Stunted Copper Supply Growth - July 2011 - Greenfields Research
1. Stunted copper supply growth How soaring copper demand is straining the supply chain and supporting the medium to long term price outlook
2. The BIG Questions How is soaring copper demand straining the supply chain and supporting the medium to long term price outlook?
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4. Where is all this demand coming from? Copper – the industry bellwether Feeding the bulls Government stimulus, Rise of China, New demand sectors, Industrialisation V2.0 Feeding the bears Asset bubbles, Western woes, Substitution, Chinese decline
5. The industry bellwether Major Uses of Copper: Usage by End‐Use Sector, 2009 Construction 7,264Kt (33%) Manufacturing 11,569Kt (52%) Infrastructure 3,266Kt (15%) ICSG The World Copper Factbook 2010 Presentation (Based on International Copper Association data)
15. 133Kt (<1%)Manufacturing 11,569Kt (52%) Infrastructure 3,266Kt (15%) ICSG The World Copper Factbook 2010 Presentation (Based on International Copper Association data)
56. Demand in summary Short term Long term Bulls Government stimulus Rise of China Bears
57. Demand in summary Short term Long term Bulls Industrialisation V2.0 Government stimulus Rise of China New demand sectors Bears
58. Demand in summary Short term Long term Bulls Industrialisation V2.0 Government stimulus Rise of China New demand sectors Bears Western woes Asset bubbles
59. Demand in summary Short term Long term Bulls Industrialisation V2.0 Government stimulus Rise of China New demand sectors Bears Chinese decline Western woes Substitution Asset bubbles
60. Bulls versus bears Government stimulus Rise of China New demand sectors Industrialisation V2.0 Asset bubbles Western woesSubstitution Chinese decline
61. Bulls versus bears Government stimulus Rise of China New demand sectors Industrialisation V2.0 In the short term? Asset bubbles Western woesSubstitution Chinese decline
62. Bulls versus bears Government stimulus Rise of China New demand sectors Industrialisation V2.0 In the long term? Asset bubbles Western woesSubstitution Chinese decline
63. Prices are at historical highs But strong demand doesn’t mean high prices The example of the 1990s Economics 101 Supercycles & supply chains What has all this copper demand meant for prices?
64. Prices are at historical highs Average monthly LME cash copper prices (US$/t): 1981-2011 Copper prices: www.indexmundi.com
65. Prices are at historical highs Average monthly LME cash copper prices (US$/t): 1981-2011 Copper prices: www.indexmundi.com Inflation data: www.inflationdata.com
66. Strong demand doesn’t mean higher prices World Refined Copper Usage versus Copper Prices, 1960-1999 ICSG The World Copper Factbook 2010 Presentation (Based on ICSG data) Copper Prices: USGS; Inflation data: www.inflationdata.com
67. Strong demand doesn’t mean higher prices World Refined Copper Usage versus Copper Prices, 1960-1999 More copper consumed than ever before... ...but historically low prices ICSG The World Copper Factbook 2010 Presentation (Based on ICSG data) Copper Prices: USGS; Inflation data: www.inflationdata.com
68. Demand & prices in the 1990s World Refined Copper Usage versus Copper Prices, 1990-1999 ICSG The World Copper Factbook 2010 Presentation (Based on ICSG data) Copper Prices: USGS; Inflation data: www.inflationdata.com
69. Demand & prices in the 1990s World Refined Copper Usage versus Copper Prices, 1960-1999 ICSG The World Copper Factbook 2010 Presentation (Based on ICSG data) Copper Prices: USGS; Inflation data: www.inflationdata.com
72. Can copper supply keep up with demand? Where does copper come from? Are we running out of copper? Brownfields - current mine expansions Can the industry’s ageing mines increase capacity or is the opposite likely? Greyfields - the scrap market The collar on copper prices and can it contain them in the future?
73. Where does copper come from? Simplified copper production supply chain Mine Mines sulphide ore to produce concentrates Smelter Smelts concentrates to produce anodes Refinery Refines anodes to produce cathodes ~12.0Mt ~12.0Mt ~12.0Mt Copper cathode image: http://en.wikipedia.org/wiki/Whim_Creek_Copper_Mine Production estimates based on ICSG June 2011 Press Release
74. Are we running out of copper? 2010 estimates U.S. Geological Survey Mineral Commodity Summaries, January 2011
75. Are we running out of copper? 2010 estimates (unless stated) U.S. Geological Survey Mineral Commodity Summaries, January 2011 Except coal & oil: U.S. Energy Information Administration, International Energy Statistics (online)
76. Are we running out of copper? 2010 estimates U.S. Geological Survey Mineral Commodity Summaries, January 2011
77. So what’s the problem? Global average copper mine head grade, 1978-2018 Average decline: ~0.05% /year Average global grade decline: ~0.015% /year ~0.15%/decade Average decline: ~0.017% /year Left chart: Robin Bahr, Credit Agricole, Global Copper Market Trends 2011-12 for the ICSG Environmental & Economic Committee Meeting, 14th April 2011 Escondida & Grasberg data from Rio Tinto Operation Reviews Q4 2002-10
78. Grade is King! Global average copper mine head grade, 1978-2018 Increase in mining + milling costs related to grade decline for a hypothetical open pit copper mine with a stripping ratio of 2:1, processing recovery of 95% and producing 100,000 tonnes of copper per year Chart: Robin Bahr, Credit Agricole, Global Copper Market Trends 2011-12 for the ICSG Environmental & Economic Committee Meeting, 14th April 2011 Operating cost data based on Costmine (Infomine USA) Mining Cost Service 2010
79. Grade is King! Global average copper mine head grade, 1978-2018 Increase in mining + milling costs related to grade decline for a hypothetical open pit copper mine with a stripping ratio of 2:1, processing recovery of 95% and producing 100,000 tonnes of copper per year Chart: Robin Bahr, Credit Agricole, Global Copper Market Trends 2011-12 for the ICSG Environmental & Economic Committee Meeting, 14th April 2011 Operating cost data based on Costmine (Infomine USA) Mining Cost Service 2010
