The copper conundrum

The copper conundrum

Written by Mandi Dungwa – Portfolio Manager

The physical and chemical qualities of copper make it the material of choice for a variety of industrial applications. We rely heavily on copper across a multitude of industries including construction, power generation and transmission, electronics and industrial machinery manufacturing.

Through its use in electric vehicles (more than a mile of copper wiring is used in an EV battery) and related charging infrastructure, copper will be very widely used in the necessary global movement towards decarbonisation. This likely increased demand coupled with the past decade of low investment in new mining supply, should set the scene for a tight market for the metal and an elevated copper pricing environment. We explore the probable outlook.

Supply and origination
Over 80% of copper deposits are classified as either porphyry or sediment-hosted stratabound and, in both cases, the copper occurs with many other associated metals:
Porphyry deposits make up over 70% of copper deposits and were formed by volcanic reactions deep in the earth. They tend to be large, comprising relatively low grades of copper, and are amenable to bulk mining methods such as open pit mining.
Sedimentary deposits constitute 10% of current copper deposits and were formed in ocean basins millions of years ago. They are usually accessed via underground mining methods and yield the highest copper grades.

As indicated below (right), South America is the largest copper producing region (37% of supply), with Chile being the world’s largest copper producer (27% of 2021 production). Chilean miner, Codelco, is the world’s largest, delivering over 1.7 million tonnes of copper in 2021.

A varied market outlook
As the Chinese economy transitions from an infrastructure growth-led economy to a consumer demand-led economy (like more developed nations), the demand for copper has decreased relative to expectations at the start of the millennium. With China constituting over 50% of global copper demand, it has resulted in relatively low copper prices and consequently, cash flows for copper miners being negatively impacted. As such, lower levels of capital have been allocated to growing and sustaining copper production or to exploring for new copper deposits.

The outlook for growth in copper demand stems significantly from the transport sector as it moves to electrification. The electric power grid will also need to transition, with renewable energy playing a pivotal role, further boosting copper demand as new generation and transmission infrastructure is built.

At current global production rates there are 42 years of copper reserves in the ground, however global decarbonisation trends are likely to mean copper demand will grow at 1 million tonnes per annum (5% of current mine supply) between 2020 and 2050. This is double the rate of the annual demand growth over the last decade (even as China has developed its economy and infrastructure) and equates to the need for a new producer of the same size as Southern Copper – one of the top five global copper producers (left chart below) – to be added each year for the next 30 years.

To date, mainly copper deposits with the highest grades have been mined for the higher revenues yielded per tonne of ore (rock) mined. Copper projects that are currently under consideration are of a lower grade than copper from existing mines, thereby requiring more ore to be moved at higher costs per tonne (to produce just a single tonne of copper).

As shown below (right), over the last 30 years copper grades have declined by more than 30% as mines are deepened and as the highest-grade sections become depleted. With over 70% of deposits being porphyry, most of the mines are open pit. As these mines mature, they require the removal of more waste product to access deeper, lower grade sections, thus significantly increasing the cost of production together with the complexity of the mining process.

Mega-drought stifles supply
In Chile, where 27% of mined copper production currently occurs and where 23% of global reserves are located, water scarcity is a huge concern. The country is experiencing a decade long mega-drought, with the picture looking increasingly grim. Water is trucked into rural areas where it is no longer available, citizens live with restrictions, farmers have seen tens of thousands of animals die, beehives are being wiped out and reservoir levels are low. These major water shortages have necessitated significant increases in water prices and yet the mining industry in Chile consumes enough water to provide for 75% of the daily needs of the country’s population.

The process of mining at deeper levels (for lower grades of copper) requires greater water consumption. Consequently, the availability of water supply will determine whether some of the 200 million tonnes of copper reserves will be mined in the future. Mining companies such as Glencore are considering creating desalination1 plants for the expansion of their Colluhausi mine in Chile, adding a further cost to expand the production base. Existing operations in Chile have had to cut back on production due to a lack of water, which now presents the greatest risk for Chilean copper supply.

1The process of removing salt from seawater.

Persistent humanitarian crises bodes poorly for African supply outlook
The Democratic Republic of Congo (DRC) makes up 9% of global copper mine supply and 4% of unmined reserves. However, child labour and relentless conflict remains a major concern for the mining industry in the DRC. While the country has decreed child labour as illegal (the minimum working age is 16 years), artisanal mining groups continue to recruit underage children as a form of cheap labour. Furthermore, ongoing conflict in eastern Congo is holding back the development of any large-scale industrial mining projects. This has led to the majority of the DRC’s mining in that region being conducted by non-compliant artisanal mines, with very little governmental oversight or health and safety standards being upheld. Glencore’s Kolwezi mine exposed these risks when 43 miners died after a closed section of the mine caved in while being illegally mined.

In 2018, the DRC revised its mining code, effectively rebalancing mining cash flows in favour of the state. This was done through increasing tax rates and reducing mining companies’ ability to extract cash from the country. These changes have, however, been challenged by large foreign companies with operations in the DRC and negotiations are ongoing. This has resulted in lower shareholder returns and higher uncertainty, which in turn leads to lower capital allocated to growing copper production in the country.

The governments of Chile and Peru are also in the process of reviewing mining legislation, with a view to substantially increasing taxes from the current levels, which will also create uncertainty in these regions.

Since 2015, mining companies have generally favoured paying out capital to shareholders rather than reinvesting in future production. The legislative uncertainty and environmental and social instability in regions that account for 45% of copper mine production and 35% of reserves, has resulted in copper miners preferring to pay out cash to shareholders instead of investing further in these high-risk territories.

Are there alternatives to copper?
With so many copper supply concerns for the future, alternative options are being explored. Currently, the best substitution for transmission applications in the power grid, is aluminium. The biggest advantage for aluminium is its cost, as three parts aluminium are required for one part copper, implying above the 3:1 (aluminium: copper) price ratio. For this reason alone, we should see more substitution in favour of aluminium going forward. Additionally, being 30% less dense than copper, aluminium cables are almost half the weight of copper cables – an incremental positive for property developers.

Just over 1% of copper demand was lost due to an increase in aluminium usage in 2021, despite the currently elevated price ratio. However, copper continues to be regarded as a superior metal particularly because of its conductivity, better energy efficiency, high resistance to corrosion and fire-resistant properties.

Demand dynamic set to see prices firm
Over the next three decades, as decarbonisation drives a significant increase in copper demand, the supply challenges outlined herein may result in a deficit in the market. This will create a robust pricing environment, incentivising miners to build new mines or grow production with the expectation of good returns if they can overcome some of the current challenges. Using alternatives such as aluminium could alleviate some of the supply concerns, although copper continues to be the preference.

Our clients are exposed to copper through our investment in Anglo American, which is increasing its copper output from 647 000 tonnes in 2021 to over 1 million tonnes in 2023 (with the ramp up of their new Peruvian mine – Quellaveco). Anglo American invested in this mine at lower copper prices and will benefit from the current and future higher copper prices.

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