Commodities | Jul 15 2014
This story features OZ MINERALS LIMITED, and other companies. For more info SHARE ANALYSIS: OZL
-Tight supply looming
-Refining capacity rising
-Oz mine expansion limited
By Eva Brocklehurst
All the supportive factors are in play for copper and a market deficit is looming for 2014. On this most brokers agree. Where they diverge is on the extent this will filter through the smelting/refining chain and deliver significantly higher prices for the red metal. Low inventory, recovering demand and tight supply all emerged this year to drive copper above US$7,000/t.
JP Morgan currently observes four bullish and two bearish risk factors in the refined copper market. Despite the bulls outnumbering bears, the broker thinks there is not yet a reason for raising official price forecasts – although current pricing around US$7,000/t should be supported – because large refined capacity additions will hit the market towards the end of the September quarter and this should put downward pressure on prices.
Supply-side constraints should keep the market tight in the near term but JP Morgan observes a complication. Copper concentrate production does not equate to refined production, as smelting/refining capacity continues to remain a bottleneck in the supply chain. There were 14 closures, on the broker's estimates, in the first half of 2014 for maintenance and technical issues. While there should be fewer of these in the second half, China is also bringing new smelting capacity on stream and production will be heavily weighted towards the second half of 2014.
What remains supportive of prices is the tight Chinese copper market, boosting Shanghai copper premiums amid the possibility of delays to shipments of copper cathode into China in the third quarter. The risk to a price resurgence is that copper consumption is entering the slower summer season and US demand remains sluggish. Moreover, JP Morgan cities reports that China was strategically acquiring copper in the first half, contributing to market tightness. The State Reserve Bureau is not expected to place further purchases but might sell old stock into the domestic market in 2014 for stock rotation.
Financing of copper inventory in China has resulted in volatile price movements over the last quarter. Falls are frequently followed by rebounds and then further gains are made. Morgan Stanley does not anticipate inventory financing will have any lasting effect on fundamentals and maintains a longstanding opinion that the global copper market is in under supply and will remain so this year. The broker observes one of the primary reasons the balance is in deficit globally is the shortage of scrap. Scrap mobilisation remains low and the net result is increased demand from refined copper markets, as smelters buy all available scrap and force other consumers to replace scrap units with refined copper.
Mined supply growth is also struggling, with Morgan Stanley noting around 3% of capacity this year was lost to disruptions and technical difficulties. Cuts to exploration spending add another dimension to the copper deficit outlook. Morgan Stanley observes global inventory is now at an 18-month low and falling. The broker envisages demand is being driven by a significant rise in US consumption as well as Europe, which is experiencing a housing rebound and construction of offshore wind projects, which require copper-heavy submarine power cables. Moreover, China's state grid plans to invest 20% more in power infrastructure this year and investment is up just 5% year-to date so this suggests to Morgan Stanley the pick up in demand will arrive in the second half.
CIMB thinks the time is right to increase copper exposure as key economic and consumption indicators suggest demand will continue to improve. OZ Minerals ((OZL)) is the preferred stock. Sandfire Resources ((SFR)), too, should benefit from a strong price and outlook. The implication from the numbers to date is that copper is heading for an annual supply deficit of between 820,000 and 860,000 tonnes, the largest since 2004. In addition to price support from China, CIMB also sees a clear trend of manufacturing growth in key economies. Moreover, the industry remains capital constrained and project developments and expansions are likely to be slowed, delayed or cancelled over the near term. Indonesia's production also dropped 26% in the first two months of 2014, primarily from cuts of 40% at the major Grasberg mine.
JP Morgan retains an Overweight rating on PanAust ((PNA)), believing there is a reasonable probability of a revised bid for the company, but has Neutral ratings on OZ Minerals and Sandfire Resources. The broker thinks both stocks have much of the upside priced in.
Australia is a small player in this market. UBS notes Australia contributes around 5% of global copper production in 2013 and its significance is expected to decline over coming years. Australia holds around 13% of global copper reserves. The country's production is dominated by BHP Billiton's ((BHP)) Olympic Dam, while other mines include Glencore/Xstrata's Mt Isa and Ernest Henry, OZ Minerals' Prominent Hill and Sandfire's Degrussa.
UBS notes the growth outlook for these mines is muted, with most already running at nameplate production. Since 2011 weak prices, poor exploration success and cost inflation have all acted against advancing new copper projects. Oz Minerals' undeveloped Carrapateena project is the most notable of the large scale developments but it too has struggled and the company has since looked at selling a stake or divesting. UBS focuses on the pure copper plays such as Oz Minerals and Sandfire Resources. The broker retains a Buy rating on Sandfire because of the stable high-grade copper production. A Sell rating on Oz Minerals is in place because a shorter mine life is likely as the open pit transitions to higher cost, and potentially marginal, underground operations.
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