Transcript Mining Journal’s Copper 20:20 Day London, October 5th 2007

MEDIUM AND LONG TERM MARKET
INFLUENCES:
WHAT IS THE EQUILIBRIUM PRICE
FOR TOMORROW’S COPPER?
Paul Dewison of Bloomsbury Minerals Economics
FINEX Conference – October 28th 2010
TOPICS ADDRESSED

Copper demand: How sustainable is its growth?
• Historically, copper moved in tandem with industrial production
• There was a major disconnect as prices rose from 2004 to 2008
• What does the future hold?

Copper supply: Enough to cover demand growth?
• Lack of good new projects and unstable supply a growing market
feature
• If demand growth holds, will there be enough copper?

Copper price: Not just a story of physical fundamentals
• With fund involvement, we need to consider the virtual market
balance as well as what the physical market can tell us
• The implications for medium term price are positive, if less certain
than a traditional supply-demand-price analysis would suggest
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• Longer term, fund influence should retreat and prices
stabilise at a more sustainable level
COPPER USE AND INDUSTRIAL PRODUCTION
AT FIRST SIGHT, THE TWO APPEAR TO MOVE HAND IN HAND
IP & Refined Cu Use
(Index)
3
IP & Refined Cu Use
Change
IP Change & Cu Use /IP
Growth Differential

Over the 20 years 1990-2010, refined Cu use moves more-or-less in line with IP

Historically, Cu use was more volatile than IP, but not in 2009

Copper appeared to be losing ground seriously against IP 2005-2008

The lost ground was regained in 2009 and appears to have been held in 2010

Will copper use resume its close relation to IP in coming years?
COPPER PRICE, COPPER USE AND IP
THE RELATIONSHIPS BETWEEN THE THREE ARE NOT STRAIGHTFORWARD
Copper Price & Refined
Cu Use Change

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4
Copper Price Change &
Cu Use/IP Differential
Copper Price & Cu Use/
IP Differential
Changes in copper use have shown no obvious relation to price in the past
Where there is a relationship, causality can run either way, leading to opposite
outcomes (i.e. high prices can limit consumption, low consumption can limit
prices - all else being equal)
Copper price change can be linked to the differential between Cu use
growth and that in IP: Rises in copper price tend to mean a negative
differential (lower copper use)
COPPER’S PRODUCTS AND APPLICATIONS
DYNAMICS OF CONSUMPTION SHOULD BE ASSESSED FOR EACH
PRODUCT/APPLICATION CELL
WIRES, CABLES & LEADS
Building Construction
Power Network
Telecom Infrastructure
Industrial & Transport Machinery
Automotive
Air Conditioners
Electrical & Electronic Equipment
General & Other Markets
TOTAL
MILL, FOUNDRY & OTHER PRODUCTS
Energy / Bare
Telecom/
Winding
Copper
Cu/Alloy
Alloy RBS
All
Cable & Wire
Data Cable
Wire
Tube
PSSF
& Other
Products
18%
1%
0%
4%
1%
5%
30%
0%
3%
11%
6%
2%
0%
3%
4%
0%
0%
3%
3%
1%
0%
1%
0%
4%
1%
8%
16%
3%
0%
8%
0%
7%
4%
1%
12%
6%
4%
0%
3%
5%
0%
1%
0%
4%
3%
12%
41%
5%
11%
10%
13%
19%
100%
Total of 19 marked cells = 90% of the market. Figures relate to total copper use, including scrap.
> 10%
5
TOTAL
> 5%
>1.5%
STRUCTURAL TRENDS BY MAIN MARKET SEGMENT
MIXED PROSPECTS FOR MOST AREAS, BUT SOME SERIOUS NEGATIVES
WIRES, CABLES & LEADS
Energy / Bare
Cable & Wire
Telecom/
Data Cable
Winding
Wire
MILL, FOUNDRY & OTHER PRODUCTS
Copper
Tube
Cu/Alloy
PSSF
Alloy RBS
& Other
TOTAL
All
Products
Building Construction
Power Network
Telecom Infrastructure
Industrial & Transport Machinery
Automotive
Air Conditioners
Electrical & Electronic Equipment
General & Other Markets
TOTAL
Note: Winding wire in automotive added as a positive despite relatively small current market size
Positive
6
Negative
Mixed Positive & Negative
THE IMPACT OF PRICE ON CONSUMPTION RE-ASSESSED
SUBSTITUTION IS MOST SENSITIVE TO THE COPPER PRICE
7
THE OPPORTUNITIES FOR COPPER IN NEW MARKETS
ELECTRIC VEHICLES, POWER INFRASTRUCTURE AND PREMISE MARKETS
ALL OFFER OPPORTUNITIES



8
The main opportunities in copper
have 3 focal points – each driven
to a greater or lesser extent by
the need to reduce carbon
emissions and to create a stable
energy future
The focal points in order of
importance are: (1) Transport
(electric & hybrid vehicles); (2)
Power infrastructure
(distributed & renewable energy,
smart & integrated networks; (3)
Premise & Equipment (enhanced
wiring, efficient systems and
equipment)
Taken together, new markets are
expected to contribute around
1.0Mt of consumption over the
next decade
LONG TERM PROSPECTS FOR COPPER CONSUMPTION
WILL COPPER CONTINUE TO HOLD ITS OWN AGAINST IP?
Status Quo Market Development

Historically, both IP and Cu use had growth at a trend rate close to 3% p.a.

