Copper prices expected to dip below US$6,000 in 2014
Copper’s world has changed. Rising mine-through-refined supply has met waning demand and market surpluses are likely to build through 2013-14. Indeed, our refreshed forecast now includes a surplus of around 380 kt in 2012. A similar excess of supply over demand we expect will herald in 2013 and once again in 2014 before price-induced cuts eat into planned mine supply. Even in the face of more modest retreats in prices than we anticipate, severe capital prudence will be the mantra for the next few years to come.
Inevitably, we think prices must come under further downward pressure soon. Although we question strict faith in short-term cost support – prices almost always under- or over-shoot when supply and demand swing – the price today sits more than US$1,500/t above the short-run marginal cash cost of supply.
‧ Within the next 6-12 months we expect LME prices to be tracking at the bottom of the US$6,000-9,000/t range in which the metal has traded since 2006.
‧ Our forecast pitches us fairly and squarely at the bottom of consensus but we would remind readers that this price path still allows profitability for virtually all mines, even if the pickings will start to become much leaner.
Physical tightness is an artificial construct
The only reason we can see for prices holding at current levels a shade above US$7,000 is because of investor positioning (helped by a residual belief in copper’s price immortality) and physical tightness in accessing cathode. This tightness is not a function of buoyant demand and fundamentally constrained supplies – it appears to be an orchestrated move aimed at controlling metal flows, boosting regional premiums and, for now, keeping a floor under prices. Physical tightness now extends to China where the major copper producers seem intent on countering speculative short positions in an effort to lift meager profits from smelting and refining as primary- and byproduct prices slip away.
However, with the investor profile having shifted already to a more neutral stance, it may become increasingly difficult for producers to defy the laws of gravity. As with their mining counterparts, we contemplate that Chinese smelters/refiners will also cut back (on previously planned output), though we believe a wall of plant expansions will keep the system in growth mode.
‧ The move above the $9,000 mark in 2011 was fuelled by a ‘perfect storm’ of a large demand stimulus (mainly in China) and weak copper supply growth; this is a combination unlikely to be repeated soon.
‧ In contrast, in 2013 copper faces weak global economic growth, with a structural downshift in China, conspiring with much-improved delivery of copper mine supply growth.
‧ While prices are likely to fall towards $6,000, we highlight that this remains consistent with a relatively tight market – essentially, we are keeping the “super cycle” (2002 to 2006) price gains in place.
For the market to remain in supply shortfall this year, optimists need to believe in much stronger world demand and/or wholesale disruptions to supply well in excess of 1 Mt/y in 2013-15. These allowances do not include those disruptions which are now more visible in 2013 where we have trimmed forecast mine-through-refined supply.
‧ A more modest level of disruptions could lead to much greater surpluses than most forecasters predict. Such an outcome does not appear to be encapsulated in current spot and futures prices.
Supply: on a higher track
We have made a range of important changes to our supply/demand outlook since April. However, we continue to expect improved performances in delivering new mine supply.
• That said, we have modified our mine-by-mine forecasts to show likely investment deferrals, with lower growth rates postulated in all major regions – our forecast is for an expansion rate of just below 4% p.a. in 2013-15, with the momentum easing from 2014 as prices decline.
− We are much more skeptical that ambitions to return African production back to historical peaks will take place as smoothly as intended, with 2 Mt/y still an ambitious undertaking by 2015.
− We have trimmed our expected production levels for both Peru and China, where we think growth will be maintained but lower prices will mean slower progress.
− Our view of Chile’s production profile is generally unchanged; here we balance improved performance at key mines against the challenges associated with deteriorating ore grades (Chile is no longer the sole catalyst for copper mine expansions).
• We have retained our 6% allowance for unexpected disruption and “market adjustments” in response to prices. Over and above the losses experienced at Freeport’s Indonesian mine (probably more than 100 kt) and at Kennecott’s Bingham Canyon in the USA (125 kt), we have factored in additional unforeseen losses of almost 450 kt in the final six months of this year, losses which mount to almost 1.5 Mt/y by 2015.
− There is a crucial caveat in our S&D outlook in this regard – if disruption does not take place at this scale, market surpluses could be substantial; under this scenario prices would likely plunge, probably into a range below US$5,000 for a period of time.
