Metals commentary: Wood Mackenzie says Copper prices to ease, but ‘not massively so’

Wood Mackenzie is forecasting global demand growth for copper this year of 3.6%, a copper deficit of 100,000 tonnes and London Metal Exchange cash prices averaging US$8,700 per tonne, or US$3.95 per lb., down from an average of US$8,800 per tonne, or US$4 per lb. in 2011.

The consulting group forecasts a pick-up in Chinese demand in the second half of the year with copper prices peaking in the third quarter at US$8,900 per tonne. Last year copper prices peaked in February at US$10,000 per tonne.

“The year didn’t start off particularly well but we’re expecting much stronger prices as we move into the second half,” Richard Wilson, the consulting group’s chairman of metals, said in an interview at the Prospectors and Developers Association of Canada’s convention in Toronto. “We’ll probably end up lower than where we were in 2011, but not massively so.”

Wilson concedes that while that prediction might look optimistic given continuing worries about tepid conditions in China, he believes policy-makers in Beijing “are going to have to open the investment floodgates sometime this year to prevent a potential meltdown, which they definitely don’t want . . . the difficulty is if the Chinese government are too late to step in and start pushing liquidity into the economy, they’re in real trouble. And I don’t think they’re going to have a choice, actually.”

“You have to be very careful when you look at China,” he adds. “You can’t assume that China will respond like a mature Western economy would to its problems. The one thing that China has is a lot of cash.”

Wilson also notes that it is not uncommon for the Chinese to buy half a million tonnes of copper metal over a couple of months because they are speculative when it comes to metal purchases. “If you get to a point where the copper price drops down much below US$6,000 per tonne, let’s say, you could see very strong Chinese buying, just for pure speculation,” he explains. “So it’s not ‘all over’ by any stretch of the imagination.”

Wilson says copper has performed so well in recent years because stock levels measured in days of consumption — about 50 days — are “way, way below other metals,” whereas a normal stock level would be in the 65- to 75-day range. Last year copper stocks were measured at 54 days of consumption and in 2010 were at 57 days of consumption. Wilson predicts they will rise to 60 days of consumption in 2013. Zinc, conversely, is at about 120 days of consumption.

When the marginal cost of production is considered, which Wilson defines as the ninetieth percentile of the cash-cost curve, the price of copper last year was at a 95% premium above its marginal production cost, which he says is “a pretty big differential when you had a copper price of almost US$4 per lb., on average.” By contrast, the aluminum price last year was below its marginal cost of production, nickel was almost at its marginal cost of production and zinc was at a 41% premium.

Wood Mackenzie puts the marginal cost for copper production at US$2.20 per lb.

At the same time, however, capital costs of copper projects have soared. Between 2004 and 2011, capital costs on average escalated at 22% per year while costs at the mine site during the same period grew at a pace of between 16% and 17% a year. In 2004, for example, the cost of copper concentrate may have been US50¢ per lb., but today it is probably closer to $1.50 per lb., he says.

The only reason cash costs haven’t shown a similar increase, Wilson argues, is because of the “very, very decent prices” for by-product metals associated with copper production such as gold, silver, molybdenum, zinc and lead. “You’ve seen a major increase in the offsetting by-product credit for those costs, so that is what brings your average costs down to about somewhere probably just under US$1.30 per lb.”

Looking ahead, Wilson forecasts that 2013 marks the year when the market will see fairly big projects coming through — copper prices are likely to be US$3.70 per lb., and could range from the mid-US$3 to the high-US$2 range in 2014 and 2015.

“The gold-plated run that copper has enjoyed in these last five, six, seven years is beginning to look a lot more questionable because we have a lot more supply coming through, and I don’t think we can rely on China for double-digit growth as it moves from an infrastructure-rich economy into a more consumer-driven economy. So those growth rates will slow considerably, and that will create different conditions for the market,” he concludes.

“The outlook for copper is that it’s still okay for now, but watch out over the next few years because there could be choppier waters ahead, but nothing disastrous.”