80. Can mine production keep pace with demand? Simplified copper production supply chain Mine Mines sulphide ore to produce concentrates Smelter Smelts concentrates to produce anodes Refinery Refines anodes to produce cathodes ~12.0Mt ~12.0Mt ~12.0Mt Copper cathode image: http://en.wikipedia.org/wiki/Whim_Creek_Copper_Mine Production estimates based on ICSG June 2011 Press Release
81. Can mine production keep pace with demand? Simplified copper production supply chain ~4.0Mt SXEW Mine Mines oxide ore to produce cathodes ~12.0Mt ~12.0Mt ~12.0Mt Sulphide Mine Mines sulphide ore to produce concentrates Smelter Smelts concentrates to produce anodes Refinery Refines anodes to produce cathodes Copper cathode image: http://en.wikipedia.org/wiki/Whim_Creek_Copper_Mine Production estimates based on ICSG June 2011 Press Release
82. The miracle of SXEW Typical oxide capped copper sulphide deposit
83. The miracle of SXEW Typical oxide capped copper sulphide deposit Conventional mining of sulphides (pre-1970s)
84. The miracle of SXEW Typical oxide capped copper sulphide deposit Conventional mining of sulphides (pre-1970s) Modern mining of sulphides & oxides (post-1970s)
85. Can mine production keep pace with demand? World Copper Mine Production, SXEW versus Concs, 1900-2009 ICSG The World Copper Factbook 2010 Presentation (Based on ICSG data) Copper cathode image: http://en.wikipedia.org/wiki/Whim_Creek_Copper_Mine
86. Can SXEW supply continue to grow? Indicative depth of discoveries, 1980s, 1990s & 2000s Depth chart: Robin Bahr, Credit Agricole, Global Copper Market Trends 2011-12 for the ICSG Environmental & Economic Committee Meeting, 14th April 2011
87. Can SXEW supply continue to grow? Indicative depth of discoveries, 1980s, 1990s & 2000s Sulphuric Acid Import Prices, CIF Meijillones, Chile, 2001-2008 Depth chart: Robin Bahr, Credit Agricole, Global Copper Market Trends 2011-12 for the ICSG Environmental & Economic Committee Meeting, 14th April 2011 Sulphuric Acid chart: Cochilco, The Chilean Sulfuric Acid market Estimations Through 2015, Aprll 2009
88. Mine production growth stalling World Copper Mine Capacity versus Production, 2005-2010 +1.9% +4.2% +3.5% +5.5% +6.5% +0.9% +2.6% +0.4% +3.3% +0.5% 2005-2010 Data: ICSG Press Release 23rd May 2011
89. Can mine production keep pace with demand? Simplified copper production supply chain ~4.0Mt SXEW Mine Mines oxide ore to produce cathodes ~12.0Mt ~12.0Mt ~12.0Mt Sulphide Mine Mines sulphide ore to produce concentrates Smelter Smelts concentrates to produce anodes Refinery Refines anodes to produce cathodes Copper cathode image: http://en.wikipedia.org/wiki/Whim_Creek_Copper_Mine Production estimates based on ICSG June 2011 Press Release
90. What about non-mine production? World Copper Mine Production versus Copper Usage, 1960-2010 2000-2009 Data: ICSG The World Copper Factbook 2010 Presentation 2010 Data: ICSG Press Release 23rd May 2011
91. What about non-mine production? World Copper Mine Production versus Copper Usage, 1960-2010 3.2Mt shortfall (~16.7%) 0.8Mt shortfall (~17%) 2000-2009 Data: ICSG The World Copper Factbook 2010 Presentation 2010 Data: ICSG Press Release 23rd May 2011
92. Can copper supply keep pace with demand? Simplified copper production supply chain SXEW Mine Mines oxide ore to produce cathodes ~4.0Mt ~12.0Mt ~15.0Mt ~15.0Mt Sulphide Mine Mines sulphide ore to produce concentrates Smelter Smelts concentrates to produce anodes Refinery Refines anodes to produce cathodes ~3.0Mt Scrap Low grade “old scrap” for smelting into anodes and high grade “new scrap” for refining into cathodes Copper cathode image: http://en.wikipedia.org/wiki/Whim_Creek_Copper_Mine Production estimates based on ICSG June 2011 Press Release
93. Can copper supply keep pace with demand? World Refined Copper Production, Primary, Secondary & SXEW, 1960-2009 ICSG The World Copper Factbook 2010 Presentation (Based on ICSG data) Copper cathode image: http://en.wikipedia.org/wiki/Whim_Creek_Copper_Mine
94. Can scrap supply continue to grow? “New scrap” Generated during manufacturing Usually high grade Production linked to industrial production (IP) Production is price sensitive “Old scrap” Generated from disused end-use products Usually lower grade Production linked to construction Production is price sensitive
95. Scrap acts as marginal supply World Secondary Copper Production, 2006-2010 2005-2010 Data: ICSG Press Release 23rd May 2011
96. Scrap supply tight World Secondary Copper Production, 2006-2010 Scrap chart: Robin Bahr, Credit Agricole, Global Copper Market Trends 2011-12 for the ICSG Environmental & Economic Committee Meeting, 14th April 2011 2005-2010 Data: ICSG Press Release 23rd May 2011
97. Can copper supply keep pace with demand? Simplified copper production supply chain SXEW Mine Mines oxide ore to produce cathodes ~4.0Mt ~12.0Mt ~15.0Mt ~15.0Mt Sulphide Mine Mines sulphide ore to produce concentrates Smelter Smelts concentrates to produce anodes Refinery Refines anodes to produce cathodes ~3.0Mt Scrap Low grade “old scrap” for smelting into anodes and high grade “new scrap” for refining into cathodes Copper cathode image: http://en.wikipedia.org/wiki/Whim_Creek_Copper_Mine Production estimates based on ICSG June 2011 Press Release
98. New mines required! Simplified copper production supply chain SXEW Mine Mines oxide ore to produce cathodes ~4.0Mt Sulphide Mine Mines sulphide ore to produce concentrates Smelter Smelts concentrates to produce anodes Refinery Refines anodes to produce cathodes ~12.0Mt ~12.0Mt ~12.0Mt Exploration & Development Of new mines, particularly sulphide mines to produce copper concentrates ~3.0Mt Scrap Low grade “old scrap” for smelting into anodes and high grade “new scrap” for refining into cathodes Copper cathode image: http://en.wikipedia.org/wiki/Whim_Creek_Copper_Mine Production estimates based on ICSG June 2011 Press Release
99. Why are so few new copper mines coming on stream? Geology versus geography Is it the house that matters or the neighbourhood? Capital costs versus operating costs Pay now or pay later? Delays Why are so many copper mine projects late and over-budget?