High prices have essentially included a “scarcity premium” over and above the marginal cost of producing copper, a level currently of around US$5,000-5,500/t in our estimates. Copper miners have struggled to lift production and the universe of highly-enriched deposits amenable to low-cost exploitation has shrunk.
Costs have risen but concerns over operational challenges and investment risks mask likely advances in adding supply already financed and committed as a consequence of the high price years. This supply has been delayed, not lost forever. The track record on mine delivery in the year to date is much better than in recent times, even taking into account present labor tensions in Chile and a variety of incidents elsewhere.
Better progress for (most) brownfield and greenfield projects
Progress at existing mines and new projects is mixed, but is generally taking better shape than in recent years:
• The accident at Freeport’s Grasberg mine in Indonesia has undermined progress made since a strike-disrupted 2011-12. Q1 copper production returned to the 100 kt mark, compared to 324 kt in 2012. We have prudently forecast that the current halt, even if concluded within 2-3 months, will have some impact on progress in opening up new block caving sections. Our forecasts for broader Indonesian production have been cut to 435 kt in 2013 and a more modest increase to 600 kt in 2014. Freeport also expects increases from its US and Chilean operations, including Candelaria, where improving head grades will lift output.
• Anglo American’s latest interim quarterly statement indicates a mixed performance early in the year, with Los Bronces’ output running at higher levels. Production at Collahuasi remains impacted by the planned 45-day shutdown of its SAG Mill 3 responsible for 70% of the mine’s throughput. Lower grades also led to a 17% year-on-year drop in output. However, completion of maintenance work at the mill and a focus on addressing 2012’s problems is likely to lift production in the balance of 2013.
• Copper production at BHP Billiton’s Escondida in Chile increased by 61% during the nine-month financial period to end-March while output remains on track to rise by 20% in the company’s financial year to end-June 2013. In the March 2013 quarter output was running at an annualized 1.2 Mt of payable contained copper, 250 kt/y higher than a year ago. Antamina in Peru also achieved record production for the nine-month period ended March 2013. Olympic Dam’s production in Australia increased as well by 42% in the March 2013 quarter following the completion of major planned maintenance.
• Codelco continues to suffer industrial relations tensions, but this has resulted in delivery delays rather than meaningful production losses at this stage. The Chilean state producer saw copper output slip 5% to 1.65 Mt in 2012 due to dwindling performance at its large, ageing mines, its lowest level since 2008. The company has embarked on an ambitious long-term investment plan with the aim of producing more than 2 Mt/y by the 2021. Despite a fractious industrial relations landscape, Chile posted a 4% yoy increase in mine supply to 422 kt in February, following greater increases in January. Largest gains were made at previously troubled Chuquicamata, Radomiro Tomic and at El Teniente.
• Antofagasta’s Esperanza mine has shaken off the teething troubles that held back ramp-ups at the Chilean operation last year (90% towards capacity targets). Despite these challenges, Esperanza’s introduction contributed to a 10% increase in the company’s copper production last year to 710 kt, a level it expects to match in 2013.
• More broadly, a list of mines entering production in 2012 and 2013 will make a mark. These include:
− Commissioning of Xstrata Copper’s Antapaccay project in southern Peru in August 2012 and with initial copper production in October (the mine could add more than 100 kt to 2013 totals).
− Vedanta’s Konkola Deep in Zambia, on stream in Q4 2012.
− Vale’s Salobo mine in Brazil commissioned in H2 2012. Our projections are as follows: Salobo I; 100 kt/y nominal capacity of copper concentrate after capex of US$2.5 billion. Salobo II: 2014 start-up with a nominal capacity of 200 kt of copper concentrate, at a cost of US$1.7 billion, with Vale stating its target is 200 kt of copper production in 2016. However, Salobo II is subject to delays as operational licenses have yet to be obtained (H1 2014) and the project is only 68% completed.
− First commercial production from Rio Tinto’s Oyu Tolgoi mine in Mongolia. Despite tensions over the JV structure with the Mongolian government, we expect the operation to move to 250 kt/y by 2015.
