Will copper recover sooner than people think?

A review of what is happening in copper supply suggests that losses in output through closures and project abandonments may be sufficient to turn the market round quicker than many analysts would seem to contemplate.

Author: Chris Welch
Posted: Tuesday , 17 Feb 2009

LONDON (Bloomsbury Minerals Economics) -

Copper's near term prospects are bleak, of that few are in any doubt. But, the loss of many mining projects in the production pipeline due to the credit crunch and low copper prices gives hope for a copper price recovery sooner than many would expect. This can only be good news for the mining industry.

Recent History

The rapid increase in copper prices in late 2005 and early 2006 encouraged all copper miners to operate at maximum capacity irrespective of operating costs, which had become a small fraction of copper prices. In spite of the price stimulus, between 2005 and 2007 copper mine production only increased by 4% to 15.5 Mtpy. The inability of producers to increase production enough to meet the runaway demand during the 2005-07 period shows how difficult copper mining had become.

From mid-2005 to mid-2008, the copper mining industry was plagued by rapidly increasing operational and development costs, due to high energy prices, insufficient technically skilled staff, equipment shortages and long delays for long-lead items such as SAG mills. The copper price was incentive enough to encourage production and expansion during this period. Now that copper prices are more than 60% lower than at the price peak in mid-2008, the incentives to achieve maximum output is no longer there.

Present Situation

Miners have reacted to the global economic slowdown and the credit crunch by drastically cutting capital expenditure, reducing staff, and altering mine plans to favour cheap ore production rather than maximising copper output. This shows more dynamism in miners' response to the demand slowdown than in previous periods of weakening demand. Production cuts will lessen the extent of the stock build, but will be no means prevent one in the near term.

The immediate problem facing copper miners of all scales is maintaining a positive cashflow. Recent acquisitions encouraged by high metals prices have left several of the major diversified mining firms with large debts, in particular, Rio Tinto. Its purchase of Alcan has left the company with a debt of approximately $40 billion. Refinancing debt and securing more debt financing has become a key issue due to the credit crunch, particularly those companies crossing from the development stage to the production stage. Many have had to find alternative means to fund their operations, or have sold stakes in their operations to provide cash. Others have turned back to the shareholders to generate capital by issuing more stock. Some, like Anvil Mining, which has several operations in the Democratic Republic of the Congo, have put their mines on care and maintenance to preserve capital. Until credit becomes easier to acquire, more smaller scale mines are likely to follow the same path.

Primary copper consumption is in the doldrums. A year on year fall of 4% to 7% is expected in 2009. As a result, the pressure for miners to produce is off. However, BME expects consumption to recover in 2010. This will require a 5% increase in mine production to reach a balanced refined market, an increase that the industry had not been able to achieve during the last three years even though copper cash prices were much higher at over $7,000/tonne.

2008 copper projects - costly start-up delays

At the start of 2008, we expected that 18 new projects of significant size would increase mine production by 440 kt, or approximately 42% of the total increase in mine production for the year. BME's current mine production estimate for 2008 is a fall of 150 kt down to 15.4 Mt and of the 18 projects, 5 will not enter production and the remainder will have added only 235 kt.

A fire at Equinox Minerals' Lumwana project in Zambia was the cause of the largest production loss from a new project in 2008. The project was originally due to enter production at the start of the third quarter and produce at least 70 kt of copper-in-concentrate during the year. The company successfully brought the mine into production in December, but at a much higher cost than expected at $814 million in pre-production capital expenditure. Due to the delay in start-up, Equinox Minerals had no cash flow for the second half of the year yet had to fund development activities at the project. This led to the company securing an additional $80 million in debt financing on top of its previous debt finance facility of $582.7 million. The company also closed out its put options - or options to sell copper at a set price - which enabled the firm to raise $11.6 million in cash. The mine is now on-track and is expected to produce 172 ktpy of copper-in-concentrate during the first five years of a 37 year operation.

In Spain, Inmet Mining has just received approval from the local water authority to continue the development of its Las Cruces project. The authority had earlier disapproved of the company's de-watering and re-injection system and suspended development in the third quarter of 2008. Start-up of Las Cruces is now expected in March this year, 9 months later than previously expected. Las Cruces is expected to produce 26 kt of cathode copper this year, and will be an important, and long awaited, new source of refined copper in the region.

Codelco's Gaby mine, otherwise known as Gabriela Mistral, entered production in May 2008, two months later than expected, and as a result, produced 12% less copper than previously expected in 2008. The mine reached its full capacity of 150 ktpy in the fourth quarter, and in spite of the credit crunch, Codelco has committed to a 10 ktpy capacity expansion for 2009 and 2010. Gaby, and Codelco's other projects, should benefit from the $4 billion stimulus package announced by the Chilean President in January, of which $1 billion has been allotted to Codelco.

The credit crunch has hit Oz Minerals very hard as it has been unable to refinance a debt of US$560 million. As a result the start-up of its Prominent Hill project in South Australia has been brought into question. The project's commissioning has already been delayed into the first quarter of 2009 due to a fault with the SAG mill pushing back the start of ore supply to the concentrator. The company is now looking at selling a large stake in the project to help meet its refinancing needs and is looking to the major producers in the area, as they are the only ones with sufficient cash on their balance sheets.