100. Why are so few new copper mines coming on stream? Challenges facing copper mine development Based on “The Share Buyers Guide to Investing in the Australian Mining Boom” by Dr. Allan Trench, 2011
101. Geology versus geography Challenges facing copper mine development Based on “The Share Buyers Guide to Investing in the Australian Mining Boom” by Dr. Allan Trench, 2011
102. Falling resource grades or... Resource size and grade of recent large copper mine start-ups TenkeFungurume 4.23 Mt Copper Prominent Hill 2.60 Mt Copper Lumwana 6.27 Mt Copper Esperanza 7.38 Mt Copper Data from company websites: Antofagasta (Esperanza); Equinox Minerals (Lumwana); Freeport McMoRan (TenkeFungurume); OZ Minerals (Prominent Hill)
103. Falling resource grades or... Resource size and grade of recent large copper mine start-ups TenkeFungurume 4.23 Mt Copper Prominent Hill 2.60 Mt Copper Current average global mined copper grade Lumwana 6.27 Mt Copper Esperanza 7.38 Mt Copper Data from company websites: Antofagasta (Esperanza); Equinox Minerals (Lumwana); Freeport McMoRan (TenkeFungurume); OZ Minerals (Prominent Hill)
104. Falling resource grades or... Resource size and grade of recent large copper mine start-ups TenkeFungurume 6.70 Mt Copper Eq. Prominent Hill 4.00 Mt Copper Eq. Current average global mined copper grade Lumwana 6.34 Mt Copper Eq. Esperanza 15.18 Mt Copper Eq. Data from company websites: Antofagasta (Esperanza); Equinox Minerals (Lumwana); Freeport McMoRan (TenkeFungurume); OZ Minerals (Prominent Hill)
105. Geology versus geography Challenges facing copper mine development Based on “The Share Buyers Guide to Investing in the Australian Mining Boom” by Dr. Allan Trench, 2011
106. ...increasing political risk Key copper mining countries in mining risk ranking surveys U.S. Geological Survey Mineral Commodity Summaries, January 2011
107. ...increasing political risk Key copper mining countries in mining risk ranking surveys Chart: Robin Bahr, Credit Agricole, Global Copper Market Trends 2011-12 for the ICSG Environmental & Economic Committee Meeting, 14th April 2011 U.S. Geological Survey Mineral Commodity Summaries, January 2011
108. Pay now or pay later? Challenges facing copper mine development Based on “The Share Buyers Guide to Investing in the Australian Mining Boom” by Dr. Allan Trench, 2011
109. Going underground... Indicative depth of discoveries, 1980s, 1990s & 2000s Chart: Robin Bahr, Credit Agricole, Global Copper Market Trends 2011-12 for the ICSG Environmental & Economic Committee Meeting, 14th April 2011
110. Going underground... Indicative depth of discoveries, 1980s, 1990s & 2000s Effect of stripping ratio on operating costs Chart: Robin Bahr, Credit Agricole, Global Copper Market Trends 2011-12 for the ICSG Environmental & Economic Committee Meeting, 14th April 2011 Operating cost data based on Costmine (Infomine USA) Mining Cost Service 2010
111. Going underground... Indicative depth of discoveries, 1980s, 1990s & 2000s Effect of stripping ratio on operating costs Different underground operating costs versus open pit mining Chart: Robin Bahr, Credit Agricole, Global Copper Market Trends 2011-12 for the ICSG Environmental & Economic Committee Meeting, 14th April 2011 Operating cost data based on Costmine (Infomine USA) Mining Cost Service 2010
112. Mining costs on the rise US Mine Cost Input Indices versus US Consumer Price Inflation Operating cost data based on Costmine (Infomine USA) Mining Cost Service 2010
113. Mining costs on the rise US Mine Cost Input Indices versus US Consumer Price Inflation Operating cost data based on Costmine (Infomine USA) Mining Cost Service 2010
114. Pay now or pay later? Challenges facing copper mine development Based on “The Share Buyers Guide to Investing in the Australian Mining Boom” by Dr. Allan Trench, 2011
115. Capital costs soaring US Capital Cost Input Indices versus US Consumer Price Inflation Prominent Hill Construction Stats Man hours: 4.3 million Litres of diesel/day: 2,400 Concrete: 23,000 m3 Steel: 2,400 t Cable: 252,000m Pipe: 43,000m Capital cost data based on Costmine (Infomine USA) Mining Cost Service 2010 Prominent Hill Data: Prominent Hill Analyst Tour, 3 June 2009
116. Battling with grades & scale US Capital Cost Indices versus US Consumer Price Inflation Capital cost data based on Costmine (Infomine USA) Mining Cost Service 2010
117. Battling with grades & scale US Capital Cost Indices versus US Consumer Price Inflation Increase in mining + milling capital costs related to decreasing resource grade for a hypothetical open pit copper mine with a stripping ratio of 2:1, processing recovery of 95% and producing 100,000 tonnes of copper per year Capital cost data based on Costmine (Infomine USA) Mining Cost Service 2010
118. Delays and blow-outs! Data from company websites: Antofagasta (Esperanza); Equinox Minerals (Lumwana); Freeport McMoRan (TenkeFungurume); OZ Minerals (Prominent Hill)
119. Delays and blow-outs! Data from company websites: Antofagasta (Esperanza); Equinox Minerals (Lumwana); Freeport McMoRan (TenkeFungurume); OZ Minerals (Prominent Hill)
120. Delays and blow-outs! Data from company websites: Antofagasta (Esperanza); Equinox Minerals (Lumwana); Freeport McMoRan (TenkeFungurume); OZ Minerals (Prominent Hill)
121. Delays and blow-outs! Data from company websites: Antofagasta (Esperanza); Equinox Minerals (Lumwana); Freeport McMoRan (TenkeFungurume); OZ Minerals (Prominent Hill)
122. Weighing up the challenges The BCG Box for mine projects Challenges Black Holes Politically challenging (Capex Risk) Stars Marginals Technically challenging (Opex Risk)
123. Weighing up the challenges The BCG Box for mine projects Challenges Black Holes S. America Asia Africa Politically challenging (Capex Risk) Chile N. America Australia Stars Marginals Europe Technically challenging (Opex Risk)
124. Where are we heading? The BCG Box for mine projects (into the future) Africa Challenges Black Holes N. America Chile Australia Politically challenging (Capex Risk) Asia Europe Stars Marginals S. America Technically challenging (Opex Risk)
125. How will copper supply problems affect long term prices? The mining (super)cycle Where are we in the mining cycle and where are we going?
126. The economist’s view Average annual LME cash copper prices (US$/t): 1914-2010 World War 1 Oil crisis Iranian Revolution Vietnam War Korean War Housing boom GFC Great Depression Collapse of Soviet Union World War 2 Asian Flu Dot.com War production Post-war collapse Reconstruction of Europe & Japan Demand miniaturisation / substitution Rise of China War production Copper prices: USGS & www.metalpages.com Inflation data: www.inflationdata.com
128. “The mining cycle” Idealised mining cycle 1 2 3 4 5 6 7 8 1 Balanced market, steady demand, steady supply. Demand increases, but supply cannot respond as quickly, prices rise and spike. Supply begins to respond to demand, prices stabilise at a high level. Lagging supply continues to come on stream even though demand has stabilised, prices fall from high levels. Lower prices and demand, discourages investment in new supply, prices stabilise at a lower level. Falling demand or falling costs lead to low prices. Falling prices and demand eventually leads to falling supply which steadies prices. Slowly responding supply reductions may lag and lead to a small bounce from the lowest prices.
129. The mining investment cycle 2. DEMAND SPIKEHistorically low prices encourage new demandUnderinvested supply size not readySharp rise in prices as supply doesn’t respond 3. MARGINAL RESPONSEInvestment in marginal supply to meet new demand Prices stabilise at high levels as high prices discourage increased demand 8. & 1. LOW PROFIT MALAISELow prices create unprofitable mining industry stopping investmentDemand stabilises as low prices discourage demand destruction 4. & 5. NEW LONG TERM SUPPLYHigh profits for low cost miners encourages investment in major minesPrices begin to fall 7. DEMAND DESTRUCTIONEffects of demand destruction begin to take holdMine supply focuses on cost cutting to preserve marginPrices fall steeply 6. EXPANSION OF LOW COST SUPPLYNew low cost supply pushes marginal supply off the curve Marginal costs fall, allowing prices to fall
130. Where are we in the mining cycle? Idealised mining cycle Copper is here 1 2 3 4 5 6 7 8 1 Balanced market, steady demand, steady supply. Demand increases, but supply cannot respond as quickly, prices rise and spike. Supply begins to respond to demand, prices stabilise at a high level. Lagging supply continues to come on stream even though demand has stabilised, prices fall from high levels. Lower prices and demand, discourages investment in new supply, prices stabilise at a lower level. Falling demand or falling costs lead to low prices. Falling prices and demand eventually leads to falling supply which steadies prices. Slowly responding supply reductions may lag and lead to a small bounce from the lowest prices.