Copper mine production costs
Meanwhile, we highlight that our seemingly pessimistic price forecasts retain profitability for most copper miners, especially allowing for additional savings as factor costs start to come down alongside product prices. Historically, copper prices have invaded the supply curve less deeply than is the case for some major commodities, suggesting a more immediate responsiveness on the part of suppliers in rebalancing over-fed markets.
• On this basis, a projection that prices could dip below US$6,000/t for a quarter in H2 2014 does not seem such a bold prognosis.
China’s smelter output is on the rise but scrap is scarce
Falling prices have, of course, put smelters/refiners under profit pressure, exacerbated by weaker acid prices and lower credits from precious and other byproduct metals. The shortage of scrap has also impacted processors and fabricators alike, especially in China.
However, scrap supply tightness is nothing new, even if the H1 retreat in prices has stimulated hoarding of stocks by scrap merchants, as usually happens in a deteriorating price environment.
• Availability of scrap has been poor throughout 2012, largely as a result of weaknesses in manufacturing activity and reductions in scrapping rates of obsolete goods in the main sources of scrap, the US, Europe and Japan.
• Scrap supplies domestically in China are growing rapidly, but from a very low base; the country still has a shallow reservoir of goods in use that will eventually be scrapped.
While we have tempered our forecasts for refined supply in China, we do not feel these shortages will mean that output completely stands still as is suggested by some major refiners. Cuts announced are mainly from earlier targeted levels of 2013 production. Copper smelters are aggressively installing new primary smelting capacity and, with it, increasing their importance at the hub of the world’s refined copper production chain.
• Jinchuan states it has suspended a 200 kt/y facility in Gansu due to shortages of scrap feed for the plant, reducing planned output by 100 kt/y from the 600 kt targeted earlier in the year. Last year, Jinchuan produced 386 kt of copper from the facility, with just over 230 kt derived from primary feed. Jinchuan has been unable to secure sufficient scrap fully to utilize its new tilting furnaces installed in 2011 and in theory capable of treating around 200 kt/y of copper in scrap. We believe these units achieved output of around 155 kt of copper in 2012. Given that the plant is land-locked and far from sources of imported feed (Guangdong’s ports are almost 2,000 km from the plant), and that domestic supply of copper in scrap rose by just 73 kt nationwide last year, these plans were always going to be ambitious, at least in the shorter term.
• The company also had plans to start up a secondary smelter using the Ausmelt process in southern China’s Guangxi province. Again, the lack of imported scrap would seem likely to hamper plans to yield 200 kt/y from this plant in the immediate future.
• Jinchuan’s news follows Yunnan Copper’s decision to suspend a 100 kt/y unit and Jiangxi Copper, China’s largest producer, indicating a flat production profile in 2013 may result due to constraints in secondary production.
• Elsewhere, a number of smelter/refineries are undertaking maintenance programs in H1 to take advantage of weak economics of treating scrap, encouraging copper semi-fabricators to shift to refined copper from primary sources as the main feed for their furnaces.
Secondary smelter expansions likely to be held back
Perhaps most surprising against this background are ambitions to install considerable additional secondary smelting capacity in China. Our sources list no fewer than seven facilities intended to come on stream in 2013-14 with aggregate copper production capacity of more than 1.4 Mt/y, although just three plants (with a rating of 500 kt/y) look likely to achieve a 2013 start-up.
• In 2012, scrap imports totaled 4.9 Mt, a rise of just 174 kt, or 3.7%, on 2011 volumes (by gross weight). Assuming an average copper content of close to 40% (always a tricky assumption), this equates to around 1.9 Mt of copper units.
• Domestic scrap supplies, while rising more strongly by 7% to 1.17 Mt (copper content), are doing so off a much lower base. Old scrap generation rose by 11%, but this represents a gross tonnage of just 625 kt. Growth in new scrap supply arising from the manufacturing process was much weaker, in line with a slower pace of industrial activity in China.
• Direct use of scrap by semi-fabricators (i.e., scrap use directly in their melt-shops, and not through the smelting/refining industry) fell by more than 100 kt in 2012 and is expected to grow by barely 2% in 2013.
All in all, this places a greater emphasis on growth in primary refined supply; with imports of cathode down on 2012 levels, this means assessing the pace of copper in concentrate supplies to determine if smelters/refiners will struggle to lift production.
