Can Copper Companies Adapt?

04/18/2013 8:30 am EST

Focus: COMMODITIES

Jim Jubak

Founder and Editor, JubakPicks.com

The cost structure of mining copper requires much stronger demand than currently exists, and MoneyShow's Jim Jubak determines if the industry will right itself anytime soon.

If you walk the streets of Santiago, Chile, this week—and really not the streets, but basically the big convention hotels where all of the world’s copper miners are meeting—you would have heard the sounds of teeth gnashing and sobbing CEOs, because basically copper is a paradigm of the problems going on in the commodity sector.

It’s a really significant case. Basically, what you’ve got is not a demand that’s falling off the cliff—and demand growth from China is slowing—but you’re still looking at something like 5% growth in copper demand this year.

So what are the copper companies worried about? They’re worried about rising costs; that demand has to be stronger if they’re going to wind up compensating for the rising costs. How much? That’s what was really shocking.

The Chilean companies have been hit among the hardest in the world. So you had Codelco, which is the big Chilean government-owned copper company—it’s the biggest copper producer in the world—saying that it had seen a 57% increase in cost. Some of that was strikes and some of that is petroleum.

But most of it—and this is across the world—most of the increased cost in the industry comes from falling copper grades. If you go from a copper ore that contains 1% copper or 0.06% copper down to something that’s got only like 0.02% copper, you have to move a lot more rock, you have to process a lot more rock, you have to dispose of a lot more waste, all those things add up...and you’re still only getting a very small amount of copper.

That’s what is going on; you seem to be getting a falloff in copper grades pretty much across the globe. Maybe 100 years ago, this was primarily a US problem, and that’s one of the reasons why the US copper industry ceded global leadership to places like Chile, because US copper grades had been exploited earlier, and therefore the ore grade was falling faster and lower.

You see the same things gong on in Chile. The worst cost increases around the globe are in older mines, because they’ve already mined their best ore and are seeing costs go up more rapidly. Some of the oldest Chilean mines are seeing something like 75% cost increases. You can’t do that if demand from China, global demand is only growing like about 5% a year.

So you get into this real bind. In the short term, the problem is that you’re not making very much money—prices are down, and you don’t have the money.

Really, it’s not so much that you don’t have the money to invest, it’s you really don’t want to go to your shareholders and to Wall Street and say, "Hey, we’re going to spend $20 billion on new mines." They’re going to say to you, "Well, but your return on this, what’s it going to be? You’re not returning anything now; you’re going to have to cut your dividend to do this." So companies don’t want to do this in the short term.

In the longer term, they’ve got to find a way to increase capacity, for as ore grades go down in the current mining infrastructure, the current number of mines are going to be able to produce less and less of the ore that we need. There’s an estimate of our need for a massive increase in investment from 2012 to 2020 just to keep us steady in terms of copper production.

Where is that money going to come from? Well it will come, eventually, if the supply-demand balance gets out of whack again on the side that favors suppliers. That would drive the price of copper up again.

Right now, it looks like for 2013 and 2014, we’re not looking at copper getting above $8,000 a metric ton. At that price, it’s going to be very hard for companies to justify increasing production.

So somewhere down the road we’re going to hit one of those lovely little spikes that drives the price of copper way up, and we’re going to say copper is a great place to be. But for the short term, it looks like these stocks are still slightly overpriced, and facing a year or year and a half of really tough sledding.

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