Since late 2001 nickel prices have been on a dizzying upward trend, peaking at US$17,770/t in early 2004, and most analysts expect prices to remain high and volatile for at least another 12 months.

The price boom has been underpinned by two key factors: the slow growth of primary nickel supply, coinciding with massive growth in Chinese consumption.

The origins of the supply problem go back to the mid-1990s. Inco had completed the purchase of the Voisey’s Bay deposit, and according to the original plan the operation was due to be producing about 122,000tpa of nickel by mid-1999.

At the same time, the first generation of pressure acid leaching (PAL) projects in Australia were being developed. The Cawse, Bulong and Anaconda (Murrin Murrin) operations were expected to come on stream at the end of the decade and were scheduled to be producing around 60,000tpa of nickel by 2000.

As it turned out, Voisey’s Bay was delayed by a series of political and economic issues, and is now not scheduled to start production until late 2005 – and even then only at a rate of 60,000tpa. The three PAL operations did start production at the end of the 1990s but have not produced at original projected levels. Bulong shut in 2003, with the other two producing about 37,000t of nickel in 2004.

That these operations did not produce at expected rates had a massive impact on nickel supply. But they also had a big impact on investment in the rest of the nickel industry: the general belief was that low capital costs at the new PAL operations, coupled with operating costs of well below US$1/lb, signalled a revolution in the industry’s cost structure.

The way perceptions of long-term nickel prices changed during the 1990s illustrates the impact of the new technology. At the start of the decade, the industry was typically using US$4/lb as its long term planning price. By the end of the decade, however, figures of US$3.00-3.25/lb were common.

For existing producers, the anticipated decline in industry costs meant that cost cutting inevitably became the focus of attention. In any case, new projects were simply not viable on the basis of the new lower long-term price assumptions.

The result was investment in other new capacity was also curtailed, which has meant supply has been unable to keep pace with the growth in demand.

However, the cut back in investment might not have become such an issue but for the emergence of China as a major nickel consumer. As recently as 1999, China was consuming only 48,000tpa of primary nickel, under 5% of global consumption.

But Chinese consumption picked up dramatically in 2000 and has continued growing rapidly ever since.

Between 1999 and 2004, the country’s consumption almost tripled, taking its share of the global market to more than 11%.

The combination of slow-growing supply and fast-growing demand has resulted in stocks of nickel declining steadily over the last few years, reducing the stock-consumption ratio* to its lowest ever level.

Little wonder prices have been so high.

The market has responded to high prices in a variety of ways. On the demand side, there has been some limited substitution away from nickel. In particular, there has been some switch away from conventional 300-series stainless steel into ferritic stainless (non-nickel containing), and in Asia, into 200-series stainless (containing low levels of nickel).

Past experience suggests most of this substitution will be reversed, with consumers moving back into the 300-series once nickel prices fall. On the supply side, there are now indications that investment in new capacity is gathering pace.

Inevitably it is the big projects that have attracted the most attention, though only one major greenfield operation – Voisey’s Bay – will be on stream in the next two years. Two other large projects have received the go-ahead: BHP Billiton’s Ravensthorpe 50,000tpa nickel mine and associated expansion of the Yabulu refinery in Australia, and Inco’s 60,000tpa nickel Goro project in New Caledonia, both of which are due on stream in the second half of 2007.

There are, in addition, a number of major brownfield expansions proceeding, but there has also been a significant reaction to high prices in the small mine sector.

The production response has been particularly impressive in Australia with extra output during 2005-2006 scheduled to come from a number of mines including Forrestania, Black Swan, Sally Malay, Lanfranchi, Miitel and Sholl. Although the operations may be individually fairly small, the extra tonnage is significant in total: Australian nickel mine output rose by an estimated 20,000t in 2004, and is expected to increase by a further 45-50,000t during 2005-2006.

The result is total primary supply is now expanding strongly. World output rose by an estimated 5.5% in 2004 and further increases of 5-7% are expected in 2005 and 2006.

Even so, there remain doubts as to whether the increase in supply will be big enough to satisfy demand over the next two years, and the conventional view amongst analysts is that the nickel market will remain close to balance* during 2005.

Indeed, stocks are generally expected to be still very low even two years from now. This bullish background is reflected in analysts’ price forecasts: the average of more than 30 recent predictions monitored by Outokumpu is for 2005 US$12,985/t (US$5.89/b) and US$10,670/t for 2006. These prices imply continuing excellent profitability for nickel producers.

Looking further ahead, nickel demand will continue to be mainly determined by growth in consumption of stainless steel, which accounts for about two-thirds of primary nickel consumption and more than 75% of all nickel units.

Global growth in stainless consumption has averaged close to 5% a year over the past 20 years and it is believed growth in the range of 5-7% a year will continue into the foreseeable future.

This forecast is, however, critically dependent on developments in China. The country already consumes almost 25% of the world’s stainless flat products – more than the US and Japan combined – and Chinese stainless steel melting capacity is forecast to grow at a phenomenal rate over the next decade. Consultants CRU International predict that Chinese slab melting capacity will increase by more than 6.6Mt between 2004 and 2009; equivalent to around 30% of global capacity in 2004.

Such a strong growth rate for stainless steel production implies global nickel consumption could rise by at least 4% a year over the next decade. Analysts at Macquarie Research, for example, estimate in absolute terms the increase in global nickel demand during 2000-2010 will be 565,000t, more than double the level in any previous decade. And in the period 2010-2020, the absolute increase is projected to be almost 700,000t. In other words, a “new Goro” will be needed every year.

Whatever the exact numbers, all the indications are future nickel demand during the next 10-15 years will be very strong. And although investment in new nickel capacity is accelerating, there still looks to be a need for additional capacity towards the end of this decade.

Will this investment be forthcoming? PAL technology is still a “young” technology and countries where laterite reserves are focused (including New Caledonia, Indonesia, Philippines, Cuba and Latin America) have a generally high country risk as well as the need for expensive infrastructure. Investment in new nickel capacity in Australia, in both concentrate production and leaching projects, looks an attractive option and is expected to continue at a high level over the next few years.

*Note: Supply-demand balance refers to total world stocks and stock-consumption ratio refers to western world.

Michael Cook has worked as an economist in the metals industry for more than 25 years and is chief economist with Outokumpu in London