131. Lack of copper mine investment Start-up, capacity & current resource of top 20 copper mines Resource & Start-up Data: Infomine Production Capacity Data: ICSG World Copper Factbook 2010
132. Lack of copper mine investment Start-up, capacity & resource of top 20 copper mines 1980> Resource & Start-up Data: Infomine Production Capacity Data: ICSG World Copper Factbook 2010
133. Lack of copper mine investment Start-up, capacity & resource of large copper mines vs recent start-ups Resource & Start-up Data: Infomine Production Capacity Data: ICSG World Copper Factbook 2010
134. New capacity on its way? Start-up, capacity & resource of large copper mines vs large projects Mine Resource & Start-up Data: Infomine; Mine Production Capacity Data: ICSG World Copper Factbook 2010 Production and start-up for projects are estimates by Greenfields Research
135. The geologist’s view Average annual LME cash copper prices (US$/t): 1914-2010 World War 1 2 1 6 4 2 3 5 7 6 7 8 1 8 Marginal supply response Post-war overcapacity No investment in new supply Marginal supply response New low cost supply No investment in new supply Oil crisis Surplus building Surplus building Iranian Revolution Vietnam War Korean War Housing boom GFC Great Depression Collapse of Soviet Union World War 2 Asian Flu Dot.com War production Post-war collapse Reconstruction of Europe & Japan Demand miniaturisation / substitution Rise of China War production Copper prices: USGS & www.metalpages.com Inflation data: www.inflationdata.com
136. The BIG Answers Where is all this copper demand growth coming from? Developing world industrialisation & increased copper use intensity. What has all this copper demand meant for prices? Prices are at historically high levels partially due to strong demand but also supply side issues are required to create the spikes we have seen. Can copper supply keep up with demand? Copper supply has relied on a large expansion of SXEW capacity and scrap recycling, to keep up with demand in the medium to long term more new mines (particularly concentrates mines) will have to be built. Where will new copper supply come from? Mine developers will have to choose between high risk, logistically challenging, high capital cost but potentially very profitable projects in the developing world or lower risk, but technically challenging, high operating cost projects in mature mining regions. Asian and South American countries seem increasingly well positioned.
Welcome to today’s presentation on the subject of:Stunted copper supply growthOrHow soaring copper demand is straining the supply chain and supporting the medium to long term price outlook.
So lets get into the BIG questions, that will explain this hypothesis.
These are:Where is all this copper demand growth coming from?What has all this copper demand meant for prices?Can copper supply keep up with demand?Why are so few new copper mines coming on stream?How will copper supply problems affect long term prices?
So firstly:Where is all this demand coming from?
Well copper is generally regarded as a bellwether for industrial production.As you can see from this International Copper Study Group data copper demand is balanced between uses in manufacturing, construction and infrastructure.
Breaking these sectors down even further:You can see that copper in construction it is used for a variety of uses including electrics, plumbing, aesthetics, communication and the building plant itself.
Similarly infrastructure demand for copper is from both the power and telecoms sectors.
Whilst copper’s use in manufactured products is varied to say the least.With copper found in heavy industrial products, consumer products, vehicles, cooling systems and electronics.All in all then copper has a wide range of varied industrial uses and is a good bellwether for global industrial production.Unsurprisingly therefore copper price forecasts look heavily at global industrial growth.
So what are the prospects for global industrial growth?
In the short term.The bulls will point to the continued growth of China, as well as government policy since the Global Financial Crisis, either as low interest rates or fiscal stimulus, which have increased both physical and financial demand for copper.
Looking longer term:Bulls will point not only to the industrialisation of China but of a whole host of developing countries in Asia, South America and Africa, which go by various names – BRICs, MINTs, EAGLEs, CIVETs, BASICs, Next Eleven etc.We’re talking about countries such as India, Russia, Brazil, Mexico, Indonesia, Nigeria, Turkey, South Korea, South Africa, Colombia, Vietnam, Egypt, Iran, Bangladesh, Pakistan, Philippines etc.Bulls will also point to the continued increase in per capita copper use (i.e. how much copper each of us use each year in our daily lives), which will be driven especially by new uses for copper or existing technologies which use copper ever more intensely, for example in renewable energy plants such as wind and solar when compared to traditional coal and gas plants; or in hybrid cars compared to traditional internal combustion cars.
Countering all this the bears will point to a number of serious short term demand problems:Be these asset bubbles either in oil, tech stocks, Chinese property or commodities themselves. The bursting of any of these bubbles could have a serious affect on either physical or financial copper demand.In the background of the asset bubbles, many of the problems afflicting the Western world remain unresolved, these include:Sovereign defaults, the break up of the EU, rising protectionism, the potential for double dip recession, deflation or major civil unrest (beyond that already seen in the Arab Spring).
In the longer term bears will talk about:Demand destruction – especially substitution, but also miniaturisation and efficiency increases. Substitution will particularly come from aluminium which also has good uses as both a heat and electricity conductor.Bears also worry that China may go the way of Japan and never fulfil its apparent destiny to become the world’s biggest economy. Much of this argument is related to the “myth of the interior” - apart from the partial exception of the USA, in general continental interiors be they in Canada, Australia or Russia are only good for farming and mining and do not become industrialised in the way some seem to expect of the Chinese interior.Bears also worry that key growth economies may develop more like India than China, partially skipping the heavy industrial, manufacturing stage and moving straight into commodity light, service economies dominated by IT, outsourcing and such like.
So how do these arguments balance out.In my opinion anyway:
In the shorter term there are significant downside concerns for the copper price, mainly due to still ropey growth in the Western world and that some asset bubbles may burst – including potentially copper itself!
However in the longer term though I’m more of a bull and I think the story of developing world industrialisation and growth driven by new copper demand sectors will be the main story.
So what has all this demand growth meant for copper prices?
Well as you can see copper prices are at nominal historical highs
...and even in real terms (when prices adjusted for inflation) prices are certainly at 30 year highs.However the story isn’t all about demand!Take a look at this next graph...
This shows real copper prices versus copper usage over a 40 year period from 1960 to 2000.
As you can see copper consumption grew throughout that period, but real copper prices fell throughout the period. More copper was consumed than ever before but prices were at historical lows.
Looking at the 1990s in particular, and this time using nominal copper prices, so no trickery with inflation data here!
Demand grew strongly throughout the 90s with the global economy in 1999 consuming more copper than any year previously in history, yet nominal prices finished the decade lower than when they started.The point I’m trying to make is...
Its simple economics – its about supply and demand!
Or as I say – supercycles and supply chains.To understand the prospects of a commodity you need to understand what “demand supercycles” – China, electronics, communications, infrastructure etc the commodity is exposed to – as we have just done. But you also need to understand how stressed and strained the supply chain is – are any of the links looking weak, or even likely to break, stretching the metaphor to its fullest extent there.So lets have a look at the copper supply chain in a little more detail, and see where the problems may lie.
The basic question is:Can copper supply keep up with demand?
Traditionally (and still the case for the vast majority of copper production) copper is mined as a sulphide ore.Processed into a copper concentrate, which is sold to a smelter.The smelter then smelts the concentrate into copper anodes (and usually within the same facility) refines these anodes into cathodes.So then what is the problem with mine supply?Well most commodities are finite and one theory often put forward is that we are “running out of copper”, often referred to as “peak copper” – is this the case?
