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Copper Won’t Lead Chile’s Investment Recovery

Copper Won’t Lead Chile’s Investment Recovery

For the past few years Chile has seen its worst economic performance since the crisis of 1981, largely the result of depressed copper prices – which have been falling since 2011. With copper being bested by rivals such as iron ore and nickel, persistent global supply disruptions, and a lack of economic diversification, some have wondered whether Chile could continue to lose out on critical investment to commodity-rich neighbours like Peru.

During the first months of 2017 copper prices recovered some of their 2016 losses, with the year ending on a 350,000 metric-ton surplus – down from previous years.

Benchmark prices on three-month copper futures on the London Metal Exchange were up in February this year at US$6,204 per metric ton, a 20-month high for the metal.

This year, the copper market was struck by fears of a supply squeeze as potential outages threatened to lead to further price volatility, the same kind of volatility that prompted producers to slash capital expenditure in the sector over the past couple of years.

An Unsustainable Surge?

For Hunter Hillcoat, a mining analyst at Investec Securities, the most recent surge in copper prices is supported by copper production disruption in both Chile and Indonesia, another large producer of the metal.

The most significant interruption came when miners at Chile’s Escondida mine voted overwhelmingly to strike on 9 February. The move prompted BHP Billiton, the administrator of the mine, to announce that it wasn´t going to be able to fulfil its production obligations for an extended period of time.

BHP Billiton declared force majeure on its shipments, a contractual clause used when suppliers can’t meet obligations because of circumstances beyond their control.

Minera Escondida, the world’s largest copper mine, churns out more than one million metric tons of the metal a year, or about 5% of the global production.

By mid-February, the 2,500 workers had already cost the company about 41,000 tons of metal, enough to wire a million cars, an inflection point for global markets.

Supply constraints were also generated by disruptions at Freeport-McMoRan's Grasberg mine in Indonesia, the world's second-largest copper mine. Freeport said its suspension of copper exports would require the Grasberg mine to slash output by around 70 million pounds of copper per month. It also said that due to limited storage, it would need to cut output to about 40% of capacity if it did not get an export permit by mid-February.

The US political climate also helped boost the price of copper, particularly in the run-up to the November elections. Prices moved even higher after Donald Trump’s victory, largely as a result of his infrastructure spending commitments. The hype generated record volumes of open interest (the number of contracts outstanding on an exchange at any one time) in US copper futures on Comex.

Chinese demand for the metal is also a key driver of prices – but it isn’t necessarily correlated with fresh investment. Indeed, the price of copper is often used as a proxy to measure China’s economic health, and the country’s economic challenges over the past year led to a reassessment of demand and fuelled a broad-based slump in commodities, prompting companies to slash investments. As the Chinese economy started showing signs of improvement, so too did Chinese imports of copper from Chile – which rose 26.7% to 4.74 million tons in 2016, almost the same percentage rise witnessed in 2015 — when shipments rose 27% from the previous year. Meanwhile, average capital expenditure at mining companies in Chile actually declined over both years.

Making Cents of It All

Getting an accurate reading of the impact of supply disruptions is challenging to say the least. With global copper share prices already quite low, strikes at mining companies and other supply disruptions could lead to a widespread squeeze in the second quarter of 2017, a recent Goldman Sachs report explained. The strike at Escondida prompted BHP's share price to rise more than 2% the day it was announced, while Moody's upgraded the debt outlook for its holding company Minera Escondida to ‘stable’ from ‘negative’ the same day, prompting a bizarre simultaneous rally in the company’s equities and credit.

Hillcoat agrees that broadly speaking, the outlook for copper is much more positive today than it was last year or the year before. But even he is unsure of the impact of the strike.

“They have to go through the existent copper inventory to evaluate the true impact of the strike on the copper prices,” the investor added.

The positive outlook on copper has also been reflected in the derivatives markets, and the shift in the positioning of large-scale derivatives speculators. As many hedge funds reduce bullish gold bets they have pushed for extended positions on copper. According to CFTC data, managed money investors have taken net longs to a recorded high of just over 91,000 lots at the end of January – before the bulk of the supply-constraining worker unrest kicked off.

This spike in copper price will have an impact on Chile´s capital markets, with DCM analysts betting that improved price forecasts may facilitate a higher volume of issuance and bank borrowing at lower yields – but only if borrowers get their hedging strategy right.

“If the company issuing also hedges its production, then the certainty around future cash flows would be a helping factor regarding debt uptake by investors,” one analyst told Bonds & Loans.

Copper accounts for about 55% of all Chilean exports and generates 20% of the government’s revenues. Chile had once flourished under the copper boom between 2009-11, when the price of copper trebled from US$3330 per metric ton in Feb 2009 to US$9500 per metric ton in March 2011. But over the past five years, copper prices have slid by over 25%, and with that the economy’s GDP, with growth tumbling from almost 10% in 2011 to 1.6% as of 2016.

With FDI flatlining and growth stagnating it has become clear sole reliance on copper is unsustainable. The country’s socialist President Michelle Bachelet has made breaking the country’s ‘copper addiction’ on of its key priorities, emphasizing new initiatives that target boosting productivity and innovation, education, and research related to a broad range of sectors beyond the natural resources industries. With fresh elections in the offing, it is Bachelet's successor who will have the immense task of shielding Chile´s economy from its exposure to copper. But until then, the country could struggle to put in the kind of growth that made it the beacon of economic sophistication and development it is.

 

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