Commodities | Mar 31 2008
By Chris Shaw
The “Chindia” story has been well documented in terms of the impact on commodity demand of the industrialisation occuring in both nations, Barclays Capital pointing out if copper demand per head of population in both countries were to increase from current low levels to levels more in line with other industrialised Asian nations it would imply demand of more than twice current global output.
This underlying demand has proven to be a boon for copper prices, as China in particular has supported global demand even as Western world demand growth falters given the economic slowdown that began in the US. On RBC Capital Markets numbers Western world consumption fell 0.4% in 2007 but Chinese demand grew 17.8%, the result being a 3.8% increase in global demand. As Deutsche Bank points out, this growth in emerging world demand is offsetting any risks of slower demand from OECD nations.
RBC Capital Markets doesn’t see demand slowing much in coming years, forecasting global consumption growth of more than 5% in each of the next three years – 5.4% this year and in 2009 and 5.2% in 2010, before a decline back to 3.8% in 2011. Barclays Capital agrees, noting global copper demand growth averaged around 3% in the 1990s but is now around 4%, and while this doesn’t sound like a significant increase in tonnage terms it implies demand of around 800,000 tonnes annually now as against 360,000 tonnes a decade ago.
This steady rate of increase in demand growth means the focus for the copper market remains on the supply side, where the story is equally supportive for prices to remain at historically high levels as supply has simply struggled to meet the new demand requirements.
Some of the supply shortfall is to do with the fact new copper discoveries are now largely being made in less attractive regions of the globe, which increases political and development risk and project development costs, while operating costs at existing projects are also trending higher given shortages of skilled employees and lengthening lead times for accessing new materials and equipment.
These pressures mean the supply side shock absorbers are now wearing thin, making the market more and more vulnerable to any supply side shortfalls. As Barclays notes commodity analysts are now building in such shortfalls into their pricing models based on around 3% of annual global production, though the shortfalls in recent years have been even greater than expected and this has led to price forecasts being revised higher.
Deutsche Bank notes another factor on the supply side has been the unequal growth rates between concentrate and smelter capacity that has held back growth of refined output, RBC Capital Markets suggesting this is likely to continue given the ongoing disruptions to production.
Marginal costs of production have also more than doubled to US$1.36 per pound over the past five years according to Barclays Capital, which implies additional support for copper prices as producers in the market now need higher prices if they are to generate adequate returns.
This leads the group to suggests the forces that have pushed up copper prices are structural rather than cyclical, which is positive for future gains in the price of the metal. Reflecting this Barclays has lifted its long-term average price forecast to US$2.27 per pound, noting even though this is above industry consensus risk is weighted to the upside given the industry fundamentals.
RBC Capital Markets agrees fundamentals have been important in pushing up prices but the group suggests there has also been an increase in investment demand, implying prices have moved further than they should have based only on the supply and demand fundamentals. This opens the way for a correction this year, particularly as the group expects the copper market to move into a modest surplus through the course of 2008.
Current inventory levels of around 3.8 weeks are expected to increase to about 4.8 weeks worth by the end of the year and 7.6 weeks of consumption by the end of 2011, before the market again returns to a deficit in 2012. The group cautions there are risks to its numbers, the most significant being the potential for Chinese production to take some time to recover from recent problems, which would mean the expected surplus this year may not eventuate.
Factoring in all the variables RBC is forecasting prices of US$3.20 per pound this year, US$3.00 per pound in 2009, US$2.50 per pound in 2010, US$2.00 per pound in 2011 and US$2.50 per pound in 2012, while its long-term forecast stands well below that of Barclays at US$1.30 per pound.
Deutsche Bank’s forecasts are higher than RBC’s, with the group expecting prices to average US$3.41 per pound in 2008, US$3.14 per pound next year and US$2.50 per pound in 2010. The current spot price for copper is around US$3.87 per pound.