Well looking at this USGS data, which shows copper mine production at 16.2 million tonnes last year against their estimate of economic copper mine reserves of 630 million tonnes it would appear not to be the case.This is about 39 years of current supply, and even factoring copper supply and consumption growth it would appear there’s a decent buffer of reserves.The USGS lists a global copper resource of some 1.5 billion tonnes , which again at least doubles this depletion period.
Even when compared to other natural resources the level of reserves seem normal – somewhere between the very prevalent bulk commodities and the precious metals and the rarer base metals.It would appear then the current level of mines reserves are economically normal.
When looking at the breakdown by major copper mining countries though, a story does start to emerge.Most key countries do have more than ample reserves, though there are a few maturing regions – Canada in particular where national reserves are running down. A lot of the biggest copper miners though – most worryingly Chile, but also China and the USA are the below the red line, showing that these regions will deplete quicker than the global reserves as a whole, which will have an effect on where copper is mined in the future.In general though the conclusion is that we are not running copper, so what is the problem with mine supply?
The problem is those maturing regions we were talking about and in particular the maturing mines in those regions.This is most visibly expressed through “ore grade decline” – a phrase that copper analysts have become increasingly used to. As you can see global average copper grades have declined about 0.015% per year for the last 20 years.This doesn’t sound a lot, but bear in mind we were starting from just short of 1.5% in the first place – in effect this is a 1% decline per year or 10% per decade.The spike in the graph is caused by the giant Escondida and Grasberg mines coming on stream in the early 90s, so it seems appropriate to look at these two mines in more detail.We can see that through the 2000s both have suffered severe grade decline, with grades declining about 25% over the decade at both Escondida and Grasberg.
People often talk about grade decline, but seldom seem to spell out just how critical grade is to the economics of a mine.Looking at how mining and milling costs change by moving from 1.4% average grade to 1.0% average grade you can see that for a typical open pit copper mine, this results in an increased operating cost of a few hundred dollars per tonne of copper produced.Again this may not sound like much but it is upward pressure on costs, and these economics also transfer through to the marketing, corporate and capital costs that come on top of the basic mining costs – so the effect of grade decline is multiplied.
The most worrying graph though is this one on the right.This shows the affect on mining and milling costs by moving from a grade of 2% to 0.5% (the typical sort of operating range for major copper mines). The key point is the relationship is not linear but a power law. Whilst dropping from 2% to 1.5% only increases costs by a few hundred dollars per tonne, going from 1% to 0.5% increases costs by $1,500 per tonne!Worryingly the global average head grade is moving towards 1% and this steeper part of the graph, where operating costs increase alarmingly.The other point that has to be made about grade decline is it makes it more difficult for miners to produce large amounts of copper (more rock has to mined to produce the same amount of copper), so in general we’re seeing mine capacities falling and smaller new mines starting up.The “peak copper” theorists therefore have a point – although we’re not “running out” of copper we are finding it ever more difficult to increase output.
So going back to our simplified supply chain, we can see there are definite problems in maintaining and increasing out output from copper sulphide mines.Industries facing problems with rising costs and maintaining production, generally have one choice – innovation – in the mining industry innovation focuses on finding new sources of ore.This can be done by moving geographically to new locales or by developing new technologies to exploit different types of ore in the same locale.The high capital costs and social and environmental damage involved in mining definitely mean there is an incentive to try and utilise existing mines and mining regions, rather than moving wholesale to new regions and starting again.
This is of course where SXEW technology comes in.Developed and commercialised in the 1960s and 1970s, SXEW is just this sort of revolutionary technology that allowed miners to exploit new ores within current mines and mining regions.In this case oxide copper ores where leached (usually using sulphuric acid) to produce copper cathodes. This also has the advantage to miners of not have to pay treatment charges to smelters.
Looking a bit deeper at the “miracle of SXEW” we can see how it was really a double whammy for the copper industry.Your typical copper sulphide deposit exposed at surface has an oxide ore cap at the top formed by the weathering of the exposed sulphide ores.
These oxides are difficult to process into copper concentrates, so traditionally (pre-1970s) the oxide cap was removed as waste to access the valuable sulphide ore underneath.This of course increases pre-stripping costs, thus increasing capital costs. It also increases your operating stripping ratio, thus increasing your operating cost. Storing and managing the waste ore also adds to operating costs – so all in all not a good thing.
The invention of SXEW however allowed this oxide cap to be leached into copper cathodes, thus waste was not just reduced but turned into cash flow – the double whammy I was talking about.These small SXEW caps also allowed miners to secure a small amount of cash flow in advance of mining the larger volumes of sulphide ores, which helps with the financing of such operations.
Unsurprisingly with so many positives, SXEW production has grown strongly over the last 40 years, from virtually nothing, to about a quarter of mined copper production currently.In this chart in particular you can see how sulphide mining to produce concentrates has really not grown over the last few years, despite the incentive of a high copper price.Without the invention of SXEW, copper mine production would definitely have really struggled to keep up with copper demand and we would no doubt be seeing much higher copper prices.So the question now becomes – can SXEW copper mine production continue to grow?
Well lets look at some evidence.This is a chart of the increasing depth of copper deposit discoveries over the last 40 years. For obvious reasons those deposits exposed at the surface are found first, so as a region matures fewer surface deposits are found and more “underground” / “covered” deposits are found.As we saw earlier oxides form at the surface by the weathering of sulphide ores.If copper discoveries are getting deeper, we will see new deposits with increasingly small or even no oxide cap, thus the capacity to develop SXEW operations will be limited.
Combined with this are problems with sulphuric acid prices.This chart plots the Chilean price for sulphuric acid (where a good proportion of the world’s SXEW mines are). Prices in 2008 spiked from $50/t level to over $500/t – a tenfold increase in 1 year!SXEW mines consume between 1.5 and 8-10 tonnes of acid to produce 1 tonne of copper. Typically it can make up 20% of production costs, so clearly such a price spike was not good for mine economics and in fact made many mines and projects temporarily unprofitable. This has somewhat discoloured the image of SXEW since then and such operations are now looked on by miners and investors alike with more suspicion.What the chart doesn’t show is that prices collapsed at the end of 2008 and even went negative in some regions (this is where you pay someone to take the commodity off your hands!) and although forecasts indicate prices are likely to remain low in the near future, such volatility in your main input cost is not a good thing for project economics – especially when there is no clear mechanism for hedging the risk.
All in all then if there are problems with both sulphide and oxide copper mining, then we will see mine production stalling.This data from the ICSG shows that over the last 5 years (the key “boom years”) mine capacity growth has tailed off, whilst production itself has really struggled with three years in five registering less than 1% growth. Clearly there are problems increasing copper mine production.
So going back to our simplified supply chain, what other sources of copper supply can we turn to?
Well, of course mine production isn’t the only source of copper.As you can see there has always been a gap between mined production and refined consumption.Part of this is the depletion of periodic stockpiles, but in general the majority of this gap is filled by scrap (or secondary) copper production.
Over the last 40 years whilst the relative proportion of the copper market that is scrap production has remained the same, because of massive growth in the overall size of the market, this supply has grown to some 3.2 million tonnes of copper from less than 1 million tonnes of scrap per year.Clearly this is not a market to be ignored.
As you can see from the simplified supply chain - scrap comes from waste further down the supply chain and then re-enters the supply chain through either smelting or refining.
