October 1, 2012 7:43 pm

Commodities: Supercycle jitters slow projects

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BHP Billiton's Escondida mine

BHP has plans to relocate another plant to allow the Escondida mine to expand even further

One phrase to strike fear into the heart of any Chilean politician is: “The end of the commodities supercycle.” For a decade, the Andean country has surfed a wave of booming Chinese demand and soaring prices for copper.

As the red metal rallied from less than $2,000 a tonne in 2000 to a peak of more than $10,000 early last year, the Chilean economy flourished.

But now everyone from hedge fund managers to Australian politicians is proclaiming the boom is finished. Martin Ferguson, Australia’s resources minister, says: “Anyone with half a brain knows that today’s record commodity prices are over.”

The reason for this is that China’s astonishing rate of growth of the past decade appears to be slowing.

The country, which now consumes about 40 per cent of the world’s copper, has seen a marked slowdown over the past year, with economic growth rates expected to fall to about 8 per cent, from more than 10 per cent two years ago, as the government clamps down on its property boom and slowing growth elsewhere knocks exports.

Moreover, the Chinese economy is changing. The government is attempting to engineer a transition from an investment-led economy, where the main driver of growth was the construction of cities and transport links, to a consumption-led model, driven by ordinary citizens’ purchases of TVs or washing machines.

That may be desirable for China’s long-term stability, but, for industrial commodities, it presents a problem: TVs use less metal than skyscrapers.

The shift has played out most starkly in the iron ore market. The raw material of the steel industry has seen its price plunge from $150 a tonne in April to a low of $87 in September, in the process leaving miners who had assumed that prices would remain above $120 for several years reassessing their projects.

But iron ore is of little significance to Chile. The country’s confidence is etched in copper, whose price directs everything from the strength of the Chilean peso to the Santiago stock exchange IPSA equity index. The metal accounts for more than half of Chile’s exports, 13.5 per cent of GDP and employs more than 200,000. And, while iron ore prices have tumbled, along with metals such as nickel, zinc and aluminium, copper prices have remained buoyant.

By late September, copper was trading at about the same level as the start of the year – $8,300 a tonne – while iron ore was down 35 per cent.

For bearish investors and analysts, the only question is when copper will take a tumble and catch up with other commodities – especially as several new mines are scheduled to start production in the next 18 months.

Julian Jessop, chief economist at Capital Economics, a global consultancy, says “We still think the price of copper could fall as low as $5,000 a tonne next year, a decline of nearly 40 per cent. This is broadly consistent on past form with where iron ore prices have recently been trading.”

But others dismiss such pessimistic forecasts. For a start, Chinese growth continues apace, even if it has slowed from the breakneck rate of the past few years. And some of Beijing’s bigger projects, such as railways and power grids, will still demand copper.

More important, miners are struggling to increase supply – even at the current, fairly sluggish, rate of global growth. Despite lacklustre economic growth this year, copper inventories on the London Metal Exchange have fallen by nearly half.

Problems as diverse as the difficulty of finding new deposits to a shortage of world-class mining engineers are restricting supply and raising costs.

Marius Kloppers, chief executive of BHP Billiton, the mining group, said in a recent briefing with analysts: “Quite simply, the world has not yet found an obvious solution to resource depletion and the resource degradation that continue to constrain the pace of low-cost supply addition in copper.”

Other miners agree. For example, Glencore believes that “the market continues to underestimate the potential for supply-side weakness to keep key commodities such as copper in deficit”, while Rio Tinto says that the copper industry’s challenges “have shown no signs of abating”.

However, the current lack of interest among investors towards the mining sector is causing some large projects to be delayed or cancelled, potentially prolonging the period of high prices until 2016 or beyond.

BHP recently postponed indefinitely its Olympic Dam copper-uranium mine in South Australia – which had been billed as an Esperanza for the next 100 years – a reference to the world’s largest copper mine, itself majority owned by BHP, in northern Chile. Xstrata’s Las Bambas project in southern Peru, one of the most significant mines in development, is also likely to be reconsidered if the miner’s merger with Glencore is successful.

Pedro Fuenzalida, mining analyst at LarrianVial, the Chilean brokerage, says: “The only thing this ‘end of the supercycle’ noise will bring to the copper market ... is a delay in copper projects. This will keep the market tight for longer, since the issues of the copper industry are still there.”

Ironically, the jitters among investors about the end of the supercycle, focused as they are on commodities such as iron ore and coal, may end up being positive for Chile.

“The relationship for Chile with the commodities cycle is only a copper-related story,” Mr Fuenzalida says. “While some materials look like bringing significant added volumes in the next years (iron ore being the typical example) other metals look tighter on supply issues. The supercycle is far from dying for them.”

Sebastián Piñera, Chile’s president, hoping his centre-right bloc can be re-elected in 2013, must surely be hoping he is correct.

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