September/October 2008
Purchasing insurance, for most scrap managers, means venturing into the unknown. To get the right coverage, find an agent or broker you trust—but also shop around regularly for better deals.
By Mark Crawford
As the world struggled with an economic downturn through late 2007 and the first half of 2008, things in the copper market continued to look bright. Then, in August, prices fell significantly, with the LME three-month average contract hitting a six-month low of $3.35 by the middle of the month, down from around $4 in early July. Was that a sign that copper's astonishing run of average annual growth, which began in 2003, is coming to an end? Or was it a brief tremor in a market whose fundamentals point to continued high prices for the next several years?
Many analysts seem to believe the latter. They say copper's fundamentals—specifically, primary supply shortfalls, low aboveground inventories, and strong demand in the developing world—will keep prices relatively high. "Copper fundamentals, in my opinion, are quite strong right now, and it would not be surprising to see copper prices move even higher in the coming months. Prices might even test new highs," says Arne Lohmann Rasmussen, senior analyst with Danske Bank (Copenhagen, Denmark).
"The big problem facing the copper market is the continued gap between mine supply and refined copper demand," Rasmussen says. Market participants place the shortfall at 3 million mt in 2007, up from 2.1 million mt in 2006. Inventory draw-downs and secondary copper production from scrap filled the gap last year; the question now is whether this year will be the same. An in-depth look at each of these factors will help you come to your own conclusions.
Dissecting Demand
The demand picture for copper seems to have three parts: the developed world, the developing world, and China, with recent demand trends of stagnant, growing, and off the charts, respectively. Some analysts expect the latter two parts to continue to outweigh the former, leading to continued global growth in demand, but others are not so sure.
Most end markets for copper are related to construction, infrastructure development, electronics, and transportation. As the economy has cooled, "developed countries are mostly seeing declining demand or slowing growth, particularly in segments sensitive to construction," says a copper analyst with CRU Group (London). "We expect declining volumes in the United States, [Western] Europe, and Northeast Asia this year."
That said, "continued economic growth in developing countries" will have a bigger impact on copper demand, the analyst says. Rapid infrastructure development in places like India, the Middle East, Asia, and Eastern Europe lead CRU to forecast 1 percent global growth in refined copper demand this year.
It would be difficult to overstate China's role in the growth of world copper demand. China has become the world's greatest consumer of copper. The country grew from taking in 10.1 percent of the world's copper in 1996 to 27.2 percent in 2007, according to Copper Journal. "China is not only the largest global market, but also the fastest-growing [one], up 27.5 percent" from February 2007 to February 2008, says John Mothersole, a principal with Global Insight (Boston). He also makes this point: "Globally, copper consumption is up 5.5 percent year to year. Take out China, and it's down 0.9 percent."
This growth—and the West's decline—in copper demand relate at least in part to the globalization of manufacturing, notes Daniel Edelstein, copper commodity specialist with the U.S. Geological Survey (Reston, Va.). "As a consumer [and] producer of manufactured goods, China affects demand in more established markets as it displaces manufacturing capacity [elsewhere in favor of] its low-cost labor market." But China's need for copper also relates to the country's rapid economic development and expanding electric grid.
China's refined copper demand seemed insatiable—until the start of this year. "Refined copper imports from January to April 2008 were lower by some 22 percent, offering evidence, to some, that China's copper consumption may prove to be less robust than many believe," says Bob Garino, ReMA's director of commodities. It's possible some of China's recent demand growth was anticipatory buying by smelters that expected to shut down during the Olympic Games in Beijing to reduce the country's emissions. That would explain the post-Olympic slowdown in purchasing, as the smelters work through their inventories. But if much of China's copper consumption goes to wiring and plumbing cities throughout the country, demand should remain high. CRU Group forecasts that 2008 will show an 11.1 percent annual growth in refined demand for China, down from 19.3 percent in 2007.
China's copper scrap demand picture also is promising. China imports nearly one-third of all scrap copper worldwide. In 2007 it imported 5.6 million mt of scrap copper, up 13 percent from 2006. "Copper scrap demand is not showing any let-up. Scrap imports are up 37 percent year to date," Garino says. Just from the United States alone, copper scrap exports to China (including Hong Kong) were up 8.6 percent in the first quarter, from 145,090 to 157,546 mt.
