Copper supply to remain tight until 2010, Citigroup forecasts

Copper prices are often viewed as a barometer for many other base metals and if current indications are any guidethere’s nowhere to go, it seems, but up.

“The copper price has recently soared to over US$3.9 per lb on supply side disruptions,” new equity research from Citigroup Global Markets says. “Though we expect some weakness in the second half, we are positive on the metal long-term as structural changes are expected to make supply challenging.”

Over the last five years, phenomenal demand coming from China’s industrializing economy has caused a tectonic shift in global demand for base metals.

Copper demand in China’s red-hot economy more than tripled to 3.5 million tonnes per year between 1995 and 2006. (Currently the country makes up about 21% of global copper demand.)

Citigroup forecasts consumption growth will continue to outpace mine supply and refined production in China, with copper demand averaging 12% per year. Global demand growth, by contrast, is anticipated to be in the range of 4.5%.

Enormous demand, tight supply and rising costs have pushed spot prices for the metal from about US$2,000 per tonne in 2002 to about US$7,000 per tonne today.

The industry faces a number of challenges, however. One of the most significant will be declining ore grades. Citigroup estimates that over the next decade copper ore grades will decline by 20% for concentrates and by 40% for solvent-extraction electro-winning. This will in turn drive up operating costs.

Given a steepening cost curve, Citigroup anticipates a long-term industry average cash margin of 45%. The bank also predicts average cash costs for the industry will rise to US70 per lb. on a sustained normalized basis. (Industry average cash costs in 2015 could be as high as US80 per lb.)

With a 45% margin the industry should see long-term prices at US$1.45 per lb., the bank argues. “With our long-term copper assumption of US145 per lb. and operating costs of US80 per lb, our generic copper model calculates an internal rate of return (IRR) of just 4.5%,” Citigroup notes in its May 28 equity research report.

“For a new copper mine to achieve an IRR of 15%, we would require a long-term copper price of around US230 per lb, which is 51% above our long-term copper price of US145 lb.”

Citigroup expects supply will remain tight until the end of the decade. “Slower mine production growth is the main reason for the change, and as a consequence the concentrate market should also stay tight to 2010,” it predicts.

In terms of supply, new copper projects take on average more than 10 years to bring them from discovery into production

Chile will continue to be the dominant source of copper. Production in central Africa (the world’s riskiest mining jurisdiction) is recovering slowly after a 20-year depression.

China lacks large copper mines, especially large-scale open-pit ones. Most mines are underground with low grade and high costs.