some of the pressure off these integrated systems, with indicators of new order flow showing a noticeable trend break from the March to the June quarters of 2022.

The labour market and energy themes will be considered in the flow of the discussion. What they have in common is that they both have a large local flavour to them. Electricity networks are generally contained within national or sub-national boundaries, but they are connected to the world through globally determined feedstock costs. Labour markets are the very essence of local in the short run, but when you lose recourse to the international market for skills for an extended period, that will cast a very long shadow.

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Operational jurisdictions and labour markets

The Australian dollar depreciated in the first half of financial year 2022, with a -1.7% move from the previous half year, on average, to around US 72¢. Point-to-point over the half (end of December-2021 versus end of June-2021), the Australian dollar depreciated by US 3.7¢ to US 68.9¢. The Chilean peso weakened by -3.4% to around 825 pesos per dollar on average, but it declined by a larger -8.2% point-to-point to 920. Indeed, early in financial year 2023, the CLP recorded all-time lows against the dollar, temporarily breaching the 1000 level when market expectations of US Federal Reserve tightening reached their crescendo.

For Chile specifically, we note that there is a wide gap between where the currency is trading and its fundamental fair value based on historical empirical relationships, most notably the very favourable copper prices that have prevailed for most of the last two financial years. This gap opened 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 - for instance its July 2022 swoon was aligned to a sharp drop in copper - 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 June-2022, the unemployment rate had declined to 3.5%, the lowest level since the monthly data series began in the late 1970s. Remarkably, there is now roughly one job vacancy per unemployed person in the country.

The extremely low unemployment rate 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. Net overseas migration was a staggering net outflow of -88,800 in financial year 2021, the largest since World War One. The Federal government's preliminary estimate for financial year 2022 is +41,000, less than one-sixth of the pre-COVID inflows. Entrants on skilled visas (permanent and temporary) saw a net inflow of around +49,000 in financial 2022 - somewhat less than a typical January prior to the pandemic.

Mining has been one of the sectors contributing strongly in terms of job creation, reaching an all-time high of around 295,000 jobs in the June quarter of 2022.

The coal mining PPI, the only resource subsector which has a dedicated input price index from the ABS, has picked up progressively from 7.9% YoY in the December quarter of 2021 to 11.6% YoY in June-2022. Competing sectors such as construction were somewhat slower to re-attain pre-pandemic levels of employment, but the sector now employs an all-time high 1.2 million workers. Heavy and civil engineering jobs hit their all-time high somewhat earlier, reflecting the lumpy nature of project delivery.

The tight labour market 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 recurrent COVID-19 outbreaks is something that requires considerable vigilance. While we continue to manage these challenges effectively, operational risk will be heightened while these conditions pertain.

Mining wages, as measured by the wage price index (WPI) have been growing at a rate slightly below to the national average, despite the relative out-performance of the sector since the beginning of the 2020 calendar year. We continue to argue that the WPI is giving a false sense of security on labour cost pressure: at just 2.6% YoY in the latest reading, it feels palpably out of touch with the reality on the ground. The national minimum wage and award increases (ranging from 4.6% to 5.2%, with 5.2% being the minimum wage outcome) and "wage bill" measures of employee compensation such as the weekly payrolls, feel closer to the true picture at the margin.

The Chilean economy has faced difficult circumstances since October 2019. First civil unrest, and then a series of COVID-19 waves, and then rising inflation and the associated policy response, have restrained the economy in a number of ways. There was a patch of blue sky in calendar 2021, with surging copper prices and the release of pent-up consumer demand (assisted by the release of pension savings and government support programs) which pushed economic activity upwards and unemployment down. Inflation though was a looming issue, with the Banco Central de Chile responding by initiating an interest rate hiking cycle that is still ongoing today.

The unemployment rate bottomed at 7.2% in December-2021. By May-2022 it had risen to 7.8%, as the reality of monetary tightening and "bad" inflationary headwinds started to take a toll. Low levels of labour force participation remain a constraint on the economy's productive potential and are therefore giving some impetus to the inflationary trend. In June-2022, the employment to population ratio and the labour force participation rate were both 3 percentage points below the levels of June 2019 (before the pre-pandemic recession began).