The country is taking steps to ensure a steady supply of copper for its growth industries. It has developed the largest copper refining industry in the world—even larger than in Chile, the country that mines the most copper. It is investing in primary production in Africa and Afghanistan, Edelstein notes. It has exercised export and import controls to prevent the export of refined copper. Its rapidly expanding infrastructure—and its population's increased ownership of consumer electronics—are creating a pool of domestic copper scrap that's growing faster than anywhere else in the world. But the parallel increases in treatment capacity are handling the extra scrap, leading to predictions that China will continue to import large volumes of copper scrap for the foreseeable future.
Investigating Inventories
Preliminary data from the International Copper Study Group (Lisbon, Portugal) show the refined copper market was essentially balanced in January 2008, with a small apparent production surplus of 6,000 mt, increasing to about 18,000 mt after seasonal adjustments. This is about the same production surplus that existed in January 2007, even though year-on-year usage and production both declined by about 1.4 percent in that time period. ICSG projects a small surplus of around 85,000 mt (0.5 percent of usage) in 2008 and a larger surplus of around 430,000 mt (2.2 percent of usage) for 2009. ReMA's Garino is somewhat skeptical, however. "Note that last year's expected surplus turned into a deficit," he says. "While global consumption is at best standing still, ongoing problems on the mine side, coupled with declining inventories of refined metal held on the London Metal Exchange and Comex, as well as the attraction of copper as an investment alternative, offer compelling evidence not to aggressively short copper."
As Edelstein puts it, "Refined copper supply is a global issue and is generally very tight. Comex stocks are almost nonexistent, and LME stocks are very low. Reduced Chinese imports in early 2008 have kept them from going even lower." That's why prices were nearing historic levels this summer, he says.
The Supply Situation
The expected trend, when commodity prices rise, is for production to ramp up in response, and the glut in supply brings prices back down. Even with near-record copper prices, though, supply of primary copper has simply not been able to outpace demand. "Supply has been the frustrating aspect of the market for the past several years in the sense that promised capacity additions and subsequent production have never quite met expectations," Mothersole says.
World mine production actually decreased 3.4 percent in January 2008 compared with January 2007, according to ICSG. Reduced output from copper operations in Indonesia and Mexico were named as the main causes for the slowdown. January 2008 mine production also was down a striking 10 percent compared with December 2007, due largely to adverse conditions at copper operations in Chile, Peru, and China.
Mines are facing a wide variety of challenges: poor or difficult ore grades, power shortages, and labor disruptions, to name a few. With concentrate stocks down to low levels, mine outputs will likely fall short of smelter requirements for the duration of the year.
Looking ahead, the primary picture isn't much brighter. "The possibility of electricity cuts in Chile this summer [the Northern Hemisphere's winter] might affect the mining sector," Mothersole says. "It shouldn't be as bad as what has happened in South Africa," where power shortages shut down mines for several days at the beginning of 2008, "but Argentina has cut off natural gas deliveries because of its own domestic energy crisis, and rainfall has been very low, threatening hydroelectric production," he says. "A worst-case scenario could easily see prices hitting $10,000 per mt."
One issue is the sometimes-dire shortage (and higher prices) of sulphuric acid, which is essential for solvent extraction operations. "Sulphuric acid is a localized market that's limited by transportation costs, so it impacts some areas more severely than others," the CRU Group analyst says. "In Chile, it is a problem for many producers. Demand has been booming from the fertilizer sector, leaving the market tight." If copper prices are high enough, some copper producers will buy any sulphuric acid they can find, whatever the cost, so they can continue production, the analyst says. Others will decide the acid price is too high, based on their cost of production, regardless of what they could garner for the copper they extract.
Overall, Mothersole says, "the frustration in expanding production is tied to three things: increases in production costs, fewer new mine projects (a function of low exploration budgets in the late 1990s), and the fact that many capacity additions are in politically risky areas. This means production has not ramped up as foreseen on paper." Over the next five years, major mine openings or expansions include Equinox's Lumwana mine in Zambia (planned to start in December); Freeport McMoran, Lundin Mining Corp., and Gécamines' Tenke Fungurume mine in the Democratic Republic of the Congo (2009); Southern Copper's Tia Maria mine in Peru (2010); Konkola Copper Mine's "Konkola deep mining" expansion in Zambia (2011); and Antofagasta's Esperanza mine in Chile (2011). But those dates are optimistic, CRU's analyst says. "On rare occasions, projects do finish on schedule, but most mine projects continue to suffer from delays, and a number of large projects will now not be on stream before 2012. The average delay is between two and three years."