Katanga Mining's Kamoto mine entered production in 2007 but was carrying out a large scale expansion in 2008. It expected to increase the mine's output from 10 tkpy to 40 ktpy during the year, yet announced in the last quarter that it did not expect to meet its production targets as ramp up of the operation was proving to be harder than originally expected. A shortfall in expected copper sales left the company with a significant financing gap, and in December the company asked for permission from its shareholders to issue more shares to raise capital. Katanga has been approached by Glencore, which holds a large stake in the company, for a possible takeover. Kamoto is part of the much larger KOV mining complex which has potential to produce 400 ktpy of copper. Katanga's plan to incrementally increase production may be foiled by the credit crunch should an acquisition not materialise in the near future.

Of the smaller scale projects that entered production in 2008, African Copper's Mwana (previously Dukwe) project's start-up delay caused the company a big problem. The company was left with little cash in the bank and has asked for the permissions from its shareholders to issue a further 750,000,000 shares in the company to raise cash. The project, which is situated in eastern Botswana, was expected to produce 2.5 kt of copper-in-concentrate in 2008, yet only produced 1 kt.

Pan Aust's Phu Kham mine in Laos, Quadra's Carlota mine in the USA, and Vedanta's Konkola Deep mine in Zambia have all entered production with little delay, as did First Quantum's Frontier mine.

Project Pipeline - Will there be sufficient copper to meet demand when consumption recovers?

Figure 1 - Major project delays

The credit crunch and copper price collapse have reduced 2008 and 2009's expected production significantly. This is well understood. What is not so well appreciated is the even larger impact on the mid-term project pipeline. Whilst the firms involved remain committed to their projects, many have now opted to slow the rate of development, or even reduce the scope of the proposed mines, to better accommodate the world where copper is no longer worth $8,000/tonne.

The biggest project to be delayed is the Oyu Tolgoi joint venture owned by Ivanhoe Mines and Rio Tinto. The Mongolian project has potential to produce 440 ktpy of copper and 320 kozpy of gold and is of major strategic importance to the developing nation. However, development was delayed by the Government requesting a 51% free-carried stake in the project and also by the re-writing of the nation's mining law to accommodate a mine of this size. In December, Rio Tinto cut the non-essential staff at Oyu Tologoi, reducing staff numbers by 40%, in response to a lower copper price, and also to reduce its short-term capital expenditure.

In mid 2008, Freeport McMoRan announced several Brownfield expansion projects for its North American mines, in particular at its Bagdad and Miami mines. Exploration and development work for all these projects has now been cancelled, and some 600 workers fired, in response to the drop in copper prices.

Baja Mining's Boleo copper-cobalt project, located in Baja California, Mexico, was originally expected to enter production in 2010, but the company decided to fast-track it to enter production in mid 2009. Boleo has potential to produce 56 ktpy of cathode copper and has an expected capital cost of over $550 million. In October 2008 the company announced that due to the drop in copper and cobalt prices and the lack of available credit facilities, the project could no longer enter production in 2009. No new timeframe has been given for the start of production. Also in Baja Caliafornia, Southern Copper Corp, a subsidiary of Grupo Mexico, has decided to re-evaluate its El Arco project, which has potential to produce 190 ktpy of copper, due to the drop in copper prices. The company had announced in mid 2007 that it would go ahead with the project as copper prices had exceeded the threshold of $2,650/t ($1.20/lb) that made the project economically viable.

Nautilus Minerals has cancelled its engineering contract for the deep sea mining equipment and vessel for the development of its Solwara 1 seafloor copper project offshore of Papua New Guinea. This means that the project, which has the potential to produce over 100 ktpy of copper-in-concentrate, is now not likely to enter production before 2011.

Anglo American has pushed back the start-up of its Los Bronces expansion project to the fourth quarter of 2011, 8 months later than planned. The expansion project, which is expected to cost $1.7 billion, will lift production by 170 ktpy to 400 ktpy, with scope to increase capacity much further by 2016. Importantly, Codelco has won the right to ENAMI's options to purchase a stage in Anglo American Sur's projects, giving it the option to purchase all or part of Los Bronces, which it could, potentially, merge with its own operations.

Further down the project pipeline, exploration work at Xstrata and Indophil Resources' large scale Tampakan project in the Philippines was further delayed in late December when an employee was shot by local communist rebels. The project, which is estimated to contain 12.8 Mt of copper and 15.2 Moz of gold, was originally expected to enter production by 2012. The near constant rebel activity, which has caused many deaths and destruction of one drill rig and several buildings at the base camp, will likely delay the development of the project significantly.

The Petaquilla project in Panama is believed to have potential to support production of 223 ktpy of copper and 87 kozpy gold for the first 10 years of a 23 year operation. With development costs of over $3.5 billion, however, it will also be an expensive project to develop. Its cost is over twice that allotted by Freeport to bring Tenke Fungurume online, for example. Over 2008, Inmet Mining increased its stake in Petaquilla to 74% after a dispute arose between Petaquilla Copper Ltd and Teck regarding Teck's 26% stake. Inmet has committed to bringing the project to the permitting stage, at which point it will make a development decision as to whether to take the project to the production stage. The permitting stage is expected to be reached by 2011.