Twelve 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: exceeding 30% YoY. Risks of downstream pass-through were obviously elevated. Subsequently, consumer price inflation lifted to 7.2% YoY in December-2021 and 12.5% YoY in June-2022.

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.

Wages for the general population increased 9.6% YoY in May-2022: a strong figure in nominal terms, but one that has been leapfrogged by inflation. Mining wages increased by 10.3% YoY in May-2022. 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 well if Chile effectively leverages its future facing commodity endowment. Mining jobs reached a nine year in the June quarter of 2022.

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. Although the appointment of former President of the Central Bank, renowned moderate economist Mario Marcel, as Finance Minister, gave some relief to the markets, several policies that have been announced, such as a wide ranging tax reform (which includes a new and higher version of the mining royalty), new labor regulations (which include a substantial strengthening of unions and the right to strike, as well as the reduction in weekly working hours), and stricter environmental standards that may delay permitting and make them more unpredictable, have caused uncertainty for the business sector.

The outlook remains highly uncertain. The Constitutional Convention that was entrusted to draft a new Constitution has recently ended its work and the text will be subject to a referendum on the 4th of September, 2022. The proposed text is introduces radical reforms in several aspects of Chilean life (political system, decentralization, elimination of the Senate, Indigenous rights, environmental standards, nationalisation of water rights, among others). Although the private mining concessions regime is not touched by the new text, it loses the protection of the super-majority quorum enshrined in the existing Constitution. Forecasts for the outcome of the referendum initially showed that the "Reject" option had a clear lead, but this has narrowed somewhat in recent weeks. The existing Constitution (written in 1980) was rejected by 78% in the 2020 referendum; it is not clear yet what would happen if the new constitutional text is also rejected. It seems likely that new constitutional process would have to be proposed, prolonging the institutional uncertainty for several months if not years.

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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 we estimate as a weighted average of inputs - increased around +87% over the financial year in Australia and +124% in Chile. Constrained supply, strong fertilizer demand (a much larger market for ammonia feedstock than AN based explosives) and steeply escalating natural gas feedstock costs (which has seen some European operators choosing to reduce or temporarily cease ammonia production) have all contributed to upward pressure on prices. Russia's on-again, off-again approach to exports has been a major source of volatility within the half year.

Earth-moving tyre raw material costs (weighted) increased by 6% in the second half of financial 2022 versus the prior half. Natural rubber has the highest weight in our index, and it peaked in the middle of calendar 2021 after a strong run-up. Modest increases in steel and sizeable gains in petroleum derived inputs explain the remainder.

Sulphuric acid prices for Chilean end-users, sourced from Argus, moved up sharply in the first half of financial 2022, and continued to build on those gains in the second half. CFR Chile pricing ranged from $241/t to $286/t over the second half of the 2022 financial year. Point-to-point Japan-Korea FOB prices increased +2% to around $138/t, with ocean freight rates have increased 45%, explaining most of the price uplift for Chilean end-users. For most of the financial year 2022, 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. However, in line with the global industrial slowdown, the non-freight factors have shown signs of unravelling recently, which could see FOB prices move lower in the first half of financial 2023.

Power prices were volatile globally in the first half of the financial year 2022 and then crisis-prone in the second half. For a time, our main operating jurisdictions saw less dramatic price changes than, say, Europe, but the forces unleashed by the invasion of Ukraine, unfavourable weather (including floods and early onset of winter in Australia and poor hydrology in Chile) and unplanned outages led to steep price appreciation in both Australia and Chile.

Chilean spot power prices in the Northern grid (SING) increased +73% in financial 2022 versus the prior year, averaging US$89/MWh. Prices were up by 39% half-on-half. 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 retirement of conventional plants and contracted additional gas imports from Argentina.

Australian NEM spot power prices had been relatively insulated from malign global forces for the first three quarters of financial year 2022, but the energy crisis landed in the June quarter. For the overall financial year 2022, prices increased 121% on average across the NEM (noting that the individual states can face widely varying prices at times). It is the half-on-half volatility that tells the story better: prices fell -9% in the first half but they rose +219% in the second.

