Copper supply to remain tight to 2010: Citigroup

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

“The copper price has recently soared to over US$3.90 per pound 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 con- trast, is anticipated to be in the range of 4.5%.

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

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 40% for solvent extraction-electrowinning. 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 US$1.45 per pound and operating costs of US80 per pound, our generic copper model calculates an internal rate of return of just 4.5%,” Citigroup notes in its May 28 equity research report.

“For a new copper mine to achieve an internal rate of return of 15%, we would require a long-term copper price of around US$2.30 per pound, which is 51% above our long-term copper price of US$1.45 per pound.”

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 advance 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 operations. Most mines are underground with low grades and high costs.