By Andy Home
Supply shortfall has defined the copper market for several years now.
Many of the world’s biggest copper mines are aging and ore grades have been falling accordingly.
Mine capacity utilization fell steadily from over 90 percent at the start of the last decade to 80.4 percent last year, according to the International Copper Study Group (ICSG). This year has been even worse. Capacity utilisation in the first eight months slid to just 77.5 percent.
Overlaying the problem of lower grades has been the spate of industrial action that has plagued the copper mining sector throughout 2011.
The tally of units lost to strikes is still rising thanks to the ongoing shutdown of the world’s second-largest copper mine, Grasberg in Indonesia.
A growing number of analysts are now expecting copper mine supply to contract this year, such has been the litany of hits to production. But, if the deal between U.S. miner Freeport McMoRan and Japan’s Pan Pacific on the supply of concentrates next year turns out to be a benchmark, it will be a strong signal that copper’s supply dynamics are about to change.
The first question, though, is whether the Freeport deal with Pan Pacific is the “true” 2012 benchmark.
The terms mirror a similar supply deal negotiated between Freeport and China’s Jiangxi last month, namely a treatment charge (TC) of $63.5 per tonne and a refining charge (RC) of 6.35 US cents per pound.
The fact that smelters in both China and Japan, the two biggest buyers of copper concentrates, have signed up to the terms will make it difficult for others to argue that these are not the 2012 benchmark terms. But argue they certainly will.
After all, these terms are up on the 2011 benchmark of $56 and 5.6 cents even though the spot market for concentrates is trading at much lower numbers.
Offtake deals between miners and traders have seen TCRCs fall as low as $20 and 2.0 cents in the last few weeks, albeit with likely offsets in the clauses that don’t make it into the headlines such as quotational period.
These are distress levels and suggest a market that is desperately short of units to the point that spot terms are not commercially viable for smelters for any sustained period of time.
Of course the key cause of this distress is the three-month-old strike at Freeport’s Grasberg mine, where production has ground to a complete halt.
Freeport has declared force majeure on deliveries from Grasberg, which injects a degree of complexity into the 2012 terms it has negotiated with Jiangxi and Pan Pacific.
Part of the concentrates included in next year’s contracts will come from Grasberg but, assuming the mine is producing by that stage, the Grasberg component will likely be delivered under 2011 terms as the company backfills this year’s contractual commitments.
Evidently the longer the strike continues, the more Grasberg tonnage will be affected and the more the benchmark will start to look like pricing for the second half of next year rather than the full calendar year.
The question of whether this is a “true” benchmark for 2012 goes beyond the esoteric confines of the copper raw materials market.
After all, the terms are clearly an improvement on this year’s and signal better availability of concentrates next year. That in turn implies better availability of refined metal. In itself that is not too surprising.
World mine supply is projected to grow by 9 percent in 2012, on paper at least, according to the ICSG.
Of course this being copper, no analyst is taking that growth figure at face value. All will put a disruption allowance calculation into their projections.
The ICSG, for example, is allowing for just over 700,000 tonnes of copper lost to disruption in one form or another next year. That just about halves the theoretical rate of production growth.
Others will contend that even that assumption is too generous, given the multitude of potential problems lurking within the world’s ageing minestock.
But it would still be remarkable if copper mine supply didn’t grow at all and that is broadly what the terms of the deals Freeport has struck are telling us.
The question, though, is one of timing. And this is where the issue of whether Freeport’s terms are the real 2012 deal or a false signal comes into play.
There are massively different implications of the copper concentrates market returning to surplus early next year, as implied by the Freeport terms, or later next year, as implied by the spot market.
If it’s later in the year, copper concentrates availability will remain a constraint on overall supply growth for several more months at least.
The refined copper market will remain in underlying deficit and the price will remain prone to upside surprises in the event of industry restocking, particularly in China.
But if the raw materials market is poised to turn sooner, indeed just as soon as Grasberg restarts production, better availability along the supply chain will coincide with deteriorating demand conditions to undermine price.
What the market therefore needs is confirmation that smelters can wring similar terms out of producers other than Freeport, in effect removing the problematic Grasberg part of the equation.
BHP Billiton is a power house in the copper raw materials sector because it markets concentrates from the world’s biggest mine, Escondida in Chile.
Historically the company has also led changes to the way concentrates are sold, such as forcing through the removal of price participation by smelters a couple of years ago. Last year it partially blew apart the annual benchmark by offering six-month contracts.
It is likely to do the same again this year. Indeed, there has been talk of quarterly contracts, mirroring the pricing revolution BHP has pioneered in other raw material markets such as iron ore and alumina.
While moving away from annual benchmarks is a matter of faith for BHP, last year’s move was at least partly due to negotiating stalemate with smelters.
The compromise between two completely differing views of the copper raw materials market was to use shorter-dated contracts, giving greater weight to spot market gyrations. If the same were to happen for the first part of next year, the terms would almost certainly be lower than Freeport’s, given current bombed-out levels in the spot market.
A BHP Billiton copper concentrates deal for 2012 remains conspicuous by its absence, attesting to another stalemate with buyers.
How that gap is bridged this time around will tell us a lot about how the world’s miners and smelters see copper supply evolving over the coming months.
Andy Home is a Reuters columnist. The opinions expressed are his own.
© Thomson Reuters