Similar (slightly higher) IP trend growth is expected for the long term


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Trend 1% Loss of Cu Use Against IP
The experience of 2005-2008 has shown that while copper usually moves with IP it
can underperform when prices are high. Some divergence is forecast by 2015
Very high prices sustained over a long period opens up the very real
possibility of a sharp divergence between IP and price (see chart on right)
COPPER OUTPUT AND COPPER USE
SAME TREND GROWTH, BUT SIGNIFICANT ANNUAL DISPARITIES
Refined Cu Output &
Refined Cu Use (Index)


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Refined Cu Output &
Refined Cu Use (%change)
Refined Output/Use
Differential & Usage Growth
Both copper output and use grew at a trend rate of 3% p.a. 1990-2010
In individual years, wide disparities between output and use emerge, with
differences in growth rate of over 2% p.a. being commonplace
This suggests that supply is not particularly responsive to demand, at least in
the short term
COPPER PRICE, COPPER OUTPUT AND USE
SUPPLY RESPONDS TO PRICE STIMULUS, BUT GROWTH APPEARS CAPPED
Copper Price & Refined
Cu Output Change



11

Copper Price Change &
Cu Output/Use Difference
Copper Price % Cu
Output/ Use Difference
At face value, history has shown no obvious relationship between price and output
In general, copper output has underperformed copper use growth at times when
prices have been rising
The period 2004-2008 was an exception, as output rose faster than use, in part
reflecting a strong supply response in the context of very high prices
Even given price stimulus, it appears that copper is not able to sustain an
output rise of more than around 4% p.a.
CONSTRAINTS ON COPPER SUPPLY GROWTH
AGEING MINES, LOWER ORE GRADES, OPERATIONAL CONSTRAINTS,
POLITICAL AND ECONOMIC RISK COMBINE TO LIMIT OUTPUT GROWTH

At some large existing mines ore grades are falling
e.g. Escondida, Codelco Norte, and La Candelaria

In traditional mining areas new ore grades are typically lower (around 0.6% Cu)

New high grade mine projects are mainly in remote or high risk regions

Global constraint on the availability of engineering services & skilled workers

Local constraints on water and power supplies

Capital and operating costs are rising

Strikes and tougher tax regimes are being encouraged by high prices

Unexpected and serious problems emerging with some host governments
e.g. The revoking of First Quantum mining licences in D.R.Congo

Environmental issues threaten to scupper viable projects
e.g. A ban on open pit mining in part of the Philippines, threatening Tampakan

Arsenic impurity affecting some projects, with limited treatment facilities
CONCLUSION: COPPER OUTPUT UNLIKELY TO HOLD ITS
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HISTORICAL GROWTH RATE EXCEPT UNDER VERY HIGH PRICES
THE BIG COPPER PROJECTS TO 2015 (INTIERRA)
SMALL NUMBER OF PROJECTS OVER
100 KTPY AFTER ESPERANZA
CONFIRM THE POSSIBILITY OF A SUPPLY SHORTFALL
13
LONG TERM PROSPECTS FOR COPPER OUTPUT
IF COPPER USE CONTINUES UNABATED, A SUPPLY SHORTFALL IS LIKELY
Status Quo Market Development


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
Possible Supply Shortfall if Demand Unabated
If copper carries on as before, we should see a trend rise in output and use of 3% p.a.
Some commentators now believe that copper faces an absolute supply growth cap of
around 2.5% p.a.
Given very high prices output may perform better, but at prices below around
$5,000/t, low investment should mean output growth of 2% p.a. or less
Considering the above, a significant supply shortfall looks likely unless
prices are sufficient to encourage new capacity, and reduce consumption
WHERE IS THE MARKET EQUILIBRIUM? (1)
PHYSICAL DEMAND
/ SUPPLY ECONOMICS GIVE LITTLE INSIGHT ON PRICE


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Traditionally, analysts have
expected price to move along with
the physical market balance, as
indicated by the movement in
exchange stocks
This chart shows just how little
explaining power this type of
analysis offers
Either the stock to price curve is
subject to frequent realignment, or
we should be looking somewhere else
entirely to explain price
In fact both are true, and long
investment is the common driver
Investment longs, a growing feature
of the market, tend to shift the stock
price curve upwards and to the right,
meaning that for any given price, the
market will sustain a
higher level of exchange
stock than previously
WHERE IS THE MARKET EQUILIBRIUM? (2)
HOW INVESTORS’ LONG POSITIONS IN THE FUTURES MARKET OFFSET
THE BEARISH EFFECT OF HIGH STOCKS IN THE PHYSICAL MARKET

The relationship of exchange stocks to price has two elements:
1) The level and direction of change of total stocks are good indicators of physical market
conditions generally and, via sentiment, indirectly affect price, mostly rather gently
2) In the normal contango market, exchange stocks are hedge sold forward. This locks up
stock in the futures market, directly depressing prices


