Copper at sixes, should it be sevens?

“Awash with metal” best describes market participants view of the current copper cathode market– the USA aside - with regional premiums generally close to multi month or multi year lows. While exchange stocks remain at relatively low levels, there was recognition by almost everybody we spoke to that visible inventories have only been telling part of the story. The apparent build-up in stocks of copper raw materials or metal in China last year being the missing piece of the narrative. Our calculations show that depending on how you measure it the gap between growth in real consumption (+5.0%) and apparent demand (+9.0%) meant an accumulation of between 500,000 t and 1 Mt of off-warrant cathode last year. No one during CESCO Week could offer an over-arching explanation. Government directed buying by state owned or sponsored entities, to improve security of supply ahead of tighter controls on scrap imports and ongoing US-China trade concerns, was one – the recent reported liquidation of refined copper stocks, albeit held in the bonded zone, by the Tianjin government-owned Tewoo Group lends some support to this view. In addition, there is likely to have been an increase in working stocks at new semi-manufactured products capacity.

In the case of Europe, demand, or rather the lack of it, was the primary concern last week. The downturn that began in the second half of last year had its origins in the automotive sector but has become more widespread, at least in part due to the negative repercussions of the slowdown in global trade on export-focused economies such as Germany. Conversations vindicated our pre-CESCO week decision to lower the region’s refined copper consumption growth forecast from 1.5% to 0%, and further downward revisions may be necessary. For the US market, metal availability was a discussion point, due in part to smelter maintenance shutdowns. Feedback on demand was slightly disappointing with weather-events hampering first quarter consumption in some end-use sectors and traders reporting that spot enquiries have subsided more recently.

Optimism on China needs to be qualified

Despite a downbeat assessment of the current cathode market, the status quo is generally viewed as temporary and most of our contacts expressed a more positive outlook for the reminder of the year. Here, the hook was the likely pass-through of the Chinese stimulus measures to copper demand. This had already persuaded us to raise our 2019 refined copper consumption forecast from 2.7% at the start of the year to 3.5% now, despite only pockets of post-Chinese New Year improvement in end-user demand (see Copper China Fortnightly, 12 April). Additional plus points are the recently announced easing and lifting of residency restrictions for Chinese cities; a generally above-consensus print for March macroeconomic data releases, at least to date; and apparent progress on US-China trade negotiations.

However, those looking for significantly more than the 420,000 t increase in absolute primary metal demand that our growth forecast implies may be disappointed. As CRU’s Economics team have pointed out the current stimulus is smaller and likely to be less potent, due to a greater emphasis on tax cuts rather than direct government spending, than previous episodes. From this perspective, the post-GFC stimulus in which over 80% of the fiscal boost came from construction and infrastructure projects, is probably not a good reference. Remember also that approaching 0.5 Mt of the 1.5 Mt increase in Chinese refined copper consumption in 2009 was due to much lower scrap availability and that the SRB bought around 160,000 t of metal in that year as well.

Are low spot terms a reflection of a Q1 deficit in the concentrates market?

With some important exceptions, the view among our contacts is that the concentrates market is heading towards a deficit. The deficit is expected to appear in full force by H2 2019 and to grow larger in 2020, as new Chinese smelters approach full capacity utilization. The question arises as to whether prevailing low spot terms (in the high-60/6s in China, with rumours of deals being concluded as low as the mid-$60/6.0¢s) are the result of a Q1 deficit in the concentrates market or are due to other reasons.

In our view, a Q1 deficit seems unlikely, considering the numerous disruptions that continue to affect smelters, including not only the ones that so heavily altered the market in 2018, Tuticorin and PASAR, but also the shutdowns at Codelco’s Chuquicamata and Potrerillos and the issues affecting smelters in the US. In addition, imports of copper concentrates into China grew by 20% y- on-y in January-March 2019.