As you can see copper scrap supply has grown robustly over the last 40 years, and again without this supply, there is no way copper supply would have kept up with copper demand.So what are the prospects for growth in supply from the copper scrap market?
To assess this we must first understand where copper scrap comes from.There are many ways of classifying copper scrap, but in general there are two main types. New scrap and old scrap.“New scrap” is generated by the manufacturing industry and tends to be off cuts from copper and brass components, and as such is high grade and its production tends to track industrial production.Production is also price sensitive as higher prices encourage manufacturers to try and generate revenue from it.“Old scrap “ comes from disused end use products – be these houses or mobile phones. This scrap tends to be lower grade as it is mixed in with other material – concrete and steel from buildings, circuit boards and plastics from electronic goods.In general though old scrap production is linked to the western world construction sector.Again production is price sensitive as there is more incentive to collect scrap at higher prices.However as you can see copper scrap is linked to a couple of weak economic sectors here – industrial manufacturing and construction. New scrap generation in Europe and North America will be weaker due to the weaker domestic economies, similarly old scrap generation will be weak in these regions due to the ropey construction sector.It is the western construction sector that is key (despite strong construction sectors in Asia) as Western construction generally involves the knocking down and refurbishment of old buildings (which produces scrap) whereas Asian construction involves much more new build, which doesn’t generate scrap.In fact there is an argument that the housing boom which involved a lot of “flipping” properties by refurbishing them, often including stripping out the copper plumbing and brass fittings to be replaced by plastic and chrome, has effectively “mined out” a large copper resource, that can’t be used again, even if there is another housing boom.The growth prospects for copper scrap therefore may be more limited than suggested. To check this we can turn to the data.
Over the last five years copper scrap production has in fact operated as the marginal production in the copper industry, switching on and off in response to the ups and downs of prices.When prices are high more scrap becomes available, when copper prices are low the market disappears.Thus scrap acts as a collar on copper prices – stopping prices spiking up so much when demand increases (and mine supply can’t respond quick enough), but also supporting prices when demand suddenly collapses.You can see a sudden increase in production in 2006 in response to prices and the stalling of production in 2009 due to lower prices.The chart in fact doesn’t tell the full story as the real nadir in prices and the scrap market was late 2008 and early 2009, whilst early 2008 and late 2009 were typified by relatively high prices and strong demand.
You can see this better in a chart of the copper scrap discounts or premiums.A premium (over the LME copper price) is paid for scrap when there is a shortage of scrap and a discount is paid when there is scrap available.As you can see discounts increased sharply in 2005-6, as prices soared and more scrap was encouraged onto the market.The discount/premium is volatile, responding to seasonal changes in demand (and also scrap production) , which is a good thing for miners, as although it may limit the higher prices it reduces volatility. What you can see is the huge premium that formed in early 2009 in response to the collapsed copper price, as the scrap market effectively disappeared (which undoubtedly supported prices, and stopped prices reaching the lows many analysts anticipated). Disturbingly, since then prices have soared again, however discounts remain modest (certainly not at 2005-7 levels) suggesting that not as much scrap is around as required and that the scrap market may not be able to fill in the gaps between mined copper production and copper demand.
So as we’ve seen then there are problems in growing supply from the three major sources of copper.So what options remain open. Well we’re back to finding new places to extract copper, and setting technological innovation aside (and there are none in the wings that will suddenly add a fourth source of copper), miners must find new copper deposits and build new mines.
Preferably sulphide mines, as this still remains the largest and most important source of copper. However we remember from earlier data that mine capacity has struggled to grow in the manner we would have hoped over the last few years.
So why, if there is such an economic incentive to develop new mines, have we not seen a sudden flood of new mines starting up?
Well here’s the excuses list. The myriad of risks mining companies face in trying to develop a new copper mine.The intertwined geological and technical risks.Market risks.The related human resource and completion risks.The various legal risks in their environmental, corporate and political guises.Capital cost risk.Delay risk and force majeure.I don’t want to dwell here, as time is limited, but I recommend you look at this slide afterwards.However I would like look at four of these factors in more detail that are really shaping the mine project development climate.
Firstly the “geology vs geography” debate – is it better for your project to have good geology or be in a friendly country.Or as I like to describe it in housing terms – is it better to own a good house in a bad neighbourhood or something run down in a nice part of town?
We’ve looked at geological risk a bit earlier when discussing grade decline at operating mines – well grade decline applies to new discoveries as well.This chart plots the resource grade (y axis) versus the amount of ore (x axis) for the four biggest new mines to start up in the last 2-3 years.The bubbles reflect the combined effect of grade and tonnage and show just how much copper is contained in the deposit.
This line shows the current average global head grade for copper production.As you can see three of the projects are located below this line, meaning they have resource grades below the average global mined copper grade – so not only are grades at mines declining, but at the projects as well – so grades seem likely to continue their march downwards into the future.The one project above the line – TenkeFungurume – is based in the none-too-friendly Congo – which hints at where this discussion may be heading.
Lets look at this chart first though.This is the same concept but now considering the copper equivalent grade and the amount of copper equivalent metal in the resource – i.e. factoring the by-products into the economics.Cobalt at TenkeFungurume, mainly gold at Prominent Hill and mainly molybdenum at Esperanza.As you can see this moves Prominent Hill above the line and Esperanza up nearer the line, suggesting by-product economics are very important to the economics of these projects. But as mentioned earlier this is increasing the market risk of these mines.
TenkeFungurume highlighted the next part of this discussion – location or political risk – or geography, as its about where you are in the world. Or in our housing terms a good house/mine (which TenkeFungurume definitely is) but in the worst of neighbourhoods.
As we can see from our USGS data of important copper mining countries and their national reserves, when compared to their ranking in three different mining risk surveys. A number of the most politically stable countries – USA, Chile and Canada have lower national reserves.Whilst many of the countries with larger reserves are more politically risky – Indonesia, Russia, Kazakhstan, Peru, Mexico etc.
We can see an increasing chunk of production is going to come from politically riskier countries.
This “geology versus geography” debate is feeding into another dichotomy in mine project development – that of capital costs versus operating costs. Or as I like to phrase it “pay now or pay later”. Higher capital costs obviously increase your upfront costs, whereas higher operating costs affect your profits further down the line.In general choosing to develop a poorer quality deposit in a friendlier country means higher operating costs as the mine is more technically challenging.Conversely developing a decent mine in an unfriendly country, means higher capital costs as more infrastructure (power, transport etc) has to be built to service the mine, more labour and equipment has to be imported, and often money is lost to either bureaucracy or corruption. Similarly the higher perceived risk means, a project has to be very attractive to attract the investment in the first place, meaning a greater chance that a successful project will be bigger and more expensive. So lets have a look at this technical and capital cost risk in greater detail.
Firstly technical risk. As already discussed, one of the big drivers in copper mining is the deeper copper deposit discoveries are becoming.To mine these deeper deposits, miners are faced with one of two unattractive choices:
Either an open pit with a greater stripping ratio, as more covering and surrounding waste rock has to be removed to get to the ore. This obviously increases operating costs.
The other option is to employ an underground mining technique and in general most underground mining techniques are more expensive than running an open pit.Block caving which can be cheaper than open pits is still a relatively new concept, which can have teething problems, and in general is only applicable to the biggest operations.
