Copper looking down a long, dark tunnel — Surpluses, weak demand could depress price for several years

Anyone that cashed out of the copper market around the time of the Sumitomo rogue-trading scandal had impeccable timing.

Recent reports on the copper market by two metal trading firms and a Canadian bank offer little hope for higher copper prices over the next four years. London-based metal trading firms Credit Lyonnais Rouse and Billiton Metals both paint a gloomy picture of copper markets over the next five years, suggesting that depressed demand — particularly in the formerly booming economies of the Pacific Rim — and vastly increased production capacity could put copper prices on a long-term slide.

Even though current prices are probably lower than is justified by supply and demand, Rouse sees a period of three to four years during which the market should be in a significant surplus. The worst-case predictions show drops of 10 to 20% in demand from Asian countries, whose rapid industrial growth over the last decade had underpinned the growth in demand for base metals.

Rouse sees demand from Asia generally falling by 2 to 3%, with Japan, South Korea, Thailand and Indonesia taking the heaviest hits. European growth should be steady, while the economies of the Americas are expected to grow, albeit more slowly than in recent years.

The weaker demand indicates an actual contraction in the copper market in 1998, followed by several years of growth in the 2.5% range. A report by the Canadian Imperial Bank of Commerce (CIBC) predicts the same, with the supply overhang expected to cause warehouse copper stocks to double in 1998 to over nine weeks’ worth of consumption.

Billiton sees similar effects from the Asian economic woes, suggesting that surpluses might only begin to decline by the turn of the century. Asian countries other than Japan took about 19% of copper production before the market meltdown of late 1997.

In another recent report, Billiton looks at the automotive industry and sees further bad news for the base metals. Japanese automakers, who are major consumers, have cut production between 5 and 15% compared with last year. A steep decline in the other Asian economies, which have always been big export markets for the Japanese manufacturers, has forced cutbacks to production levels last seen in 1996.

Although they churn out only one-sixth as many units as Japan’smotor industry, South Korean vehicle producers are also hurting. Staring at inventories that are twice the size of last year’s, they are cutting production by 40 to 45%.

“None of the LME-traded metals would be able to ignore a significant decline in the number of motor vehicles produced annually,” Billiton notes, adding, “with this in mind ….the Asian region looks particularly vulnerable.” The flip side of decreased demand is increased supply over the next four years. Both Rouse and Billiton see increases of 700,000 to 1 million tonnes of refined metal coming on to the market in 1998, and though increases should tail off in ensuing years, capacity is still expected to grow. Only by 2001 does Rouse expect to see the percentage growth of demand match that of supply.

The biggest culprits are expected to be two new projects, Collahuasi in Chile and Batu Hijau in Indonesia, and two expanding ones, Grasberg and Los Pelambres. Falconbridge’s Collahuasi is expected to come on stream this year, and annual production should be around 330,000 tonnes by 2001. By 2002, the Newmont-Sumitomo joint venture at Batu Hijau should be producing just over 200,000 tonnes annually.

Both large expansions will make similar contributions. At Grasberg, Freeport is adding capacity for another 275,000 tonnes per year, which will bring the giant Indonesian mine’s annual production to 800,000 tonnes. At Los Pelambres in Chile, Antofagasta Holdings and Nippon Steel are adding capacity to bring production there to 260,000 tonnes per year from the current 23,000.

Two other new mines — Codelco’s Radomiro Tomic mine in Chile, which will come on stream this year, and the MIM-North-Rio Algom project at Baja Alumbrera in Argentina — will both contribute between 160,000 and 190,000 tonnes annually over the next few years.

The picture from the old east bloc countries is not as bleak, says Rouse, which also notes that Chinese internal demand should outstrip that country’s smelting capacity over the next five years unless the economy contracts drastically. A domestic shortage would curtail Chinese exports and reduce the Western oversupply.

Billiton, on the other hand, believes recent moves by Russia to defend its currency have destroyed hope for economic recovery there, with a corresponding effect on metal consumption.

CIBC’s report, by economist Bart Melek, also points out that about 90% of copper production has costs below the current price levels. This, in turn, suggests that large, lower-cost producers will be able to expand production enough to force a number of higher-cost producers out of business.

Rouse’s price forecasts show copper declining to US$1,450 per tonne in 2001 before any recovery takes place.