A definitive explanation, however, remains elusive and it is worth noting that some of our contacts do in fact estimate that there was a deficit in Q1 2019. Spot terms have fallen sharply every year after benchmark terms are agreed, as smelters return to the market following the negotiation period. In addition, some smelters are particularly reliant on the spot market this year and new capacity has to build up stocks. Furthermore, concentrates availability could be lower than mine production if shipments are restricted, as happened with Las Bambas. However, the high level of imports into China clearly contradicts the notion that availability was constrained. Fears about Las Bambas, as it declared force majeure and faced imminent closure before a fragile agreement was reached with communities, allowing it to restart shipping concentrates, were also mentioned as a possible explanation. Interestingly, we also heard about traders, Chinese traders in particular, buying and stockpiling concentrates, not just betting on a tighter market ahead this year – a plausible but risky proposition – but also in the interest of increasing their books’ sizes and their presence in this market.

Timing is crucial for the copper concentrates market

The concentrates market is far from a steady state. The main driving forces, smelter disruptions and smelter project developments, are unstable. Any departure from assumed trends could place the market on a different path. The timing of key events is thus fundamental to how the market will evolve over the next quarters and even over the next few years. If smelter disruptions remain high or take longer to be resolved, or if new capacity is slower to enter the market and to reach full capacity, then deficits can not only be delayed, but they could become less defined, as the rate of demand growth more closely matches that of supply growth and concentrate stocks can satisfy excess demand for longer.

Hence, it is not surprising that discussions during CESCO Week centred around disruptions on the smelting side and about progress at different smelter projects. Official views about smelter disruptions were generally deemed too optimistic. Our contacts did not expect to see Chuquicamata operating before June, Tuticorin to restart before the end of the year, or PASAR to improve its utilization rate above the current 65-75% until after a July maintenance.

Some of the firm smelter projects in China’s pipeline are understood to be slightly delayed, while we heard rumours that Chinalco’s ramp-up is progressing slower than anticipated. More importantly perhaps, financial issues were rumoured to be affecting the ability of key Chinese smelters, both existing and projects, to feed their furnaces.

Most smelter maintenance closures in 2019 are clustered in Q2, which begs the question about how much this will impact terms over the next few months - if it will be enough to revert recent trends in spot terms.

The above seems to suggest that the bigger risks lie on the side of a softer than anticipated market. However, it should be noted that during CESCO Week we confirmed our view that the pipeline of smelter projects could easily change. In contrast to mining, smelter projects take a shorter time to develop and to build and hence their visibility can be limited. As an example, we learned from our contacts about a fully-permitted, large-scale Chinese smelter project that remains an option for their owners to expand production in the future. In addition, smelter projects outside China should not be entirely dismissed.

Concentrates market pricing mechanism questioned

One issue that has been a recurrent topic of discussion in recent years has been the pricing mechanism under which the concentrates market operates. Criticised and defended in equal measure, the benchmark system seems to be facing a serious assault. Our contacts suggest that a departure from the benchmark system is more likely this year than in the past, with miners making firm strides towards quarterly negotiations and index-based pricing.

Mine disruptions catch the market slightly by surprise

Going into CESCO Week, there was probably an underlying expectation that mine disruption rates this year would probably undershoot. This was despite the fact that we, along with a number of other analysts, had relatively recently lowered estimates, primarily due to very low levels of disruption in recent years. However, the mine-smelter problems described above in the concentrates commentary plus production hits at some SXEW operations, for example Las Cruces, suggest that through the first quarter mine outages were actually consistent with the CRU forecast of a 4.6% disruption rate for the year as a whole, made at the start of 2019.

Conclusion: refined market still looking relatively balanced in 2019

First quarter mine disruptions, along with a shifting smelter disruption/maintenance and project start-up narrative, are a curt reminder of the fragility of the copper supply chain. This is not helped by uncertain Chinese government policy towards scrap imports, which could still upset the market balance for primary metal either way this year. Nonetheless, in the base case we are still calling for a relatively balanced refined market in 2019, which is likely to keep the price in the $6,000s /t, with macro-related sentiment probably deciding precisely where. The lack of any visible deficit in the refined copper market over the medium term means the price is unlikely to reach $7,000 /t until the early 2020s and in real terms will remain well below that level. However, there could be considerable upside for the price through the mid-2020s if this outlook, which is well below the incentive price for new mine capacity, discourages further investment over the next couple of years.

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