Investor longs affect the second of these relationships, long investment directly
counterbalancing the contango-earning hedge shorts and raising the price
corresponding to any given stock level
Thus, a new market equilibrium emerges:
Old Equilibrium
New Equilibrium
Cu Output = Cu Use
Cu Output = Cu Use + Net Tonnage Bought by Investors
Stock Change = Zero
Stock Change = Investment Holdings Change
Consequences for Price
Higher prices are required to stimulate an equilibrium rate of stock increase
A contango is needed so that exchange stocks are hedged
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WHERE IS THE MARKET EQUILIBRIUM? (3)
INVESTOR LONG CONTRIBUTION TO VIRTUAL BALANCE RAISED PRICES
Exchange Stocks and Cu Price
Virtual Balance and Cu Price
Investor longs
often work to
greatly
accentuate a
physical market
imbalance but
can, as in 2008,
run counter to it
DATA, SELECTED YEARS
2003
2006
2009
2012
2015
-484
97
296
-65
207
-20
-195
649
-128
71
5
40
347
-53
161
Physical Balance
-504
-98
945
-193
278
Virtual Balance
-499
-59
1292
-246
439
Effective Stock Additions (kt)
Exchange Stocks
Off Exchange Physical Stock
Investor Long Holdings
Market Balances (kt)
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Cu Price ($/tonne)
1,779
6,721
5,149
8,640
7,725
WHERE IS THE MARKET EQUILIBRIUM? (4)
PHYSICAL EQUILIBRIUM WHERE DEMAND AND SUPPLY CURVES CROSS
Cu Output and Use Annual Volume
Change at Different Prices*
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* The annual volume changes above are based on
a notional 20 Mt market
Since 2004, prices have been
influenced by investment longs,
allowing high prices and quite high
stocks to co-exist
In the short to medium term,
investor long influence should rise,
especially if ETFs become a part of
copper’s landscape
For the period to 2015 we expect
prices to range up to $9,000/t on an
annualised basis, at the cost of large
increases in physical stock (around
800 ktpy at $8,500/t, 500 ktpy at
$7,500/t, 250 ktpy at $6,500/t)
By mid-decade, fresh investment in
copper should subside, not least
because of the build up of physical
stock. Long term, prices may move
close to the physical market
equilibrium of around
$5,500/t
COPPER PRICE PROSPECTS BEYOND 2015? (1)
PRICES ARE QUITE LIKELY TO REVERT TO THE PHYSICAL EQUILIBRIUM
POINT
($5,500/TONNE)
A Notional View of Copper Market Balance and Price to 2030
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COPPER PRICE PROSPECTS BEYOND 2015? (2)
HUGE INVESTMENT INFLOW WOULD BE NEEDED TO ALLOW SUSTAINED
HIGHER PRICES
An Alternative Notional View of Copper
Market Balance and Price to 2030


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
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Here we consider the implications of
a constant price of $6,250/tonne
There would be structural gap of
about 1% p.a. between supply growth
(boosted by the higher price), and
demand growth (constrained by price)
A huge cumulative rise in annual
market surplus would result,
meaning the build up of visible stocks
to levels many times what we have
seen to date
This increase could be offset by
drawdown of virtual stock through
fund investment and ETPs, but only
if such investment reaches many
times the level we are seeing today
So, sustained prices even modestly
above physical market equilibrium
imply a very different type
of copper market
CONCLUSION
WHAT IS THE EQUILIBRIUM PRICE FOR TOMORROW’S COPPER?

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Copper Demand: Despite new markets, consumption growth is
vulnerable at high prices
Copper Supply: Difficult to sustain growth much above 2.5% p.a.,
even at high prices
Price Dynamics: Prices no longer relate simply to the physical
market balance, as investor longs influencing the effective (or “virtual”)
market balance need also to be taken into account
Equilibrium Prices: We estimate that a physical market equilibrium
can be achieved at around $5,500/t at 2.5% p.a. growth in both copper
output and copper use. Investor influenced prices may be higher
Medium Term Prices: Growing investor commodity exposure and the
introduction of ETFs should buoy up prices beyond the physical
equilibrium price to at least 2013, taking average annual prices up to
as much as $9,000/t
Long Term Prices: Growing physical stocks and a move of investors
away from commodities is likely to lead to an erosion of prices towards
the physical market equilibrium point ($5,500/t), but continued
growth in investment may allow sustained pricing above this
While this presentation has been prepared with care, Bloomsbury
Minerals Economics Ltd makes no warranty regarding the contents,
and shall not be liable for any incidental or consequential damages
arising out its use.
Further information on BME price models and whole industry models
can be obtained from Robert Goldstein: [email protected]
The Interactive Copper Price Model is available on a multi-client
basis for a license fee of £10,000 per annum. Sponsorship opportunity
available for the proposed Copper Whole Industry Model price on
application.
BME’s monthly Copper Briefing Service is available at a price of
£1,850 per annum for a single user.
See also our website: www.bloomsburyminerals.com
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