The unhelpful stacking of planned and unplanned outages, wet weather hindering coal feedstock supply, plants that were online running at higher than anticipated utilisation rates (exposing them to record spot coal prices), periods of low renewable generation and strong demand from the early onset of winter pushed the system towards marginal gas generation. That meant exposure to LNG netback feedstock costs at a time when global forces had pushed LNG prices to all-time highs. Very low gas storage levels in Victoria created further complexity. This combination of stressors produced erratic market function, highlighted by generator withdrawals under administrative price caps. AEMO was forced to intervene to restore effective market functioning in June, suspending trade for a week. The possibility of a similar confluence of events in the northern winter/ southern summer, is real.

Diesel prices increased sharply in the wake of the invasion of Ukraine, with both high crude oil prices and record refinery spreads contributing to the spike. Singapore diesel (into Minerals Australia) rose +60% half-on-half to $133/bbl, while US Gulf Coast seaborne (into Minerals Americas) rose +53% half-on-half to $141/bbl. Refining spreads maxed out in the half around $75/bbl and $65/bbl in the US and Singapore respectively (averaging $42/bbl and $31/bbl), versus average levels from calendar 2017-19 of $19 and $13 respectively.

The rate of increase in the US producer price index (PPI) for mining machinery and equipment manufacturing escalated further in the second half of financial year 2022 (+13.8% on a 12-month smoothed basis, 19.7% YoY for the month of June-2022, with the YoY rate peaking in May-2022 at 21.2%). These figures are the highest since 1976.

The heavy machinery sector is now eighteen months into its recovery after the sharp contraction seen in the first year of the pandemic. According to Parker Bay, deliveries of surface trucks bounced back around +70% in calendar year 2021, after falling by roughly half that amount in calendar 2020. 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 general messages from the Parker Bay data. The major swing factor in surface equipment orders has been the resuscitation of the global coal industry (where energy coal accounts for the majority of volumes), which was distressed in calendar 2020, but was experiencing boom time pricing by the June quarter of calendar 2021: and outright record pricing since the Russian invasion of Ukraine. 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 had experienced 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 and above bracket are sitting around 45% of the peak, while deliveries in the 308-363 tonne bracket are around 40% of peak levels.

Bringing all 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 enthusiastic founding member of both the "Charge On" Innovation Challenge⁵⁰ (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, with rapid and broad-based sales growth across regions, despite the headwinds confronting the conventional light duty vehicle (LDVs) industry. Developments in calendar 2022 have been more mixed, with China sprinting ahead, but other markets not quite hitting the mark in terms of expectations at the start of the calendar year, when sales of 10 million units felt almost within reach as an upside case. Remarkably, despite the fact that the US and Europe are unlikely to catch-up in the second half what they could not achieve in the first, such has been the scale of the Chinese sales uplift in response to the time-limited tax incentive, it looks like China may be able to drag the global figure over the 10 million unit threshold after all. Sales are now on track for around 10.3 million in calendar 2022, growth of 52%. That follows annual outcomes of 2.4 million in 2019, 3.2 million in 2020, and 6.8 million in 2021.

Europe passed the 2 million sales mark for the first time (68% YoY) in calendar 2021. Hopes that it could leap beyond 3 million in calendar 2022 were dashed by an annualised rate in the March quarter of "just" 2.34 million. China comfortably passed 3 million (168% YoY) in calendar 2021 and then jumped out of the gate with annualised sales rates of 5 million in the March quarter and 5.4 million in the June quarter - with a bumper month of June as new tax incentives were introduced. Both Europe and China achieved total LDV sales penetration of 15-16% in calendar 2021, but China looks set to jump ahead 5 percentage points (24% versus 19%) by the time this year has concluded. Globally, the EV sales share reached 8.9% in calendar 2021, and is expected to lift to almost 13% in calendar 2022 (with the US lifting almost 3percentage point from 4.7% to 7.6%). This is what it feels like to be on the steep initial slope of a technology S-curve destined for saturation.

Emerging themes in the EV space include the evolution of subsidy regimes as the industry achieves greater scale in the US, Europe and the UK; increasing battery costs due to raw material inflation (a theme across the decarbonisation technology landscape); considerable advances in vehicle range (with Mercedes conducting a 1000 km open road demonstration); accelerated activity by US OEMs; and, as always, speculation on short-and-long term battery chemistry choices.

