Unravelling the myths and realities of 2020 – where to next for copper prices?

By Jonathan Barnes, Principal Analyst Copper, Roskill: A Wood Mackenzie Business

The global refined copper market has been in a statistical deficit for the past six years, cumulating to a total deficit of 1.8 million tonnes (Mt). 

In 2020, the market deficit was just short of 0.5Mt. In hindsight, the spectacular recovery in London Metal Exchange (LME) cash prices last year – in complete defiance of the pandemic – can be attributed more to genuine physical market tightness than to speculation. 

In truth, the copper industry has largely escaped unscathed from the impact of COVID-19 crisis. 

This was due to the unique interplay of internal and external forces that resulted in a drawdown in the industry’s visible refined copper inventories. 

Not the least among these were conditions in the scrap industry, the so-called ‘unseen hand’ of the market. 

Through its vital contribution to both supply and demand, recycled materials significantly represent 10Mt, or one third of the global market.

The principal interacting forces at work were: 

  The Chinese copper supply chain was completely destocked following the 2019 trade war

  China’s economy experienced a strong sequential recovery from March 2020

  Strong Chinese Government investment in new renewable energy generation projects

  China enforced import quotas on copper scrap at 50 per cent of 2019 levels until November 2020

  World scrap generation, collection, recovery and trade was badly affected by the crisis

  COVID-19 restrictions impacted mine supply, especially in South America

  China commissioned multiple new large scale semis plants during 2020 that were already well under construction when the pandemic hit, widening the consuming industry base

  Fabricators in China and elsewhere had to buy extra refined metal to replace missing scrap

  China’s State Reserve Bureau imported copper cathodes to build its strategic stockpile.

Disruptions to primary mine supply and scrap availability due to COVID-19 effects, falling prices (initially), and Chinese scrap quotas (to meet previously announced environmental targets), as well as logistical port and shipping difficulties, resulted in a drop in total supply. 

Consumption fell sharply in China but then rebounded strongly, creating a supply shortfall across southern China that was at its peak from March to August. 

In the rest of the world, the slump in demand was deeper and more protracted, and was at its worst in the second quarter before gradually improving thereafter. 

Demand for refined copper in the rest of the world probably fell by 8-9 per cent last year, but this was almost completely offset by the rebound in total Chinese demand in 2020, which significantly outperformed GDP (gross domestic product) growth.

Several new wire rod mills were opened in 2020, which were already being built before COVID struck. 

This added to the industrial base of Chinese consumers. Also, fabricators had to purchase extra cathode to replace scrap in their feedstock, due to the self-imposed import restrictions. 

Moreover, the secretive Chinese SRB made speculative undisclosed volumes of purchases from foreign producers and trading houses to bolster its strategic stockpiles, taking advantage of bargain international prices and weak industrial demand in the rest of the world. 

As a result, total visible stocks (Exchanges + Chinese bonded warehouses) dropped from 955,000 tonnes at end-March 2020 to under 620,000 tonnes by the end of the year. 

The impact of the global pandemic might have been novel and unprecedented, but China reacted in the same way as it did during the Global Financial Crisis. 

Those around at that time had seen this all before. History may not repeat itself, but it does rhyme.

There has been a similarly confused market picture so far in 2021. LME prices hit a nominal peak in March, spurred on by speculative influences and healthy Chinese demand. 

However, Chinese consumers have been very resistant to paying higher prices and refined demand has subsequently slumped in the second quarter compared to the strongest quarter for demand last year. 

Recently initiated sales of SRB cathodes aimed to cool commodity price inflation in China, though admitted only at a rate of 20,000 tonnes per month, have dampened market sentiment particularly that of the speculators. 

Chinese refined consumption will likely decline again in the third quarter but may improve by the fourth quarter.

The baton for recovery consumption has been firmly passed from China to the rest of the world. Demand in North America is exceptionally strong, driven by a buoyant construction market. 

Europe is not far behind, and other Asian markets such as South Korea, Vietnam and Thailand are also rebounding, though Taiwan and Japan are still struggling. In South America, the Peruvian Presidential Election, and the issue of higher mining royalties in Chile and the New Constitution are all deterring new investment. 

Brownfield and greenfield projects are proceeding but have been delayed by the pandemic, perhaps by six months. 

Roskill principal analyst copper Jonathan Barnes.

Meanwhile, Ivanhoe Mining’s Kamoa-Kakula mine in the Democratic Republic of Congo is now shipping its first concentrate, in the biggest new mine project the industry has seen for many years. 

While on the secondary side, world scrap flows are improving but are not yet back to pre-pandemic levels.

Roskill believes copper prices will largely trade sideways during the second half of this year. Demand growth in China is capped by higher prices, but consumption in the rest of the world (though not everywhere) is rebounding strongly. 

We see these two influences, plus future supply uncertainties in South America, cancelling each other out, with prices generally trading in the $US9000 ($12,170)-$US9500/tonne range during the second half of 2021. 

In the medium term, copper demand in electric vehicles, wind power and solar power will only increase to meet global decarbonisation targets. 

If primary supply cannot steadily improve and better scrap recovery does not provide the extra units required, then the price sooner or later is only heading one way, and that is back up.

In 2020, Australia produced 885,000 tonnes of mined copper (4.3 per cent of world supply) and 427,000 of refined copper (1.8 per cent of world production). 

The world will need more and more of Australia’s copper reserves and resources to achieve the energy transition over future decades. 

Ironing out demand

The perfect mix of market conditions has led to iron ore reaching record highs well above $US200 per tonne this year, but how long can the metal stay at these all-time levels?

