Copper ignores supply side, but for how long?

The disconnect between copper supply and price is finally starting to shrink.

Summary: Two mines accounting for an estimated 9 per cent of global copper are facing disruption.

Key take-out: Deutsche Bank reckons a seachange is underway in copper with 2017 and 2018 being 'transition years' from surplus copper production to years of deficits.

Key beneficiaries: General investors. Category: Commodities, shares. 

In theory, the price of copper should have been rising over the past month rather than falling; not just because demand remains reasonably strong but, moreso, because the world’s two biggest copper mines have been hit by production disputes which are limiting output.

A strike by workers at the BHP Billiton-led Escondida mine in Chile has removed 2500 tonnes of a copper a day from the market and while some work is restarting with temporary labour the world’s biggest copper mine is not expected to quickly return to full production.

It’s a different story at Grasberg, the world's second-biggest copper mine, but the result is the same with a dispute between the owner, US-based Freeport McMoRan, and the Indonesian Government over export quotas removing 1700 tonnes a day from the market.

Between them, the two mines account for an estimated 9 per cent of annual global copper output. And while it is expected that both will eventually resume production, there's no way of knowing when.

Less copper reaching the market, coupled with a steady increase in annual consumption of around 2.5 per cent, should be a recipe for a higher price and not the 4.5 per cent price fall since mid-February after trouble started at Escondida and Grasberg.

For some copper users, such as China’s copper refining companies, the reduced flow of freshly-mined material is starting to hurt, forcing them to consume stockpiles, especially of copper concentrate, the powdery feedstock used to make cathode which leads to the production of wire and other forms of copper used extensively by industry and electrical-goods manufacturers.

Jiangxi Copper, one of China’s biggest refiners, reported earlier this week that supplies of concentrate were running low. The company’s chairman, Li Baomin, told London’s Financial Times newspaper that: “It’s the first time in 15 years that copper concentrate has not been over-produced.”

There are signs that the disconnection between what’s happening in the copper supply chain and what’s happening in the copper market is starting to correct, as are the share prices of copper-mining companies.

Over the past four days the copper price has risen by US7 cents a pound from $US2.57 to $US2.64. Pure-play Australian copper miners such as OZ Minerals and Sandfire Resources have also reacted. OZ added 33c (4 per cent) to $8.36 to Wednesday this week.

Sandfire added 15c (2.3 per cent) to $6.55 and continues to rise, but both remain below their price before the troubles started at Escondida and Grasberg. BHP Billiton and Rio Tinto – Australia’s two biggest diversified miners with major copper divisions – also appear to be reacting to the copper situation, posting reasonable price rises since the start of the week.

Production disruptions are not new in the copper industry with two of the world’s traditional hot spots for industrial and government disputes, South America and Africa, accounting for the lion’s share of supply. Australia is the sixth biggest copper mining country.

Why the copper price has not risen steadily since Escondida and Grasberg were hit by workforce and government problems has investment bank analysts scratching their heads because, while the current issues could soon be fixed, the outlook is for a more fundamental shift in the copper market. Deutsche Bank reckons that a seachange is underway in copper with 2017 and 2018 being “transition years” as the past six years of surplus copper production give way to five, and possibly more, years of deficits which should underwrite the future price of the metal.

“Our initial assessment of the market for 2017 was a surplus of 150,000 tonnes, but given the challenging situation with Freeport’s Grasberg mine and the part-owned Gresik smelter in Indonesia, we now think the market will be a deficit of 210,000 tonnes,” Deutsche said in a note on March 1.

Goldman Sachs shares that positive view about copper, and the wider commodities sector, as supplies of essential raw materials continues to tighten despite concern about a slowdown in the Chinese economy.

Jeffrey Currie, head of commodities at Goldman Sachs, said earlier this week that: “All of these concerns are misplaced. The markets need a little patience to wait for the fundamentals to materialise.” Goldman Sachs reckons that copper in the June quarter will rise to $US6200 a tonne, or $US2.82/lb, up 7 per cent on its current $US2.64.

Most other expert forecasts for copper are equally optimistic. UBS is forecasting an average price for this year of $US3/lb, rising to $US3.25 next year.

“Our thesis is that demand growth from China, plus flat global mine supply in 2017 will drive a market deficit,” UBS said earlier this month.

“The (market) signals do not yet show what we expect to see soon, a tighter copper market and signs of supply anxiety.

“Grasberg stopped shipping concentrate on January 12 and is now ramping down mining operations. A strike at Escondida started on February 9 but concentrate shipments from stockpiles may have continued.

“So, the impact of these two large supply disruptions many still take a month or so before tightening the physical concentrate trade because of (material available from) stockpiles.”

Macquarie Research is concerned about China’s rate of economic growth and believes that the copper price could fall sharply when the Escondida strike is resolved.

But after the current supply disruptions and a price correction to accommodate the return to normal rates of production, the overall copper market is expected to move from surplus to deficit.

“By the end of the decade we expect copper to be in a substantial structural deficit,” Macquarie said.

In its analysis of the supply/demand balance Macquarie sees a small-copper supply surplus until 2020 when there is expected to be a deficit of 332,000 tonnes a year, ballooning out to 770,000 tonnes in 2021, when the price should average $US6425/t ($US2.91/lb).

For investors, the copper picture is changing and while the current supply disruptions at Escondida and Grasberg are being discounted as one-off events that will eventually be matched by a return to normal levels of output, the longer-term view is of a shortfall in supply which should drive the price higher. At least, that’s the theory.

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