Copper needs more investment, analyst says

AllianceBernstein, a global investment management firm with an independent sell-side research arm, is calling for greater investment in copper to build enough capacity to meet demand.

“At a conservative estimate, the world’s mining community needs to approve the investment of 1 million tonnes per annum of new copper capacity each and every year, and, so far, this has proven impossible,” Paul Gait, a London-based analyst from Bernstein’s European metals and mining division, warned in a recent research note.

“In part, this is because of the capital intensity and lead times that are required to create the economies of scale to profitably exploit either low-grade copper, or copper that is situated at extreme depth,” he noted, describing the red metal as “the scarcest and most important industrial commodity.”

He added that “it is fair to say that the continued flow of copper is a global strategic imperative, and even more so if we are ever going to meet the demands of the green energy revolution.”

This year, supply disruptions at three of the world’s largest copper mines — BHP Billiton’s (NYSE: BHP; LON: BLT) majority-owned Escondida mine in Chile, and Freeport-McMoRan’s (NYSE: FCX) Grasberg mine in Indonesia and Cerro Verde mine in Peru — have helped “support prices at 20% above the 2016 average,” according to BMO Capital Markets, which forecasts that “2017 is on track to deliver the largest disruption to initial production estimates since 2008.”

At Escondida, a 44-day strike ended in March without a new labour contract, while Freeport halted production at its Grasberg mine in February after the country banned concentrate exports, and employees at its Cerro Verde mine held an 18-day strike the same month.

Material leaves a conveyor at BHP Billiton’s Escondida copper mine in Chile. Credit: BHP Billiton.

BMO estimates that the strike at Escondida, the largest copper mine in the world, which it estimates is responsible for 5% of global mine supply, “will have cost the market nearly 200,000 tonnes of production, including additional losses, as the mine could take two weeks to resume normal operations.” Given that the strike “ended without a new labour contract negotiated [a legal provision allowed the workers to return to work for 18 months under their old contract, with a new agreement targeted for that time], another disruption in 2018 remains a possibility.”

Disruptions at the Grasberg and Cerro Verde mines, meanwhile, which BMO says are the world’s second- and third-largest copper mines — representing 4% and 3% of global supply — have “further tightened supply.” The bank estimates that “contract disputes with the government and strikes” at Grasberg and Cerro Verde have taken between 80,000 and 90,000 tonnes copper out of the market so far this year.

“Since 2004, we estimate that strikes reduced annual mine supply by an average 115,000 tonnes per annum, with 2009 the highest year at 309,000 tonnes, and 2017 already at an estimated 203,000 tonnes,” BMO reported. Grouping in Grasberg rises to 290,000 tonnes. 

“With Grasberg seeming unlikely to be resolved in the near-term, however, and additional strikes possible globally, 2017 is on track to exceed 2016’s disruption by nearly 500,000 tonnes, and to be the highest since 2008.”

The bank has raised its copper price forecasts accordingly. This year it expects copper to average US$2.64 per lb. — up 8% from its previous estimate of US$2.45 per pound. Next year BMO forecasts copper will average US$2.70 per lb., and should climb to US$2.85 per lb. in 2019, and US$3.05 per lb. in 2020.

Paul Benjamin, research director for global copper markets at Wood Mackenzie, has raised his copper price forecast for 2017. “The impact of recent stoppages at the industry’s two largest mine producers pushed three-month prices above the US$6,000-per-tonne level several times through first-quarter 2017, and with copper trading somewhat higher than expected, we have raised our annual average forecast to US$5,685 per tonne, or US$2.58 per pound.”

Beyond 2020, “as liquid stocks are eroded sharply lower,” Benjamin expects “a sizeable reaction in prices,” with the metal spiking at US$8,598 per tonne — or US$3.90 per lb. in constant 2017 dollars — by 2023.

“We remain confident that our long-term incentive price of US$7,275 per tonne (US$3.30 per lb.) in constant 2017 dollars will be sufficient to bring on adequate mine output, keep market equilibrium and retain a reasonable market balance over the next decade.”

BMO’s top picks among copper producers are Antofagasta (LON: ANTO; US-OTC: ANFGY) and First Quantum Minerals (TSX: FM; LON: FQM).

It also likes Atalaya Mining (TSX: AYM; LON: ATYM) “for its free cash flow generation potential,” and Ivanhoe Mines (TSX: IVN; US-OTC: IVPAF) “for exposure to the growth of the Kakula-Kamoa discovery.”

Antofagasta, BMO says, “offers the best exposure to higher copper prices,” and trades at a 6.4 times 2017 enterprise value/earnings before interest, tax, depreciation and amortization (EBITDA). “Although not a leveraged or near-term growth name, we see potential for the company to continue to reduce unit costs, further improving its position.”

First Quantum, meanwhile, “offers some of the best exposure to higher copper prices and increasing cash flow — a result of its growing copper production profile in Zambia and in Panama,” BMO says. First Quantum “has hedged away most of its exposure to copper prices for 2017, but remains largely exposed to prices in 2018 and beyond … we anticipate tightness in the market to move the price of the metal higher.”

Atalaya Mining’s Proyecto Riotinto open-pit copper mine in the Andalucia region of Spain reached nameplate capacity of 9.5 million tonnes per year in January 2017, and BMO expects “a near-term rerating of trading multiples, as the operation begins to deliver free cash flow for the company.

“As a higher-cost operation,” BMO notes, “it has amongst the highest leverage to the copper price and trades on an attractive estimated 2017 enterprise value/EBITDA multiple of 2.3 times.”

Formerly known as EMED Mining, Atalaya put the past-producing mine and mill back into production in February 2016. The deposit, 65 km northwest of Seville, has ore reserves of 153 million tonnes containing 680,000 tonnes copper.

BMO also likes Ivanhoe’s Kakula-Kamoa project in the Democratic Republic of the Congo, which has a resource and PEA due soon.

In March, Ivanhoe announced that a step-out drill hole had doubled the strike length of the copper-rich mineralized system at Kakula, extending to 10.1 km from an initial 5.5 km in January. The shallow deposit is open for expansion.

In a research note after the drill hole assay was announced, Bernstein’s Gait described the Kakula-Kamoa discovery as “the world’s most important development project, in what we believe is the world’s most important commodity.” 

He added that “at a time when significant lack of investment in the copper industry is manifesting itself, and with the major mining houses rapidly running low on growth options but  accumulating cash, we see Ivanhoe Mines as a compelling investment both strategically and for the underlying quality of the potential producing operation.”

Bernstein initiated coverage of Ivanhoe in October 2015, and Gait repeated the firm’s description of Kakula-Kamoa in his March 21 research note to clients: “It is the largest copper discovery on the African continent, and the world’s largest high-grade copper deposit, largest undeveloped copper deposit, lowest capital intensity major copper development project and fifth-largest copper deposit.”