Chinese steel consumption has set the stage for iron ore producers to thrive in current market conditions.

Following the initial economic impacts of COVID-19 on China, the country responded with a ramp up of infrastructure projects that has driven iron ore demand.

Such demand has seen prices maintain levels above $US200 ($270) per tonne as mine production also grows.

Iron ore giant BHP produced a record 252 million tonnes of iron ore at its Western Australia Iron Ore operations in the 2020-21 financial year as it brought the massive South Flank project online.

According to Ausbil, the global market for iron ore sits at 1.5 billion tonnes. But with production capacities stressed, some miners are struggling to overcome internal issues, including Vale and Rio Tinto, impacting ideal levels of output. 

Vale, for example, slashed its production guidance for the 2020-21 financial year from 375 million tonnes to 315-335 million tonnes due to tailings dam issues and problems restarting its suspended capacity.

Ausbil Global Resources Fund co-portfolio managers James Stewart and Luke Smith say this has left a supply gap in the market. 

“Vale are targeting a 400 million tonne per annum run-rate by year-end 2022, however, this likely only implies reaching that run-rate in the final quarter,” Stewart and Smith say.

“The wet season and continued issues with restarts are likely to impact output leading into those run rates, and as a result we currently estimate they will produce 355 million tonnes in 2022 overall.”

Rio Tinto has seen a 9 per cent fall in iron ore production in the June 2021 quarter due to rainfall issues and COVID-19 travel restrictions, adding to the skills shortages facing mining in Australia.

“Heightened COVID-19 constraints, which resulted in numerous travel restrictions, added further pressure on the business and limited our ability to access additional people, particularly in Western Australia and Mongolia, in order to deliver operational improvements or maintenance initiatives and accelerate projects,” Rio Tinto chief executive officer Jakob Stausholm says. 

Australian iron ore exports have smashed records in 2021.

According to UBS, Rio Tinto will need to lift its iron ore shipments by around 25 million tonnes to reach the middle of its 2021 guidance.

Ausbil anticipates that increased demand and limited supply will continue but will ease in the coming years.

This will be due to softening Chinese demand following a decline in construction activity and a recovery of supply.

“Our expectations for demand strength and supply weakness continue and have been exceeded during this period, with COVID only exacerbating market tightness, through Chinese construction-related stimulus and COVID-related supply issues in Brazil,” Stewart and Smith say. 

“We expect Chinese domestic iron ore supply will remain the marginal source of supply. The key question for us is how large, and how quickly, the Simandou project in Guinea will be brought online over the medium term.

“While we expect the Simandou project to come online faster and larger than market expectations – similar to what we have seen with China’s investment in bauxite in Guinea, and supporting China’s aim to diversify away from Australian supply – ultimately Chinese domestic iron ore supply is likely to remain the marginal tonne.”

Australia exports around 70 per cent of its iron ore to China, according to a UBS report, demonstrating how vital the Asian country is for the nation’s economy and its mining industry. 

In the near term, UBS anticipates that China’s steel mills are being told to halt production in the second half of 2021.

While this may be bullish for steel, it will mean a bearish market for iron ore, resulting in around 75 million tonnes lower demand for iron ore in the second half of the year.

“Press reports suggest China is imposing more restrictive measures on steel production in (the second half of 2021) to ensure output is lower year over year and to meet carbon emissions goals,” UBS states.

“The extent of the policy is not yet clear as six other producers indicate they have not received the order to cut production; we note this policy would also be at odds with the government’s aim to deflate steel prices (albeit it could result in lower iron ore prices).”

Wood Mackenzie is expecting Brazilian iron ore supply to grow in the second quarter of 2021, with its iron ore price forecast for the September quarter higher against a previous estimate as a result.

“We have raised our third quarter price forecast to $US185 per tonne (cost and freight) versus an estimated $US200 per tonne in the second quarter,” Wood Mackenzie head of iron ore research Rohan Kendall says.

“We still think the second quarter was the high point for Fe grade premiums (and discounts), and we expect both to contract slightly in the third quarter – smaller premiums and smaller discounts – as mills adjust to much lower margins than were achieved in the second quarter.

“We still believe prices will be lower in (the second half of 2021) than (first half of 2021) as Chinese credit tightening cools down construction-related demand and Brazilian mine production accelerates.

“But neither is a safe bet and the balance of risk leans towards demand overperformance and supply under-performance.”

Kendall echoes a similar sentiment to Ausbil with Chinese construction activity met with supply issues in Brazil. 

“On the demand side, Chinese construction and manufacturing hold the key,” Kendall says.

“Tighter credit availability should take some of the heat out of the property market, but manufacturing activity remains red hot as recent demand-led power shortages in Guangdong and Yunnan provinces demonstrate. On the supply side it’s still all about Brazil, as the country’s iron ore industry strives to regain its position in key markets after two dreadful years (in volume not value terms). 

“Progress is slow going for Vale on its ‘pathway to 400 million tonnes per year’ with supply of high-grade (Carajas) fines and pellets still running well below target.”

Australia’s iron ore production has taken the helm from Brazil. According to the Australian Bureau of Statistics, metalliferous ore exports achieved a record high of $20.49 billion in June 2021.

Iron ore was up by 6 per cent in the same month, delivering $17.55 billion worth of metalliferous ore exports.

With Australia breaking all-time highs for iron ore supply and demand, mining companies and government bodies will need to carefully navigate the market for future impacts derived from China and production ramp ups in Brazil. 

This story also appears in the August issue of Australian Resources & Investment.