The copper bells are ringing to warn us we are in the late cycle when metals prices have their sudden and unexpected upward moves. Unexpected, that is, for central bank macroeconomists, supply-chain-stretched manufacturers and off-the-shelf investment algos.
This is not just a China story, or unsustainable speculative demand. Speculative interest in copper futures is quite low, particularly considering that the price of the metal is up more than 60 per cent over the past two years. Mining companies’ managers still have a battered-child syndrome after the 2015-2016 pause in Chinese import growth.
There is little exuberance, rational or irrational. Despite their large cash hoards and cash flows, none of the major companies is proposing to shoot a rocket loaded with copper into the asteroid belt, or even invest enough to maintain production. So world copper production dropped more than 2.5 per cent last year, as declining ore grades and labour strikes more than offset the output of new mines or expanded production at existing mines. This was mostly because of declines in ore grades and delays in commissioning new capacity.
A macroeconomist at a central bank would tell you that, with the price a little above $7,100 a tonne, and the world marginal cost of production around $5,000 a tonne, there should be a wave of new investment in copper capacity. And there would be, if the engineering, economics and politics of the copper industry were anything like those of the American unconventional oil and gas business. They are not.
As Paul Gait of Bernstein Research in London says: “There are hundreds of thousands of oil wells in the world, but there are only about 700 copper mines. The 20 largest mines provide half of the total supply. That means that the supply response is not at all a continuous function.”
The lead time on building a new mine, or even a plant to extract copper from mine tailings, is much longer than required for most oilfields. Copper has been the object of exploration for a very long time, and the easily accessed, high-grade oil bodies were discovered decades ago. Miners have extracted copper from thinner and thinner ore grades with more capital and technology. That is becoming near impossible to accomplish with the currently mined ore bodies in politically stable areas.
As Mr Gait says: “You have to either go to Africa or go underground” to get new copper sources. Going underground means sinking shafts a thousand meters down to blast and burrow out huge caves to acquire the ore. The time from investment decision to production is measured in decades, assuming the environmental permitting problems can be overcome. This assumes the mining engineers and skilled workers can be found.
In the past few weeks miners have found out more implications of what going to Africa can mean. The Democratic Republic of Congo has announced its intention to impose retroactive increases in royalties and taxes, despite its apparent contractual commitments. The companies have protested, and there will be long negotiations and litigation. The ores in the DRC and elsewhere in Africa are an order of magnitude richer than can be found in more predictable places. They have just too much political risk, though, to attract more money.
There is a lack of awareness of how copper-intensive a shift away from fossil fuel energy will be. Transmission grids need more copper for renewable generation. Electric vehicles require more copper than diesel or gas vehicles. Factory and office workers in hot countries need air conditioning to work efficiently, which also requires more copper. All the myriad little electric motors we take for granted need copper. Ammunition for war uses a lot of copper.
Yet copper has not been a political or financial issue in recent years. Metal mining is dirty and distant. The technology can be improved and capital added, but slowly. The smart people who might have done that went into software engineering or media studies. The first reaction of consumers, manufacturers and politicians will be to accept the copper price increases that will be created by the tight supply conditions.
It will take a lot of demand destruction to match a stagnant, choppy and depleting supply. That will happen later in the cycle than rises in rates and declines in equity prices. Copper and copper companies are cheap and interesting.