another interesting article - note previous email should read $10,000.
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A Perfect Storm For Copper?
FN Arena News - April 07 2008
By Greg Peel
Readers are directed to "Playing For Copper Upside" (Commodities, 04/04/08) as a precursor to this story.
The global copper supply situation is becoming critical. Credit Suisse notes copper consumers in the US and Europe have become scared off by talk of a US recession and made timid by the increased cost of working capital, and as such are now keeping inventories at the barest of minimums. The analysts suggest the current "just in time" purchasing policy is hazardous, especially if the US does start showing signs of a recovery in the second half of the year.
At the same time, Chinese consumers have been de-stocking since the end of Chinese New Year.
These developments are sure to be hot topics of conversation this week as the copper industry descends on Santiago, Chile, for the annual Centro de Estudios del Cobre y la Mineria (CESCO) conference. (Centre for Copper & Mining Studies)
Macquarie analysts suggest discussion will include the matter of whether or not recent strength in copper prices is simply a reflection of speculative fund buying and not of supply/demand fundamentals - "fluff" over "stuff". Macquarie notes an extra $30bn has been allocated by funds to long commodity products recently, and when you add in hedge fund short-covering there is little doubt the fluff is having a significant influence. However, the analysts believe it is currently more a story of stuff, given ongoing supply losses at the mine level, and at Chinese smelters and refineries since the devastating weather earlier in the year.
Chile's Escondida, which is 57.5% owned by BHP Billiton (BHP), and Collahuasi (Xstrata, Anglo American each 44%) are the latest mines to be added to the list of those having already lost significant amounts of production in 2008 as Chile battles to maintain a sufficient electricity supply. In the south of Chile, electricity relies on hydro power, and that area is currently in drought (one presumes it is the flipside of the La Nina turnaround). In the north, where the copper industry is most highly concentrated, mining relies on natural gas power. The gas is mostly imported from neighbouring Argentina, as long as Argentina has enough. Recently it hasn't. Mining companies have been forced to build back-up diesel-powered plants for such shortages, and diesel is much more expensive than gas.
Chile is one area in the world where analysts have been pencilling in new mining projects as part of the "supply catching up with demand" equation. This is all part of the longstanding "regression to the mean" theory of commodity prices, where higher prices encourage new supply and eventually new supply forces prices back down once more. Veteran resource analysts still underestimating China back in 2004 used this theory to forecast much lower commodity prices ahead. They soon had to admit they were wrong - not only on the strength of China's demand, but on the capacity of supply to catch up given a decade of commodity disinterest. Thus was born the "super cycle" or "stronger for longer" theory.
However, while analysts may have shifted their peak price forecasts out further into time, the rush to build new mines has meant regression theory has still played a part. Only now there is a new threat to the concept of prices ever returning to equilibrium. The world's power supplies cannot keep up with global mining industry expansion. The world is trying to win a Christmas lights competition by piggy-backing more and more power leads into the one socket, and that socket is starting to crackle.
While Macquarie's focus has been on Chile, the intrepid analysts at Credit Suisse have been trekking into the wilds of the Congo - another significant copper source. There they found the Congo's copper-rich Katanga Province has been suffering from - you guessed it- power supply problems. To make matters worse the sneaky Chinese, who operate smaller smelters in the region, have been sucking up most of the power while the government has been conducting a protracted licensing review for the larger mines. The larger mines are pencilled in to account for 11% of the world's copper supply growth for the next six years.
Both Macquarie and Credit Suisse further note sulphuric acid - a necessary ingredient of the refining process for 25% of the world's copper ore - is also in short global supply.
Costs are rising fast. Production is being constrained. Inventories have been run into the ground. New projects are in jeopardy. Funds are pouring money into commodities. As Credit Suisse puts it, "It seems a perfect storm is beginning to build".
So all that remains is to determine whether or not the demand side will hold up. If demand falls, then supply constraints are not so crucial.
Macquarie notes that despite what one might assume given the state of the US housing industry in particular, and the economy in general, US copper demand is at or above the current levels of this time last year. Yet global demand still hinges firmly on China, which accounts for 25%. One question which will surely be hotly discussed in Santiago is whether China has truly decoupled from the US, and as such a demand drop will not be experienced. Macquarie analysts are firmly of the belief China is decoupled - they note that when total global copper demand weakened in 2001, 2005 and 2007, Chinese demand remained "incredibly" strong.
Bear in mine that copper is the bellwether metal, given its extensive use in so many applications. Just think about the houses the Chinese are now building, the cars they are now demanding, and the sheer number of citizens lining up for their first telephone connection. Now consider that the last time all of the US, Europe and China were short on copper inventories due to de-stocking was in October 2005. Within six months the copper price had doubled.
It is with that in mind that Credit Suisse analysts believe their target of copper at US$12,000/t could be hit this year. Friday's LME spot price was US$8,635/t. CS is thus predicting a near 40% run-up.
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