• Scrap shortages have prompted us to halve our forecast growth in Chinese refined supply in 2013 to 733 kt.
• As we have outlined before, a 5%-6% increase in Chinese copper consumption equates to little more than 500 kt of copper; we do not envisage constraints on primary supplies will fall short of this mark.
China mine-through-refined copper balances in 2010-13
Substantial primary smelter capacity additions under way
While China’s copper producers may be protesting shortages of scrap, they clearly do not anticipate similar constraints on securing feed for their ambitious primary smelting expansion programs. Although utilization rates have eased back a shade in April, these still stand at close to 90%. Rising spot treatment terms have also helped smelters partially offset the sapping effects of weaker sulphuric acid and precious metals prices.
We have counted 15 plants that have recently commissioned or plan to do so soon at brownfield or greenfield facilities in 2013. Allowing for some deferments into 2014, these plants account for more than 2.5 Mt/y of incremental smelting capacity. All these plants have received government permits. A further nine or ten projects totaling 1.5 Mt/y of primary smelting capacity are also on the drawing board.
While not all these smelters will expand according to ambitions, continued constraints on secondary production, including new rulings on capacity limits, environmental standards and energy consumption aimed at this subsector, mean that forecasting China’s copper supply is increasingly about forecasting mine supply, or rather, concentrate flows.
The bottom line is that concentrate shipments to China have doubled since 2009 and further rises are in store, swinging the balance of copper units consumed in China away from imported primary cathode and scrap. Whether consumers can access this material without paying hefty premiums remains to be seen.
Demand: not bad, but not too great … worries for 2H 2013
Global demand is undoubtedly soft and we are now picking up reports from manufacturers of very weak orders looming in 3Q in both the tube and cable areas. Most significantly for commodity markets, after “outperforming” substantially in 2010 and 2011 as the largest stimulus in history worked its way through the system, it is now evident that growth in China has moved to a new structurally weaker pace and we would not be surprised to see economic expansion drift below the 7% mark for CY2013.
It is also notable that consumption growth for copper was not as rapid as seen in many other commodities over the past decade, mainly because supply growth continued to struggle.
• In a world of greater demand growth (as evidenced by the increase in global GDP growth and in particular Chinese growth of all persuasions) and continued weak supply, higher prices were needed to ration demand.
• In the case of copper, given the fact that it is relatively demand inelastic, at least in the shorter to medium term, the surge in demand, coupled with still weak supply, required a dramatic increase in price.
− India is a good case in point where the loss of production from the 300 kt/y Tuticorin smelter (India suspended pending an environmental probe) and maintenance work at Hindalco’s 400 kt/y Dahej facility have effectively resulted in virtually no growth in demand for copper this year. This regional lack of supply has killed demand and is far more neutral to price than many think.
This period of high prices has had its toll and the pressures of substitution and weight saving are common talking points on our regular visits to Chinese manufacturers. Discussions with experts put these losses somewhere in the 400-500 kt/y range. Examples include:
• Downsizing of copper tube in aircon units (typical room aircon units now use thinner-walled 5 mm tube as opposed to 7 mm diameter tube a few years ago). The average copper content of a typical aircon unit in China today has fallen by more than 50% since 2005.
• Loss of markets to aluminium in the high-voltage and medium-voltage power grid. Aluminium has also made strong inroads in the rural grid on which a significant part of current investment activity is centered.
• Loss of copper tubing in plumbing applications worldwide. The uptick in US housing activity is positive for copper but loss of markets for tubing mean this growth is likely to no higher than 100 kt/y in 2013-15.
Nevertheless, we are forecasting annual increases in global copper demand of 700-800 kt/y in 2013-15, a major improvement on 2011-12, but less than half the pace of 2009 when major stimulus had its impact. China dominates this usage pattern, with annual increases of 5%-6% projected.
Use of copper in power applications continues to dominate, currently accounting for 35% of overall world refined copper demand of 20 Mt/y, while use in buildings follows close behind at 28% market share.
This leads us to contemplate annual surpluses of supply over demand of about 350-400 kt in 2013-14, with obvious ramifications for prices.
• This price weakness will likely slow the pace of supply growth and shrink this surplus by 2015-16, potentially sowing the seeds for tighter markets and a subsequent price recovery.