On the latter point, our proprietary battery chemistry framework allows us to assess both commercialised and nascent options side-by-side. On the short run, while thrifty consumers in China have been willing adopters of LFP chemistries in recent years, we are not convinced that they will play a major long-term role in other regions or in China itself as consumers become more demanding and EVs move into every segment. LFP is not competitive with nickel-based chemistries in 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.

Longer term, we do see the potential for new technologies to emerge that take their place in the EV landscape, taking some market share from the nickel-rich family, which we see as the basic workhorse of the electrification of transport megatrend. At present, we see the quantum of that change as a +/- 10 percentage point swing for nickel-rich versus emergent chemistries in 2050.

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Important Notice:

This article contains forward-looking statements, including regarding trends in the economic outlook, 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 the Ukraine conflict and 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

Footnotes

¹ Data and events referenced in this report are current as of August 8, 2022. All references to financial years are June-end, as per BHP reporting standards. For example, "financial year 2022" is the period ending June 2022. 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, S&P Global and I.H.S Markit, among others.

² With the completion of the merger of BHP's Petroleum business with Woodside on 1 June 2022, we will no longer be providing detailed commentary on oil and gas markets. These commodities will be covered indirectly through our commentary on input costs such as power and diesel.

³ Monetary independence is the state of being free to choose the policy setting most appropriate for domestic economic conditions. Loss of independence is the state of being forced into an adverse trade-off with respect to monetary policy. The classic circumstance is where a developing country is forced to raise interest rates despite a slowing domestic economy in the attempt to stem net capital outflows that drive exchange rate depreciation that in turn produces more onerous hard currency debt service obligations.

⁴ The UN released new long-term population projections on World Population Day (July 11, 2022). At a global level, these are essentially unchanged from the prior vintage out to 2050. There are, however, important regional differences and there are considerable changes in the second half of the century. We will review these changes and their implications in a future blog.

⁵ Data comparisons are between 2019 and 2030 and reflect our latest central case forecasts, which incorporate aspects of the potential physical impacts of climate change and responses to them for these global indicators, the projected green investment boom, updated estimates of global inflation 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 expected share of gross capital formation (GCF) applied to this measure of GDP. In PPP terms, the 2019 GDP base is around $135 trillion.

⁶ Paris-aligned" means a societal pathway aligned to the aims of the Paris Agreement. 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 1.5°C above pre-industrial levels.

⁷ We note, of course, that there is 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 publicly 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 which requires steep global annual emissions reduction, sustained for decades, to stay within a 1.5°C carbon budget. Demand figures derived from the pathway, together with its assumptions and limitations, are described in our Climate Change Report 2022, available at bhp.com/climate.

⁸ Available from https://www.iea.org/topics/net-zero-emissions

⁹ UN Climate Change High Level Champion for Egypt, Dr Mahmoud Mohieldin, has indicated that with his country hosting COP27, adherence to NDCs will be a major focal point.

¹⁰ The average price is expected to fluctuate as market-based mechanisms such as EUAs move over time. A combination of WRI and World Bank data was utilised to make the estimates in this paragraph. For a discussion on the role of carbon pricing in decarbonisation, see our joint report with LGIM, the UK's largest asset manager, here. Note that the average price for all GHG emissions is estimated at just $6/t - i.e., the $26/t average price levied multiplied by 0.23 of emissions (the share of emissions that are priced).

¹¹ This judgement is reached via a mixture of traditional and innovative research techniques. We have conducted 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. We have also used data science techniques to scour open access web traffic to derive an alternative viewpoint on social attitudes.

¹² For a more detailed discussion, see our Social Value framework presentation at https://www.bhp.com/news/media-centre/reports-presentations/2022/06/social-value-investor-presentation-28-june-2022

¹³https://www.imf.org/en/Publications/WEO/Issues/2022/07/26/world-economic-outlook-update-july-2022#Projections

¹⁴ Investment bank UBS estimates that supply chain bottlenecks were a stunning 4.4 standard deviations above normal in October 2021. That has improved to +1.8 standard deviations in June 2022, with three-quarters of a standard deviation improvement in June alone.

