April 22, 2024 (UPDATED: April 29, 2024 for Prices & Data)
By: Bentley Atteberry
On March 13, 2024, representatives from Chinese copper smelters met in Beijing to discuss ways to resolve the growing tightness copper concentrate supply. The results of the meeting were measures to curb future smelter capacity and potential pull back on refined output plans for 2024. These headlines sparked a speculative buying frenzy in copper linked assets throughout the financial markets.
A deep dive into the underlying fundamentals of the market point to a premature rally in which the physical participants appear only interested in utilizing the rally to sell.
Top: LME Copper 3 Month Price | Bottom: LME Copper Cash to 3 Month prompt spread
Source: London Metals Exchange | LSEG | Myst Capital
The looming shortage of copper concentrate has been well anticipated for the past several years. Capex for new projects dried up after major miners dumped tens of billions into projects in the early 2000s that were brought online during the depressed market from September 2011 (triggered by Euro debt crisis) through early 2016. Due to the long lead times for projects, it became apparent that by the mid to late 2020s, there was not going to be enough new supply of concentrate to match demand.
The acceleration of the energy transition combined with sliding ore grades in South America, rapidly rising costs, and labour shortages slowing brownfield and greenfield projects has pushed this looming deficit closer to the present. One of the few major greenfield projects that did come online was First Quantum's Cobre Panama mine in Panama.
Satellite imagery of Cobre Panama mine stretching more than 11km north to south
Source: LSEG
The complex, larger than the size of San Francisco, had reached over 110,000 tonnes of production in the third quarter of 2023 (Calendar Year), but protests in Panama in response to First Quantum's new mining agreement with the government forced the mine to halt operations. In December of last year, the government officially ordered the mine to shut, instantly taking around 1.5% of global mine production offline.
Production of Copper from Panama plunged to 0 in Q1 2024 as Cobre Panama was forced shut
Source: LSEG | WBMS | Shanghai Metals Market (SMM) | Myst Capital
Exports of Copper Concentrate (copper metal content) from Panama plunged to 0 in Q1 2024
Source: LSEG | WBMS | Shanghai Metals Market (SMM) | Myst Capital
Refined copper is produced either from a primary source (mined) or a secondary source (recycled) (more on secondary production further below). A majority of mined copper is produced via the traditional hard rock mining (ore --> concentrate --> pyro-refined. see process below), while around 15% is produced via one of the solvent extraction and electro-winning (SX/EW) hydrometallurgy processes where copper cathodes are produced on-site (you can read more about SX/EW here).
Copper Mine production by type since 2003
Source: Myst Capital | WBMS | LSEG | SMM | Fastmarkets |ICSG
Share of Copper Mine supply by country between 2016-2023
Source: LSEG | WBMS | Shanghai Metals Market (SMM) | Myst Capital
Chilean Copper production peaked in 2018 and hit lowest level in 2023 since 2003
Source: LSEG | WBMS | Shanghai Metals Market (SMM) | Myst Capital
Copper smelting and refining process. Source: Pan Pacific Copper (PPC)
Treatment and Refining Charges (TC/RCs) are the fees paid to the smelters by the mines for turning concentrate into a refined metal. These are the key sources of income for any copper smelter but TCs typically fall when demand for concentrate outstrips supply.
Copper treatment charge rates (Top) and smelter profitability (bottom)
Source: Shanghai Metals Market (SMM) | Myst Capital
This relationship in supply and demand for copper concentrate and the TC rates is apparent in the chart above. The squeeze in the copper concentrate markets does not necessarily equate to a shortage in metal however and despite our long-term positive view on copper cathode prices, there are a myriad of current indicators telling a contradicting story.
Supply Side
For starters, the sub-chart above shows an estimate of the profit/losses for smelters in China based on long-term contracts and spot prices. A majority of smelters operate on either long-term contract pricing (red dashed line above) or a 70/30 blend of long-term and spot prices. Additionally, they benefit from the production of by-products such as gold and sulfuric acid. The later has been in oversupply the past few years, however, due to its use in fertilizer, demand is strongest in the spring and smelters are able to sell their sulfuric acid this time of year. Therefore, despite the historically low spot TC rates, smelters are able to operate in or near profitable territory for the time being (Note: preliminary discussions for future quarterly contract prices are for TCs to be right about break-even).
Copper smelter operating rates (top) and daily output (bottom) in China
Source: Shanghai Metals Market (SMM)
As the chart above shows, larger smelters have maintained high operating rates despite the plummeting TC rates, while small and mid-sized smelters have cut operating rates a smidge. The result shows continued higher copper production with daily output running about 5% higher year over year. We do not anticipate this to last forever at these levels, but that is the reality of the current situation.
Imports of Copper Concentrate continue to grow despite tightness in market
Source: Myst Capital | LSEG | WBMS | SMM | Fastmarkets | Bloomberg
If you extrapolate the above, it paints a picture of growing smelter and refining capacity. This is one of the reasons for the record low TC rates. New refiners will purchase input inventory at whatever cost because it is needed to get their facilities operational (Note: over 850,000 tonnes of new smelting capacity is expected to come online by year end). This is much like what happened in the Lithium markets throughout 2022 when CAM and battery makers were purchasing input inventory at any cost just to get their production lines operating.
