September 3, 2013 / 1:21 PM / 6 years ago

COLUMN-Waking up to the new copper supply narrative: Andy Home

By Andy Home

LONDON, Sept 3 (Reuters) - State Chilean copper producer Codelco’s first-half results were a reminder of the market’s historic supply challenges.

Headline production from the company’s own mines, excluding its holdings in the El Abra and Los Bronces operations, fell 1 percent relative to the first half of 2012.

Three of Codelco’s six mines reported lower output. That at Radomiro Tomic was unchanged. Only two, Teniente and Gaby, managed to buck the negative trend.

The company’s costs rose sharply, and it is struggling to find the money to deliver on its investment programme.

This, remember, is the world’s largest producer.

And until very recently its uphill battle to maintain production from a portfolio of aging mines with declining grades was part and parcel of a broader market narrative of constrained supply and high prices.

That global narrative is changing, however, and Codelco is increasingly an outlier among the world’s major copper producers.

CHILEAN BOOM

Codelco is no longer representative of even the Chilean copper sector.

National copper production is surging, up a massive 16 percent year-on-year in July, according to the INE statistics agency.

The scale of the July jump is overstated by a low base point in July 2012, but cumulative production growth was still an extremely robust 6.3 percent in the first seven months of this year, compared with a 10-year average of just 1.4 percent growth, according to analysts at Macquarie Bank.

Evidently, higher production is coming from mines other than those operated by Codelco.

The single most important driver has been Escondida, the world’s largest mine, where stakeholders, led by majority owner and operator BHP Billiton, have invested heavily to return production to historic levels.

Escondida’s annualised output in the second quarter was 1.24 million tonnes, a run rate not seen since 2009.

Similar investment programmes are paying off for other local producers such as Antofagasta and Anglo American , which reported first-half production increases of 8.4 percent and 7.0 percent, respectively.

GLOBAL BOOM

Nor is it just Chile.

Global mine production increased by around 9.0 percent in the first five months of this year, according to the International Copper Study Group (ICSG).

Production of concentrates, as opposed to straight-to-metal SX-EW output, rose by an even faster 10.5 percent.

It is the rehabilitation of another historic copper-mining powerhouse, the African Copper Belt, that is the global standout. Regional copper production jumped 33 percent in the January-May period, according to the ICSG.

This growing supply surge has not yet affected the refined copper market. It remains transfixed on the state of demand, particularly Chinese demand. Witness the Monday jump in the London Metal Exchange three-month copper price on the release of a better-than-expected Chinese purchasing managers index figure.

But it is starting to impact the copper raw materials market in the form of rising treatment and refining charges, the fees charged by smelters for converting concentrates into metal.

UK analysts IntierraRMG note that, “whereas late July, spot deals between miners and smelters for clean material could be signed in the low 70s and 7s, today the figure is edging over $80 per tonne and 8 cents per lb”. (“Copper Briefing Report”, September 2013).

“Gone also are the deals in the 50s and 60s between miners and traders where, with the exception of contracts for clean material needed urgently for blending, the market rate is approaching $80 per tonne and 8 cents per lb,” it adds.

DIMINISHING DISRUPTION

Another change in copper mine narrative this year has been the relative lack of supply disruption.

The two big hits so far have come from the pit collapse at Rio Tinto’s Bingham Canyon mine in Utah and the fatal cave-in at Freeport McMoRan’s Grasberg mine in Indonesia.

Based on the companies’ most recent guidance, each will cost around 100,000 tonnes in lost copper production - not enough to cause analysts to make any revision to their disruption allowances.

There is the potential for more disruption, however, from strike action, particularly in Chile and Indonesia.

A mid-week deadline is fast approaching for a proposed walk-out by union members at Codelco’s small Salvador division , while tensions are also simmering at the far more important Escondida.

Perhaps the main “known unknown”, though, is the pending labour contract negotiations at the Grasberg mine in Indonesia.

Two years ago workers embarked on a protracted walk-out, the first in the mine’s history. The production impact lasted well into 2012.

It goes without saying that already strained management-union relations have not been helped by the fatal tunnel collapse earlier this year. [ID:nL4N0GT1XF}

MORE TO COME

This wouldn’t be the copper market if there wasn’t the potential for the unexpected to happen, which is why the analyst community builds a disruption allowance into its supply calculations.

But any further supply hits are going to do no more than delay the inevitable.

The full force of this building supply wave is going to hit next year as new mines such as Oyu Tolgoi in Mongolia and Toromocho in Peru hit their full stride.

Even Codelco has a new mine, Ministro Hales, due to start commissioning around the turn of the year, and with a bit of luck it will no longer be reporting headline declines in output this time next year.

Macquarie Bank notes that “the top 10 growth projects alone are expected to deliver close to a million tonnes of copper” in 2014. (“Copper Outlook”, Sept. 2, 2013).

It is forecasting global copper mine growth of close to 7 percent next year, which if achieved, would be the fastest rate of growth in a decade.

IntierraRMG is projecting a more conservative 5.5 percent growth rate, but even that translates into refined market surplus.

CHANGE OF NARRATIVE

All of which makes the current bullish undertone to the LME copper market slightly curious.

But the refined market is still overly focused on its own dynamics, most recently the sharp shift in fund positioning from short to neutral, and on flows of refined metal into China as a proxy for demand in the world’s largest single buyer.

Overlooked, though, is the even faster growth of China’s imports of copper concentrates and the potential for higher domestic refined output.

That in itself is perhaps the best indicator of the step-change that is taking place at the mine stage of the production chain.

Moreover, the refined copper market has got so used to the old narrative of supply woe that it risks underestimating the impact of the new one.

Codelco’s first-half results may have been one of the last chapters in that old story. Those national Chilean production figures are a sign that a new story is fast unfolding.

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