¹⁵ We define the 2020s as 2019-2030 for this exercise, with 2019 the base year. To provide some context on the amount of fiscal repair entailed in this inflation upswing, according to the IMF the average fiscal expansion in 2020 was about 6% of GDP. So, at a global level this will be "paid for" three times over by 2030, on average.

¹⁶ The three guardrails are the liability-to-asset ratio (less than 70%), the cash to short-term debt ratio (a minimum of 1 times) and a net gearing ratio of less than 100%.

¹⁷ Note that the late July Politburo meeting statement did not mention the numerical target, so this statement should be seen as describing decisions taken prior to that session.

¹⁸ We have previously reported this figure as +3 percentage points and 16%, but revisions to source data since our half-year results have lowered the estimate slightly.

¹⁹ 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.

²⁰ 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).

²¹ We utilise data from the Atlanta Federal Reserve classifying wages growth in low, mid, and high skill cohorts, white and non-white racial background, high school versus college degree and age. Low skill is leading, mid skill is second and high skill are lagging (relatively - absolute gains are solid in all instances). Non-white is leading white, high school is leading college and the 16-24 age bracket is leading older cohorts by a lot. This is all important as it speaks to both households' resilience to cost of living increases (given the higher share of non-discretionary consumption in total expenditure for these cohorts) as well as higher marginal propensities to consume rather than save rising incomes. Simply put, there are more favourable short-term multipliers for overall economy activity when the distribution of income growth is tilting in this fashion.

²² See https://www.atlantafed.org/chcs/wage-growth-tracker

²³ 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.

²⁴ Data on steel and pig iron in this chapter are from WorldSteel and official agencies, unless specified otherwise.

²⁵ 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.

²⁶ See the EU's updated waste management directive, issued in late 2021. https://ec.europa.eu/environment/topics/waste-and-recycling_en

²⁷ 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.

²⁸ All data on Chinese port stocks is sourced from Mysteel.

²⁹ Our data source for this analysis is a publicly available subscription database from Mysteel.

³⁰ 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.

³¹ 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.

³² These approximations are based on a sample of mills, not a census. Note a BF is relined every 20 years or so.

³³ LME Cash Settlement basis. Daily closes and intra-day lows and highs may differ slightly.

³⁴ 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.

³⁵ 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.

³⁶ Reserves from USGS, https://pubs.usgs.gov/periodicals/mcs2021/mcs2021-copper.pdf

³⁷ This range reflects official LME prices. Prices had surpassed the $100,000/t level at the peak of the short squeeze, but the LME cancelled and reversed the underlying trades. $100,000/t is roughly double the previous record high price.

³⁸ In 2010, 57% of nickel production was eligible for LME delivery. In 2021 that figure was just 28%.

³⁹ Technically, there is also an endogeneity between the NPI differential and the diversion of product out of the stainless steel segment, but we assess that this represents a very small component of the economics at this nascent stage of NPI-to-matte development.

⁴⁰ We focus on key uncertainties in the main text, but the future path of conventional non-battery demand is also worthy of note. Nickel first-use is dominated by the stainless steel sector. It comprises more than two-thirds of primary demand today. 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.

⁴¹ 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

⁴² The likelihood that the potash industry would encounter recurrent episodes of "fly-up" pricing was flagged in our potash and Jansen briefings. 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

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. And then came the invasion …

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 Oldendorff, GoodFuels and the Singapore Maritime Port Authority.

⁴⁸ Dramatic shifts in both base crude prices and refining spreads have had a material impact on freight. Wide spreads between low and high sulphur bunker fuels are improving the economics of scrubber fitted vessels and massive increases in LNG prices are temporarily impacting upon the competitiveness of this lower GHG emissions option.

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 and primary energy delivered, the tonne-mile will be higher than under the optimised model that pertained prior to the altered import environment in China. Likewise, dragging high CV Australian energy coal out of developed North Asia and into western Europe to fill gap created by loss of Russian tonnes is an inefficient use of shipping tonnage.

⁵⁰ The winners of the initial innovation challenge were announced in May-2022. See Winning technology innovators announced - Charge On Innovation Challenge