On top of the fundamental geological problems driving up costs, the actual unit cost of mining is increasing – well above the rate of inflation.This is because many of the inputs (which are commodities themselves) are increasing in cost rapidly – be it coal or natural gas powering the mine, the industrial chemicals and petroleum products consumed by the mine or the freight costs involved in shipping the product to market.
Commodities essentially are inflation, so rising commodity prices create a nasty feedback loop in increasing operating costs for mines, which in turn increase long run commodity prices and so on.Rapidly rising oil prices have had a particularly insidious effect on diesel intensive open pit mining, which can be seen from this chart.
On the opposite side of the cost debate are capital costs.
Which like operating costs are suffering from rising input costs – with steel being a key one here.
As you can see capital costs really took off in 2007 and 2008, which really had an effect on mine project development. Despite the recession capital costs didn’t fall, they only really moderated and seem likely to take off again in the near future, judging by the current price of oil and steel.
Again the underlying issue of grades raises its head.To produce a unit amount of copper, but with a lower ore grade, more ore must be processed and therefore a mine with a bigger capacity must be built.Again this relationship isn’t linear, but a power law, so as grades decline, capital costs rise much more steeply. It would seem we have already reached the part of the curve where it really steepens. For the hypothetical mine modelled here, going from 2% to 1.5% increases the capital cost by no more than $100 million, but going from 1% to 0.5% adds about $250 million dollars.All this hypothetical modelling is good at explaining the concept, but we really need some real world data to support the modelling. So lets look at some case studies – in particular those four new mines we looked at earlier, each of which was developed through the particularly difficult development climate over the last 5 years or so.
First on stream, was Lumwana in Zambia, owned by Equinox Minerals and which subsequently became the target of a takeover merger battle with Barrick Gold winning out over Lundin Mining and a China Minmetals.Lumwana started up in December 2008, 2.5 year late, after several re-scoping efforts (and a fire at the power plant just as it was about to start up!). It took about 10 years to develop after real efforts started in 1999 (though the deposit was discovered in the 1960s before the latest African Copperbelt boom), so this suggests early stage investors in mine projects, should be of a very patient mentality.It was some $130 million overbudget, about 20%. This however is a pretty good performance compared to Prominent Hill.
Based in Southern Australia, owned by OZ Minerals (previously Oxiana) the mine started up in February 2009, some A$800 million over original capital cost estimates (about 165% over!)– though the project was again re-scoped during the period.What isn't shown by this chart is the near death experience OZ Minerals suffered in late 2008-early 2009 as the project debt became unmanageable during the financial crisis and the company had to sell all its assets but Prominent Hill to China Minmetals.
Another project severely over budget was TenkeFungurume in the Congo. The project was owned by Tenke Mining before the Congolese civil war which broke out between 1998 and 2003.Tenke Mining eventually became part of Lundin Mining, whilst the original senior partner (BHP Billiton) dropped out during the civil war and was replaced by Phelps Dodge, who in turn were taken over by Freeport McMoRan and managed the project to completion. In general projects and mines tend to hang around longer than those that own them!Excluding time lost to the civil war, the development timeframe was again of the order of a decade, but this wasn’t the first time someone tried to develop Tenke. Discovered in the early 20th century, several companies tried and failed to develop the project in the 20th century (though unlike many investment stories this time round it was different!)Unsurprisingly a project with such a chequered history was somewhat over budget – about 110% or $900 million.
The most recent large mine to come on stream is Esperanza in Chile owned by Antofagasta with much of the project funding coming from the Japanese firm, Marubeni.The mine started up at the end of 2010.Again taking about a decade to develop, the project was delivered on time, but again well over budget – about $1.1 billion or 75% over budget.As you can see all the recent “successful” mine project developments were well over budget, and many were late.There in fact seems to be a bit of a trade-off between development timeframe and capital costs, with miners seemingly having to wait it out if they want to keep to budget, or throw some money at the problem if they want to keep thing on track.
So having looked at all these problems, I bet you’re wondering how on earth one assesses the chances of a mine project in moving forward.There are many ways to do this, none of them certain, but one of the ways I like to look at mine projects, which draws heavily from the theory discussed in this presentation is using a kind of modified BCG box.Here you plot how politically challenging a project is up the y-axis – this is usually a reflection of your capex risk.Along the x-axis you plot how technically challenging a project is – this usually indicates what your opex risk is.Projects will then plot onto the box – in one of four areas – those that are technically and politically straightforward, with low opex and capex are clearly the stars – in the bottom left – don’t expect to see many of these though.Mostly projects will either be “marginals” in relatively stable development climates but of poorer geological quality, presenting greater technical challenges and higher opex risk. Or they could be geologically more exciting projects but based in politically tough countries, often where substantial infrastructure and socio-political investment is required – these projects have high capex, but low opex risk – they are the “challenges” and plot in the top left.Try to avoid the high capex, high opex risk projects that plot in the top right though – the ones with both political and technical challenges!So lets apply this BCG box to the global mine project development climate and see if we can postulate something about the future of mine project development. In particular I want to look at the changing competitiveness of different regions –as traditional mining regions mature and the developing world continues to develop and stabilise.
So this is my view on where each of the major countries or mining regions plot on the BCG diagram.You can see Chile – the undoubted star in the bottom left there – with its good balance over the last 30 years of stable political climate and fantastic mineral deposits.Moving out rightwards into the marginal area are the mature mining regions – Europe, North America and increasingly Australia, with their stable political climates but with fewer world class deposits left to discover.Up in the top left corner are your challenging regions, less explored with some great deposits no doubt still waiting to be discovered – however these are often in politically challenging regimes, often where the owning companies also need to build all the power, transport and water infrastructure required to support the mine. In general African, Asian and South American countries plot into this box.
Looking into the future though I think things will change, and this is due to the geology vs geography and opex versus capex dichotomies I was talking about earlier.Your mature mining regions are going to see greater capex pressures (as reflected across the industry as a whole) whilst the quality of the deposits left in these regions will continue to decline – as such these regions will in general move upwards and rightwards – dangerously towards the “black hole” area. Already marginal projects from a technical point of view struggle further in a soaring capex environment, and probably aren’t worth the trouble. Chile will probably find itself in a similar position as its industry matures, however its better starting position means in the future any individual Chilean project could be many things – there are probably still some stars out there waiting to be discovered, and as the junior sector gets going in the country more marginal deposits near the big mines will be exploited. Similarly for the brave and deep pocketed companies there are probably still a number of good challenges waiting up in the Andes. I suspect also up in the Andes are a number of projects ready suck away unwary investors money though. Looking at Asia and South America though I’m more positive. As the areas develop economically and become more politically stable, they will become more attractive places to invest in. Similarly as they develop the cost of developing mines may fall (as companies no longer have to build new ports, power stations etc). These countries may become the future low opex, low capex regions that are the stars of the industry – kind of taking Chile’s place – I’m looking at countries like Peru, Colombia, Mongolia and Indonesia.Africa I think however is a different case – it temporarily benefitted from a low capex, low opex environment as the old copperbelt mines were refurbished, but both operating and capital costs are under pressure, which when combined with the political climate is a difficult situation – for me the region will become less attractive to invest in and investors may be more likely to discover they’re pouring money into a black hole.