The Pebble project is being jointly developed by Northern Dynasty and Anglo American, is located in southwest Alaska and has potential to produce over 1 Mtpy of copper from a copper resource of over 34 Mt with additional gold and molybdenum resources of 87 Moz and 1.8 Mt respectively. Northern Dynasty announced in December 2008 that it expects the project to be permitted by the end of 2012, with production start-up to follow in 2016, a year later than the start-up expectation it announced in 2007. To maintain its stake in the project, Anglo American is required to provide the next $1.425 to $1.5 billion in production funding, which is expected to take it through to permitting stage. Northern Dynasty remains well funded with $40 million available. Funding should not be an issue with the project before the development stage as both partners are well funded.

Rio Tinto, which has now refocused its corporate objectives to reduce its debt of nearly $40 billion as quickly as possible, has shelved the development plans for its La Granja projects and most likely its Resolution project as well, situated in the Peru and the USA respectively. The La Granja project in particular has a "world class" resource of between 4 and 8 billion tonnes grading 0.5% copper. It is currently undergoing a pre-feasibility study, which was originally expected to be completed in 2010. Rio Tinto announced a $652 million investment into its Resolution project in August 2008. The investment was to take the project to pre-feasibility study level by 2010, with an aim to bring the project into production by 2020. In December 2008, Rio Tinto announced that it would cut 14,000 jobs, and reduce capital expenditure in 2009 by 56%, to $4 billion. This suggests that the pre-feasibility study on the project will not be completed on time.

The development schedule of the Freeport McMoRan controlled Tenke Fungurume project has yet to be affected by the credit crunch or the global economic slowdown, yet it has suffered from rapidly escalating development costs. Freeport has also found operating in Central Africa to be more difficult than expected. The project remains on track to enter production in the second half of 2009, but no guidance has been given as to whether the output from the mine for 2009 and 2010 has changed to reflect the lower price of copper. The company has sunk over $1 billion into the project and expects to spend a further $650 million to bring it into production, which raises total costs to approximately twice the development cost estimate it used when it purchased its 57.75% stake in the project. The company has reduced its capital expenditure by $215 million for 2009 and expects the proposed mine to produce over 100 ktpy of copper during its first years of production.

The best capitalised projects in the pipeline at present are those that are owned by Chinese companies like the Galeno and Toromocho projects in Peru, owned by MinMetals Corp and Chinalco respectively. Chinese firms are heavily involved in Peruvian copper projects and are committed to spend approximately $6 billion on projects over the next three years. At Toromocho, Chinalco has just secured a $2 billion loan from Exim bank. This will enable construction at the project to start in mid 2009. Production of 210 ktpy of copper is expected to begin in 2012 with the mine operation expected to continue for at least 30 years. Minmetals has also recently signed a loan agreement with a big Chinese bank as well as a Peruvian bank that will provide 60% of the funding for its Galeno project. Galeno is expected to produce 150-200 ktpy of copper for over 20 years but has not given a time frame for its construction.

Other projects that remain on track are First Quantum's $300 million Kolwezi tailings project in the Democratic Republic of the Congo, which has a capacity of 30 ktpy cathode and is due online in 2010, and Antofagasta's $1.9 billion Esperanza project in Chile with a capacity of 195 ktpy copper-in-concentrate and expected production start-up in 2010.

Figure 2. Closure and delays tabulation

Insufficient production in 2011 and 2012 - return to market deficit

In 2009, BME expects the refined copper market surplus to be over 500 kt corresponding with a drop in consumption of 4% this year in our base case scenario. Using this base case scenario, in 2010 we expect a recovery in consumption, with year on year growth of 9%, followed by 8.7% growth in 2011. This would be more than sufficient to work off the build up in stocks during this year, requiring a significant increase in mine production and refined production. Copper prices are unlikely to recover until 2010, given the stock build we expect this year, so there will be less incentive for miners to increase production, thus leading to a stock shortage in 2011. This, we expect, will take the refined copper market back into deficit, possible by several hundred kt, with potential for a strong recovery in prices.

It is important to note that the 4% consumption drop this year is our base case, and there is potential for a much steeper reduction in consumption; with potential for a consumption loss of 7% that would lead to a much larger build in stocks and a lower copper price. If the pessimistic scenario occurs, though the stock build would be bigger, further production cuts on a larger scale, and less new production, would then lead to the stock build still being worked off reasonably quickly, with a return to a market deficit in 2010 and a larger deficit in 2011. If this is sufficient to work off the larger resulting overhang of stock, copper prices could recover sooner than expected.

Bloomsbury Minerals Economics Ltd is a London based metals price analytical firm that focuses on copper. Christopher Welch writes for BME's Copper Briefing Service and its Quarterly Report on Copper. BME also creates fundamental price models for all the LME metals. Please visit our website for more information - www.bloomsburyminerals.com