Supply demand balance for refined copper 2000-2023
Source: Myst Capital | WBMS | SMM | LSEG | Fastmarkets | ICSG
Refined copper from secondary sources plays an important role in balancing the markets. While production from recycled copper is not a majority like Lead, it holds steady at around 4 million tpa (12-16%). Copper rod producers tend to be price sensitive on their inputs and in recent weeks, tightness in the scrap markets loosened as cathode prices increased and rod producers switched to using mostly recycled material.
Annual secondary copper production
Source: Myst Capital | WBMS | LSEG | SMM
The result has been an above trend increase in refined supply globally and expectations are for a further 2% increase in refined production in 2024. As the supply/demand chart shows above, it appears that demand has kept up with recent gains; however, demand data on the surface can be deceiving.
Demand
Demand for industrial metals is nearly impossible to measure, so an implied demand figure is typically used. Implied demand is calculated by taking supply, adding net imports (subtracting net exports), and adding a decrease in inventories (subtracting an increase in inventories). The most difficult part of this equation is in the inventories figure due to the opacity of inventories held outside of the major exchanges, which are typically only used as a market of last resort.
With that said, we do our best to extrapolate what we can from a combination of exchange inventories and third-party providers of information.
Copper inventories and flows in London Metal Exchange warehouses
Source: London Metals Exchange (LME) | LSEG | Myst Capital
Inventories on the LME have steadily decreased since the beginning of the year which points to potential uptick in demand; however, there are some seasonal factors at play and there have been slower deliveries into the warehouses (middle right chart). The chart and table on the right-hand side of the dashboard above tell a story of sluggish demand from the market of last resort. There is one exception to that, which is the United States. That is due to base effects and the build of inventories in the US during the late half of 2023 (Pink shaded area in the middle-left chart).
Overall, copper inventories on the London Metals Exchange are up a whopping 75% over the past year, albeit from historically low levels. In similar respect, inventories in Mainland China remain stubbornly high following a record Lunar New Year stock build.
Copper inventories and flows in China
Souce: SMM | LSEG | SHFE | Myst Capital
As mentioned above, the seasonal build in social inventories in mainland China was the largest since at least 2016. Typically, by late March, downstream companies begin stocking up on inputs ahead of the peak season during the spring and early summer. This year however, the lack of inventory drain shows that those downstream buyers are not chasing prices to build up their stockpiles.
The middle-left chart above shows an estimate from survey data of downstream inventories. In 2023, they were drained a bit as they stocked up through the second half of 2022 and then worked through those inventories throughout 2023. A small seasonal tick up shows they were buying well before the meat of the recent rally in prices.
Overall, exchange inventories and social inventories in China are up 113% and 137% over the past year.
Bonded inventories have climbed dramatically from just 10,200 tonnes to start the year to now over 77,000 tonnes. The chart (next to the smelter & downstream inventory chart) looks like a dramatic drain through 2022 and even 2023. This was due to a rising interest rate environment that made it more expensive for traders to hold metal as well as a shift of metal from China out to LME warehouses (see the build in LME inventories throughout 2023). Additionally, there was another scandal around traders warranting their metal multiple times (essentially borrowing against the same warrant). This led to an exodus of metal by traders and financiers (banks) from the bonded warehouses and into other forms of storage.
This speculator driven price rally has created opportunities for refiners to begin shipping metal out of China to LME sheds. In fact, it has become so extreme that traders are beyond reluctant to import copper into China despite China being a net importer of refined metal.
Premiums for copper in bonded warehouses in the Yangshan district around Shanghai Source: SMM
The Yangshan premium is the premium paid on a warrant located in a bonded warehouse, in this case in Yangshan (Shanghai area), to then import into China. There are several factors that impact the Yangshan premium with the most obvious being the pricing differential between Copper in China and Copper ex China.
The import arbitrage value signals when it is profitable to buy copper cathode from outside China, ship it in, pay the duties and deliver it against the current price. When that number goes positive, it also typically means that the Yangshan premium will increase as the immediate way to take advantage of that situation would be through bonded warehouses, such as the ones in around Shanghai.
The current extreme negative levels are at a point where it is profitable to export metal into LME warehouses. This has happened in the past (shown in the shaded pink below). We also discussed an inverse situation of this midway through last year here.
Import arbitrage levels in China have flipped to attractive levels to export
Source: Myst Capital | SMM
Historically, the way these extremes have corrected is by metal showing up into LME sheds and squeezing the speculator longs out of the market. After all, in order to make money speculating on a commodity, it must be sold, which is why "markets are forward looking" does not hold up well in the commodity markets.
We only need to go back about a year to find an historic example of this situation playing out. Following announcements of ending covid zero policies throughout China in late 2022, copper rallied around 25% over the two months to late January 2023. A similar set up unfolded where LME prices were well above onshore China prices due to a lack of physical demand (See Import Arb Price Chart above for this as one of the pink highlighted periods). Smelters and traders in China thus poured metal into the Asian markets outside of China to take advantage of the price discrepancies and the price of copper sold off around 15% in the ensuing months.