So now we’ve looked at the frailties of the copper supply chain we can now ask the final question:What do all these supply problems mean for long term prices?Firstly to look long term, I think you have to look back over the long term, so lets look at copper prices (adjusted for inflation) over the last 100 years...
As we discussed earlier, some economists and analysts tend to view things only from a demand point of view.So for example when looking at this 100 year history of copper prices they will attribute demand type explanations to the price.Wars increase demand temporarily. The reconstruction of Europe and Japan after World War 2 drove copper demand in the first half of the 20th century, China is driving it now etc.But we’ve already pointed to that period between 1970 and 2000 that defies demand side explanations and suggested you have to consider the supply side too.From this chart it is clear copper prices move in cycles – big ones of 50 year scale, with smaller ones within them of say 5 years. These are the mining cycles and they (whether long or short) are created by the key dynamic of the mining industry...
Sticky supply And Dynamic demandWhilst copper demand can bounce up and down at the whim of the consumer, copper supply with it multi-billion dollar mines, that cost multi-millions to shut down, cannot react as quickly – supply is sticky so to speak.As such the industry moves through periodic surpluses and deficits as the market tries to align supply and demand.So lets have a look at this cycle.
As you can see supply increases lag demand when it increases, creating a deficit, drawing down stocks and high prices.Supply then often overshoots, as demand stabilises and this puts downward pressure on prices.Similarly as demand falls, supply is slow to react (because mines are expensive to close down) which puts further downward pressure on prices and builds surpluses.Again all this is nice in theory, but how does this relate to you mining investors out there?
Each of these phases in the cycle creates different investment incentives. Obviously when prices pick up there’s an incentive to invest in new capacity – this is box 2, which I’ve coloured green to represent a positive investment climate.Usually the first supply to come on stream, is low capex, high operating cost marginal capacity that can be easily brought on stream, these mines can be temporarily very profitable and in the short term, they raise the marginal cost of production, creating higher prices, and making the rest of the industry very profitable.The high prices encourage investment, but more importantly the increased profitability of the industry caused by high marginal costs, gives the low cost miners enough capital to invest in serious new low cost supply. In this sort of environment both low cost and marginal mine investments work. This is box 3.As this new low cost supply comes on stream though it balances the market or possibly pushes it into surplus, putting downward pressure on prices. Similarly large new low cost mines, “push” the marginal supply off stream, bringing down marginal costs and putting further downward pressure on prices. In this situation only really the low cost mine investments work, so the investment climate is more neutral and as such I've coloured these boxes blue.The falling marginal costs, cause falling prices, reducing the industry profitability, severely discouraging new investment. On top of this, after the period of high prices, demand destruction may be taking affect an putting further downward pressure on prices. In this situation all mines profits look diminished in the future and all investment look bad, hence I’ve coloured this next box red. The industry now kind of enters a low profit malaise, where they only way to increase profits is to reduce costs, as such the industry cuts back and cuts back. As you can see though this sows the seeds for the next demand spike, when the rationalised supply side will be in unfit condition to react.
So I’m sure you’re asking where is copper in this cycle.In my opinion we’re just about still in phase 2.Demand has picked up sharply, but as we’ve discussed supply has struggled to respond and this has led to a spike in prices.We have however already started to see the begins of phase 3, a lot of marginal capacity was brought on from Africa, and the junior sectors in Australia and Canada are currently very hot, so expect to see more marginal supply from them. However the GFC probably stopped the industry progressing into phase 3 as quickly, as investment was severely reduced.
You can see from this chart though we are now waiting for the new investment in low cost, long life mines – these are usually big and expensive, so companies need to generate the profits first and again the GFC will have stalled things here.We haven’t seen any big new mines come onstream (certainly top 20 size mines) since around 2000, when Collahuasi and Los Pelambres started up. There have been some fairly decent sized mines since – Antamina, Spence, Kansanshi to name a few, but none of these rank among the “biggest” and even then we haven’t really seen any mines of this scale start-up since about 2005.As you can see from the chart, the big low cost mines only come on stream every so often, and there does seem to be a cycle, with two major phases one from about 1975 to 2000 and one from about 1900 to 1920.
Zooming in to this most recent phase you can see that even that is broken down into cycles – one around the 1990s and one around the 2000s. But since then no big new mines – and this is what the industry is waiting for and until then we will see high and volatile prices as marginal supply and demand destruction do battle.
To put our four mines we case studied earlier in context, I have plotted them on as well. Although they are all very good profitable mines, none are of the sort of Escondida or Grasberg scale that will help underlie copper supply for decades to come.
The new giants are waiting in the wings though – many on the books of the majors and maybe by 2020 we’ll be seeing the arrival of new long term, low cost supply. Note the location of all these projects though, with the exception of Pebble (USA) – all are in the developing world – Toromocho (Peru), OyuTolgoi (Mongolia), Petaquilla (Panama), Las Bambas (Peru), Tampakan (Philippines) and Frieda River (Papua New Guinea). This is why I was talking about the changing of the supply base of the industry to South America and Asia.
So moving back to our long term price cycle and my conclusion – this is the same 100 year price cycle, but this time with supply side reasoning on in red – the “geologists view” so to speak.Now you can see the effects of that new supply coming on stream in the 1900s-1920s, which helped feed the war effort in Europe, but also led to significant overcapacity post-war. So much so that no major new capacity seemed to come on stream until the 1970s, when gradually rising copper prices finally encouraged new low cost supply on stream – and it kept coming on stream for the next 30 years – so this explains how you can have rising demand and falling prices – when you also have rising supply.I’ve tried to approximately indicate which of the various mining cycle phases the industry is in at the top – with the numbers. Though bear in mind the theory also applies to the mini-cycles inside the major cycles – so in the industry can be in more than one phase at once! For example clearly in late 2008, despite being in an overall strong demand and price environment, we were seeing falling demand, falling prices and a poor investment climate for mining projects!In conclusion though to me it seems in the longest of terms, we’re in a period similar to the post-depression period, where now new supply is required again, but will take a while to bring on stream, and as such we seem in for a period of high prices.
So we can now answer all the big questions.Where is all this copper demand growth coming from? – developing world industrialisation and increased copper use intensity.What has all this demand meant for prices? – prices are at historically high levels due to strong demand, but also supply side issues are required to create spikes we have seen.Can copper supply keep up with demand? – copper supply has relied on a large expansion of SXEW capacity and scrap recycling, to keep up with demand in the medium to long term more new mines (particularly concentrates mines) will have to be built.Where will new copper supply come from? – mine developers will have to choose between high risk, logistically challenging, high capex, but potentially very profitable projects in the developing world, or lower risk, increasingly economically marginal, technically challenging, high opex projects in mature mining regions.
Why are so few new copper mines coming on stream? – mine project developers face a multitude of challenges based on poorer geological quality, increased technical challenges, volatile commodity markets, financing problems, equipment and recruitment issues, political and governmental problems – by far the most significant challenges are in controlling capital costs and project timelines.How will copper supply growing pains affect long term prices? – although there is softer demand sentiment in the short term, fundamental supply problems will support medium to long term prices, creating a period of high but volatile prices (which may be exaggerated by increased investor influence in the physical copper market). – this is a normal part of the mining cycle with the higher prices encouraging investment. Ultimately though either new supply will come on stream or demand destruction will occur and prices will stabilise at historically typical levels.
So thank you for listening.Please feel free to ask questions now.