|Summary: Demand for copper is rising, with China leading the charge, while declines in copper grades and production are causing supply shortfalls. All up, it’s a recipe for a higher copper price.|
|Key take-out: While copper consumed in automotive and appliances represent only 20% of demand, the growth in these segments will be very strong as China rebalances from investment to consumption.|
|Key beneficiaries: General investors. Category: Commodities.|
Copper is often considered a bellwether metal. Extensively used in construction, power generation, automobiles and consumer appliances, it is largely representative of the base metals complex and global manufacturing activity.
China now consumes over 40% of global production and will largely dictate the demand profile for the metal. Supply growth is constrained, which will support prices over time.
As shown in Fig 1, demand for electricity continues to grow, even as a country matures. China already has an extensive national power grid across over 700,000 kilometres of transmission lines. This compares with the US at about 600,000km. However, the Chinese grid has relatively few inter-connections with the considerable coal and renewable resources in the north-west, and hydro generation in the south-west. These shortcomings will be addressed through the State Grid’s (SGCC) plan to construct a new Ultra-High Voltage (UHV) AC network. Although SGCC’s 12th five-year plan is currently the focus of China’s UHV grid expansion, further plans for expansion are likely and this will greatly support copper demand.
While copper consumed in automotive and appliances represent only 20% of demand, the growth in these segments will be very strong as the Chinese economy rebalances from investment to consumption. While demand is set to remain strong over a number of years, constant supply disruptions have held the copper price well above the marginal cost of production.
A challenge for the industry is the constant decline in mined grades. Fig 3 below shows how copper grades have fallen for the last 80 years, with the exception of two periods when significant new regions began operation. For the period from 2012 to 2016 global grades are forecast to decline a further 0.05%, and this equates to 1.6 million tonnes of copper the industry will need to replace. Lower-grade mines will generally operate at a higher cost, and therefore as new low-grade mines are brought into production, prices will be supported.
The copper industry has a history of production interruption, with a range of factors causing supply shortfalls. A large portion of global production comes from unstable regions often subject to regulatory change.
Mongolia and the Democratic Republic of Congo (DRC) are two large copper-producing nations where politics has prevented expected supply growth. Chilean copper miner Codelco, which accounts for 10% of global production, faces ongoing employment issues that ultimately will result in significant worker strikes and production shortfalls. There also exists an ongoing engineering risk as mines become larger and deeper. This was most evident in April this year when the large Rio Tinto copper mine, Bingham Canyon in Utah, suffered a major pit wall failure.
There are a number of large copper mines that will close in the coming years, with Rio Tinto forecasting 1.8Mt of copper will be shut in between 2012 and 2016.
There also has been a number of large new copper mines shelved. BHP’s Olympic Dam, Newcrest’s Wafi Golpu and Xstrata’s Tampakan have all been put on the back burner as management focuses on shareholder returns and looks to minimise capital expenditure. This supply gap will support copper prices for years to come.
Australian miner Tiger Resources (TGS) operates the Kipoi copper project in the Democratic Republic of Congo. The company is currently developing Stage 2, a solvent extraction-electro winning (SX-EW) plant coming online in 2014. The mine will be low cost and high margin. There are obvious risks associated with operating in the DRC, however the shares are trading at roughly half my conservative valuation.
Justin Braitling is a principal of Watermark Funds Management at www.wfunds.com.au.