China exports of Copper Cathode
Source: Myst Capital | LSEG | WBMS | SMM | Fastmarkets | Bloomberg
China net trade balance of Copper Cathode | Exports (Blue) - Imports (Orange)
Source: Myst Capital | LSEG | WBMS | SMM | Fastmarkets | Bloomberg
Above shows a clear dramatic increase in cathode exports from China during the aforementioned period of early 2023.
This time, the price rally picked up steam late in Q1, so the flows have not come through on the hard export data just yet. With that said, over the past few weeks, Chinese sources have reported smelters and traders sending metal to ports and bonded warehouses for exports. Just this week, Reuters picked up on the trend here. We are expecting to start seeing this metal flow into LME warehouses over the next 1-2 months.
Brief Macro and Other Information
The five followers of our insights/research will know we have spoken ad-nauseum about the depressed manufacturing sectors throughout Europe and the United States over the past year and a half. I will hold off on the monthly PMI table for now; however, I will also point to our Q4 2023 Letter where we mentioned copper's resilience in China despite their property sector woes.
China completed construction boomed in 2023
Source: SMM | China NBS | Myst Capital
New energy sectors in China continue to make up a larger portion of domestic output
Source: SMM | China NBS | Myst Capital
Copper's use in real estate construction tends to be skewed towards later stage construction since it is used for wiring and piping. That partially explains the significant demand increase in 2023 as building finishes increased over 15% YoY in China. Additionally, the new energy sectors, which are copper intensive, continued to grow throughout China and now make up around 10% of their economy. Even so, the demand increase globally for copper in 2023 was strongest since 2014 with economies throughout Europe and North America sputtering at best.
Copper annual demand by region
Sources: Myst Capital | WBMS | LSEG | SMM | ICSG | Fastmarkets
The price movement for the red metal throughout 2023 did not show the story of the above figures (up around 2% in 2023). We believe this is because traders and downstream consumers were buying lower prices and effectively borrowing from future demand. This has already started to show up with the record inventory builds to kick off 2024.
A Rising Difference Maker to Track
We cannot talk about demand stories without mentioning a soon to be power player in the industrial metals space. India has been talked about as the next great emerging story for what seems like the past 20 years. The world's largest country by population has committed to spending billions on infrastructure and the private sector appears to be following.
This is very apparent looking at Copper data as the country quickly turned from a net exporter to a net importer due to a near doubling in demand since 2020.
Implied supply & demand of Copper in India
Source: Myst Capital | LSEG | WBMS | Bloomberg
We expect the Indian growth story to remain positive over the next several years due to the rapid growth in infrastructure; however, despite recent near doubling of demand in India, the country makes up around 3% of global demand. That figure will start to have a larger impact in the coming years as the country continues to demand metal via imports.
Share of copper demand 2022-2023 by country
Source: Myst Capital | LSEG | WBMS | SMM | Fastmarkets | Bloomberg
In the near term, the strength of Indian demand may assist in putting a floor under price if they begin strategically buying significant volumes to cover future demand; however, we have not seen signs of such activity. In the longer run, we do expect imports to continue rising, particularly from Africa, as India continues to boom. This will be an increasing driving force for copper prices in the longer run, but not enough to offset the weakness in the near-term.
Imports of Refined Copper into India by Origin
Source: Myst Capital | LSEG | WBMS | SMM | Fastmarkets | Bloomberg
Basis
Sometimes, the most telling indicators to look at are the regional and prompt premiums.
Regional Copper Premiums
Source: SMM | Fastmarkets | LSEG
We spoke about the Shanghai premium above and the reason for that extreme. Generally speaking, the other regional price premiums have remained flat in early 2024 after weakening throughout 2023. Since the announcement on April 12, 2024 from the United States and United Kingdom sanctioning Russian Copper, Aluminium, and Nickel, there has been a slight increase in US premiums due to supply concerns. The premium will remain an important indicator to track if physical buyers are stepping in to purchase material.
Typically, aggressive buying activities and a tight supply/demand market leads to near term prices being higher than future prices ("backwardation.") Despite the rally, the term structure has remained in deep contango (near-term prices below future prices).
China copper premiums (Values in CNY/mt)
Source: SMM | Myst Capital
LME copper premiums (Values in USD/mt)
Source: London Metals Exchange| Myst Capital
To quote Jeff Currie, "curve dont lie." I would tend to argue that nothing is that simple but, in this case, it is tough to argue against.
The term structure in the copper markets continues to hover near multi-decade lows. Interest rates do play a role in the degree of looseness in the curve, however, if the copper cathode markets were actually tight, we would not be discussing the degree of contango.
To sum it up, recent developments in the copper concentrate markets has sparked a speculator driven rally in copper cathode prices that the physical markets are not buying.
We believe these developments help our established long-term positive view on copper prices; however, divergences between physical and financial markets presents an opportunity to take a short-term contrarian view to the long-term consensus view.
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