IT IS crystal ball time again this week as we seek out the likely future for copper prices, presently sitting near record levels. Lots of other analysts are looking into the future of copper, too, of course – with some predicting a precipitous fall to below $US1.50 per pound by 2012. Allan Trench argues that just won’t happen – here’s why.
Recent discussions across the financial sector and copper’s supply-side have highlighted a polarisation of opinion on future prices.
Given the time required to deliver new projects, the 2012 price is as important to many stakeholders as 2008. Right now, Bulls in the market see little but production shortfalls ahead.
In contrast, Bears point only to rapid deceleration in Chinese consumption growth. So will prices break record levels or revert back to historical levels this cycle?
Lenders must naturally take a conservative approach to price risk, with some credit committees using assumptions below $US1.50 per pound by 2012.
Why? A failure of analysts to reach consensus is one reason.
Why should a lender not simply choose the lowest common denominator from among analysts’ forecasts to stress-test projects?
After all, some analysts do predict prices below $1.50/lb in that timeframe.
To Strictly Boardroom’s mind the available evidence argues strongly against a copper price collapse. Here are 10 reasons why*:
1. Short-run marginal costs will lie above $1.50/lb in 2012; incremental supply will be lost should prices plummet. Lost supply will tender price support.
2. For past cycles, prices typically remain above short-run marginal costs when viewed on an annual basis, dipping below marginal costs for only short periods. The annualised price buffer to costs is around 10-15%.
3. Future investment will stagnate: trigger prices for many projects are now $1.50/lb and above. Operating costs alone of several projects likely to be commissioned are at that level.
4. Payback calculations using $1.50/lb copper do not provide a return on investment for even industry-average projects with capital intensities of $US10,000 per tonne of new copper, let alone the more capital-intense projects.
5. Market balances to 2012 are highly dependent on new projects in Central Africa. Investors seek to earn a risk-premium to invest in such locations. That premium is more likely to come from high copper prices than from Herculean effort to maintain operating margins at $1.50/lb copper.
6. The cost of project externalities and government share is becoming more significant. Examples are higher royalties, windfall taxes and off-site energy-related investments by mining companies. It is illogical that no cost pressure will come from externalities through until 2012 – even if one ignores global environmental challenges.
7. Ownership of copper projects is concentrated among a select few large miners. Projects will be sequenced to protect balance sheet strength and debt rating. Future supply may experience even further delays than currently envisaged.
8. Copper consumption forecasts must cater for China growth, India and for development in the Gulf states. These consumption hot spots will deliver above global-average growth rates to 2012. Growth in these regions is unlikely to be smooth, with the potential to spike year-on-year. Continued volatility in demand can result in prices above short-run marginal costs on an annualised basis.
9. Supply disruptions and fund interest in copper have changed the stocks-to-price relationship since early 2006. With supply disruptions to increase as additional copper is supplied from regions with power constraints, the copper price will be higher than in past cycles for similar stock levels on a weeks of consumption basis.
10. The market already foresees a stronger cycle. The far-forward curve has flattened. While the forward curve remains a poor predictor of price, flattening of the curve indicates the market is less certain that future prices will “revert to mean”. Past cycles have seen copper prices stay elevated for decades in real terms, not simply years.
Ironically, if analysts and lenders continue to believe prices will collapse below $1.50/lb in 2012, then that outcome has even less chance of becoming a reality. What do you think?
Allan Trench is adjunct professor of Mine Management & Mineral Economics, Western Australian School of Mines and is a non-executive director of Pioneer Nickel, Navigator Resources and Enterprise Metals. He is regional director, Australasia at the CRU group ([email protected]).
*This article is adapted from a recent communication to CRU copper clients.
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