Unprecedented Price Levels in 2006
The price of copper is such an important factor for most cable-makers that they will be very familiar with the recent trend in copper prices. Though there were periods in the 1990s when the price went above US$3,000/tonne, for a five-year period up to the end of 2003 the price of copper was relatively stable, generally staying in the range between US$1,400/tonne and US$2,000/tonne. In late 2003 and early 2004 the price began to move upwards. Prices continued to climb higher during 2004 and 2005, reaching US$4,500/tonne at the end of that year. This high price level did not seem sustainable at the time, but in fact during H1 2006 the price of copper shot upwards further. The peak price achieved was over US$8,700/tonne (LME 3 month) in May 2006. This is more than 6 times as high as the price in November 2001 (US$1,400/tonne)! The price of copper has been driven higher by continuing growth in demand, limited stocks and supply problems, while price volatility has been made worse by the actions of investors seeking short-term gains.
Trend in Real Copper Prices
While the price of copper appears to be very high currently in terms of US$/tonne, in real terms the current price is not quite as exceptional as it first appears in nominal terms. Since the purchasing power of the US dollar was higher 20 or 30 years ago than now, in order to analyse the copper price trend in real terms, historic prices have to be adjusted by a general measure of cost changes, such as the GDP deflator for the US economy. After applying this inflation adjustment to the nominal US$ copper price, it is clear that the rise in copper prices during 2005 was not actually that exceptional in real terms. The spike in copper prices experienced in 2006 was exceptionally high, but there were times in the 1960s when price levels in real terms were not far away from the 2006 average price.
Blame High Demand in China!
The main underlying reason for rising prices of most materials in the last three years has been growing demand from China. Strong growth of cable production in China is the principal reason for the increase in global copper demand, but other applications are also driving Chinese copper consumption higher. Due to the boom in construction in China increasing amounts of copper have been used in buildings (electrical equipment and brass fittings as well as cable).
China OEMs Ramp Up Production
In recent years there has been a major shift of global manufacturing towards low cost countries, in particular to China. This shift is very clear in some industries, for example in production of air conditioners that use copper tubes. Production of electronic and electrical equipment using magnet wire has also been growing very quickly in China. On a global level the increased production in China due to transplanted manufacturing does not add to global demand, but only shifts consumption from one part of the world to another. However, at the same time production of many goods in China is also increasing to meet growing demand from China’s own consumers, and this increased production does add to global demand.
Demand in India Also Grows
All industry commentators have pointed to the strong growth in Chinese consumption as the principal reason for increasing global demand. More recently, Indian consumption has also started to move ahead due to an upturn in the Indian auto and construction industries. Continuing Indian annual consumption growth of 7% to 8% is likely. India is growing from a much lower level than China, as India’s copper consumption is only 10% of Chinese consumption.
Copper Supply Disruptions
In practice there have been during H1 2006 supply disruptions at existing mines that have made the supply-demand balance even tighter. Recently, workers at some of the major mines in Chile, well aware of the high copper price, have been pressing for higher pay. Potential problems such as the threat of industrial action makes markets nervous and can attract further attention from speculators, which may drive the price even higher in the short-term.
Why Does Copper Supply Not Increase Faster?
As a result of booming demand, operating profits in the copper industry have grown dramatically – operating margins up from 8% in 2001 to 38% in 2005. So why does copper supply not increase faster, as the industry clearly has plenty of cash to invest? To answer this question, we need to look at the basic economics behind investment decisions in the copper industry. Much of the added value in production of copper arises in the mining stage: only 25% of added value is in smelting / refining but the rest is in extraction and processing of copper ore. Thus the key supply constraint is the limited number of mines. When copper demand was lower, there was a surplus of production capacity and additional supply could be added simply by increasing throughput from existing mines. But supply cannot be increased indefinitely without additional copper production capacity, i.e. new mines. Despite the prevailing very high level of copper prices, copper supply from mines has not risen as fast as might be expected.
Copper Industry Investors Look at Long Term Prices
The economic theory is that when prices rise due to higher demand, supply will increase as it becomes possible to operate marginally economic mines at a profit due to the higher prices. The problem in practice is that copper is supplied from facilities that require huge investment in the mine and supporting infrastructure, and a major investment decision is required. A short-term rise in copper prices – even when sustained over several months - does not necessarily change industry investors’ perceptions of the long-term copper price. Mining companies will not invest in a project unless their expectations of long-term prices are at a level where the project becomes attractive.
Copper Wirerod Premiums May Rise
Except for some of the largest cable-makers that have in-house production of copper wirerod, cable manufacturers buy their copper fabricated as wirerod or wire. While the wirerod market has its own dynamics, any shift in copper wirerod premiums is very modest compared to movements in the base copper price. Purchasers of wirerod will want to haggle with suppliers down to the last US$/tonne or €/tonne on wirerod premiums, even though the amounts may seem trivial in comparison to the overall copper price! Major buyers are likely to negotiate these premiums with their main suppliers annually, using spot purchases to top up their requirements. The most significant development in the European market recently has been the announcement of the closure of the Prysmian copper rod facility in the UK. Though there is no shortage of wirerod production capacity overall in Europe, it would not be surprising if this reduction in capacity results in price increases for some wirerod purchasers. The high level of copper prices greatly inflates the working capital requirements of wirerod producers, so they may seek to recover higher costs through higher selling prices.