Political, social stability ensures Chile’s copper future

Santiago, Chile — Way back in January, copper industry analysts thought US$2.50-per-lb. copper was “unthinkable,” but with over a dollar added to that, until recently it seemed that the copper price knew no bounds. Chile’s copper miners are smiling so hard that it hurts, but is copper getting into dangerous territory? And what are the medium-term implications of US$2-plus copper?

Copper producers are churning out every pound of copper they can and Chile forecasts production at 5.45 million tonnes for 2006, slightly higher than the 5.32 million tonnes in 2005. But to maintain this rate, companies are delaying routine maintenance, causing problems to accumulate that will have to be dealt with later. This, combined with labour issues, leads Celfin Capital analyst Cesar Perez to conclude that “no one will meet their production targets this year,” adding to price pressure.

China’s demand fell 37.3% to 205,838 tonnes in the first quarter of the year, but global demand is still robust and industry players such as BHP Billiton (BHP-N) forecast high copper prices through 2008. The squeeze is firmly on the copper market and any outage will result in a price spike.

“There is no sign of demand destruction,” says Barclays Capital analyst Ingrid Sternby. “Supply has not responded fast enough to the high price and strength of demand, so there is still a mismatch between supply and demand.”

Normally conservative state copper commission Cochilco boosted its 2006 average copper price estimate about 50% to US$2.60-US$2.62 per lb. at the end of April from US$1.72-US$1.76 per lb., due to the red metal’s performance so far this year. This was significantly more bullish than bank estimates, which “just shows that the consensus will have to move up,” Sternby says.

“The copper price is going up every minute. It is incredible,” says Roberto Souper, vice-president of sales at state copper company Codelco. “The physical market is tight, but not so tight. Apparent consumption in China is not more than last year and it is lower in Korea and Taiwan. Inventories are low, but not as low as last year.”

One of the reasons that supply is lagging demand is that projects are getting more expensive as ore grades get lower, which is not yet reflected in banking models. Speaking at the at CRU International’s World Copper conference in Santiago in April, Marcelo Awad, CEO of Chilean copper producer Antofagasta Minerals (ANTO-L) said that banks have to increase the price of copper in their financial models, otherwise projects will not be funded in the future.

Financial models

An estimated 5 million tonnes per year of production could come on-stream through 2010, but 2 million tonnes of that corresponds to “probable” high-cost projects that may find it difficult to get financing unless the financial models are revised, he said.

“The only way to justify the development of all of these projects is with higher long-term prices than the ninety cents per pound the industry has used for the last twenty years,” Awad said. “It is important that the banking sector needs to revise upwards the long-term prices or only two or three million tonnes per year of the five will be seen in the market,” he said.

New York mining analysts agree.

“It is reasonable that a high price is required to attract new investment,” one analyst says. “The industry is going to struggle as there has been a long period of underinvestment.”

“The (model) price has to go higher, but to what, I don’t know. Historically, bankers raise it too high and fund marginal projects. If you move it to two dollars per pound, all the projects will come on-stream and that will drive the price back down to one dollar,” another analyst says.

On the back of high copper prices, Chile will generate US$27 billion in exports this year, according to Eduardo Titelman, executive vice-president at Cochilco, boosting per capita gross domestic product by US$1,300 (over 18%) to US$8,330 and giving the treasury some US$11 billion of fiscal income. While it seems that Chile has never had it so good, copper has caused the peso to strengthen against the dollar to the extent that the country’s food-product exporters fear they won’t be able to compete in world markets.

“The peso has appreciated fifty per cent in the last three years,” says fruit exporter, Andres Ballas of Exportadora Los Lirios. “Seventy per cent of our costs are in pesos, so we have lost thirty-five per cent of our competitiveness. Investment in the agro-industrial sector is paralyzed.”

Labour issues

In copper capital Santiago, the only thing capable of turning the grins of copper executives into frowns at the moment is labour relations. With newspapers reporting ever-increasing copper company profits (Codelco reported US$1.68 billion for the first quarter) workers want to share in the bonuses being doled out to executives.

“There is a lot of greed in workers across the globe that want a copper-price bonus,” Perez says. “The labour market is working against copper.”

A strike was averted at the 63,000-tonne-per-year Lomas Bayas mine in Region II at the last minute in May when Falconbridge (FAL.LV-T, FAL-N) agreed to pay a bonus of US$4,400 per worker. With the giant Chuquicamata and Escondida mines that represent 2 million tonnes of copper production per year due to renegotiate their collective contracts in the second half of the year, Chile and the copper market faces the prospect of a summer of discontent, as producers try to cap escalating costs.

Copper companies seem likely to buy worker co-operation with one-off bonuses as none of them want to follow in the shoes of Mexican producer Grupo Mexico, which, paralyzed by strikes, declared force majeur on sales contracts.

“The companies will give workers a copper bonus to keep the mines open, but not a pay rise,” says an executive at a major international company in Santiago.

The competition

Will the threat of industrial action take the shine off Chile as a destination for further mining investment? There are fears that investment dollars will start heading for emerging copper destinations such as China, Australia, and Indonesia, and although exploration spending is increasing, Chile lost its regional top spot in 2005, having been overtaken by Peru, Mexico and Brazil — which all have significant copper potential.

Peru has become the third-largest copper producer in the world with production of over 1 million tonnes of red metal in 2005. The country has several large projects in the pipeline in the shape of Rio Tinto’s (RTP-N) La Granja project in Cajamarca department, Xstrata’s (XTA-L) Las Bambas deposit in Cuzco department, Peru Copper’s (PCR-T, CUP-X) Toromocho project in Junn department and the Limamayo deposit in Cuzco department that has yet to be auctioned.

Chile accounts for 35.6% of world mine production, but with no mega-projects in the pipeline like those that characterized the 1980s and 1990s, does it still offer growth potential?

In the medium term, the answer is yes. Codelco will invest over $12 billion to boost production to 3 million tonnes per year from around 1.74 million tonnes annually by 2020. The private sector is weighing in with over $3.4 billion of investment to add over 1.1 million tonnes of new production per year through 2012, by which time the country is forecast to produce 6.7 million tonnes per year, according to Cochilco.

Industry figures, including mining association Consejo Minero, whose members account for 97% of Chile’s copper production, are bullish that Chile will maintain its leading position for many years to come due to its stable political, economic and social environment — just the conditions long-term mining investors seek. And it also has a lot of copper.

“Chile had 370 million tonnes of copper reserves in 2005, representing about thirty-nine per cent of worldwide reserves,” says Consejo Minero president Francisco Costabal.

—The author is a freelance journalist based in Santiago, Chile.