Strong Outlook for Scrap
Refined demand is high, primary supply is struggling, and inventories are fairly low, leaving copper scrap to make up the difference. Copper recovery from scrap has increased sharply in recent years. Secondary production as a proportion of total production rose to a 10-year high of 15.3 percent in 2007, according to ICSG, reaching a total of nearly 2.8 million mt of refined copper from scrap. Semis producers are now maximizing their throughput of scrap at the expense of cathode, especially in China, the CRU analyst says.
Tightened environmental regulations have stopped nearly all copper smelting within the United States, making this country by far the world's largest exporter of copper scrap. In 2007, the United States exported 907,000 mt, with more than two-thirds of it going to China. That's an increase of 13 percent from 2006. Even with increased costs for collection and processing, most grades of copper scrap continue to be in high demand.
The supply of copper scrap seems to be plentiful as well. High refined copper prices increase scrap prices throughout the collection chain, bringing forth more scrap, the CRU analyst explains. In a rising market, hoarded scrap comes to the market and supplies increase. As the price stabilizes at the higher level, this speculative activity declines as the supply of hoarded scrap dwindles. Currently, availability has remained good as collection rates continue to be high and scrap moves rapidly through the collection chain, the analyst says.
In the longer term, increased environmental concerns will likely encourage more recycling. Electronics products with shorter lifespans, such as mobile phones and personal computers, are returning more quickly to the recycling stream and account for an increasing proportion of copper scrap. "Final consumption patterns are a key determinant of scrap availability," she says.
Other Market-Influencing Factors
Beyond the basics of supply and demand, copper prices take into account various other factors. Transportation costs, especially dry bulk carrier rates, "have exploded in the past two or three years," Mothersole says, mainly due to a lack of ships and high fuel costs. New ship launches scheduled for next year have the potential to mitigate this factor somewhat, he says.
Institutional investors also play a role. "Yes, interest in copper as an investment has risen, and some believe it has helped create a new super-cycle of higher prices," Edelstein says. "Others remain unconvinced of that influence." Mothersole is one of them. "The strength in commodity prices, I believe, is generally tied to fundamentals, not speculation," he says. "Certainly, investment demand is a large and growing component of the market, but the pervasive rise in commodity prices globally, in whatever currency you choose, suggests quite strongly that what is happening now is driven by demand."
One further concern: Primary supply shortages raise the specter of substitution. "Our own estimates suggest that between 2004 and 2007, around 1.3 million mt of copper were lost to substitution," CRU's analyst says. "The single largest substitution loss, in tonnage terms, was [the replacement of] copper plumbing tube [with] multilayer aluminum tubing and PEX (plastics). Technological changes and improvements have seen copper wire lose out to wireless and fiber optics." Further, the analyst says, "the main driver of roofing strip demand is the copper price relative to the prices of the very wide range of other roofing materials available," such as zinc, lead, slates and tiles, aluminum, steel, and plastics.
With all this in mind, some analysts still see continued high prices for copper for the rest of 2008. In mid-August, Citigroup (New York) upped its 2008 forecast to a $3.56 average for the year; Macquarie Group (Sydney, Australia) pegged the 2008 price at $3.84; Dahlman Rose & Co. (New York) picked $3.65; and a Reuters (London) survey of 46 commodity analysts came up with $3.66. At CRU Group, "we believe a surplus will now only emerge in 2009, with much of the excess appearing in the second half of the year, as the 2008-commissioned projects ramp up," the analyst says. "Ongoing supply-side uncertainties will bolster the market and support elevated prices." Global Insight comes to a different conclusion: Expecting slower demand growth and faster production growth, Mothersole sees copper prices "trending lower over the near term." Of course, only time will tell which is correct. •
Mark Crawford is a writer based in Madison, Wis.
Purchasing insurance, for most scrap managers, means venturing into the unknown. To get the right coverage, find an agent or broker you trust—but also shop around regularly for better deals.