Copper supply risks still count, just differently

LONDON: The copper market has lost none of its ability to spring supply-side surprises.
The last couple of weeks have brought a walkout at the Radomiro Tomic mine in Chile (ended), a port strike in the same country (ongoing) and the closure of the Tuticorin smelter in the south Indian state of Tamil Nadu (for at least a week).
None of which has stopped the price of the red metal on the London Metal Exchange (LME) from sinking to eight-month lows below $ 7,400 per ton. But then, this is a market that has, superficially at least, shifted in double-quick time from deficit to surplus.
Global exchange stocks, comprising those registered with the LME, COMEX and the Shanghai Futures Exchange, have surged by 290,000 tons since the start of the year. Visible inventory hit 832,500 tons at the end of March, the highest it’s been since 2003.
In theory such an ample stock cushion should buffer the market from precisely the sort of unforeseen supply disruptions seen in the last few days.
But does it?
Or is the market at risk of viewing disruption through the old prism of market deficit rather than the new landscape of surplus?
Until late last year copper was a market defined by supply shortfall. It’s why the price could trade significantly above the marginal cost of production for so long, in stark contrast to most of the other industrial metals traded on the LME.
That shortfall was itself defined by a systemic underperformance at the mining stage of the supply chain, a problem rooted in the aging of key mines, particularly in number one producer Chile, and a lack of investment in replacement operations.
This left the market highly sensitive to any unexpected hits to mine supply, whether through lower-than-expected grades, technical failures or labor unrest. Less mine supply equalled less metal, exacerbating underlying deficit and posing upside price risk.
Analysts even evolved their own metric to measure the unexpected, a ‘disruption allowance’ that could be super-imposed over forecast mine supply in any given year with flow-through implications for the refined copper market.
Supply disruption was a ground-zero calculation, defined by what was, or more importantly, what wasn’t coming out of the ground at any given moment in time.
To some extent it still is.
Analysts will be poring over the Q1 production numbers of the worldís major copper miners to determine which, if any, is still not producing to guidance.
The only difference is that now it’s a case of determining expected size of surplus rather than size of deficit.
Seen this way, the most important of the three supply-side hits in the news was the brief walk-out at Radomiro Tomic.
The mine is a big producer with output last year of 428,000 tons. Even a couple of days’ downtime, therefore, will have caused some production to be lost.
And seen this way, neither the closure of the Indian smelter nor the ongoing Chilean port strike really ‘counts’ as a supply disruption. The metal piling up in Chile’s ports is not lost, it’s just delayed.
As for Tuticorin, it’s not as if there is a global smelter bottle-neck in the supply chain after China’s massive build-out of capacity over the last few years.
Again the copper is not lost, it will simply have to be re-routed somewhere else, even if the smelter does remain closed for longer than anticipated.
Both incidents, in other words, affect the timing and distribution of shipments not the finite amount of copper in the world, as defined by what comes out of the ground.
Yet timing and distribution can be powerful drivers in the physical copper market.
Take, for example, events last year when the Pasar copper smelter in the Philippines was knocked out of action for around six months after a fire in January.
Refined production at Pasar slumped to 90,000 tons last year from 162,000 tons in 2011. In the bigger scheme of things the ‘loss’ of production is irrelevant since concentrates will simply have flowed somewhere else to be converted into refined metal. But the outage was far from irrelevant in terms of altering metal flows.
Pasar is a major exporter to the Chinese market. Chinese imports of refined copper from the Philippines, where Pasar, majority-owned by Swiss trade house Glencore, is the only smelter-refinery, totaled 97,500 tons in the April 2011-March 2012 period.
They slumped to just 800 tons over the next five months, corresponding to the outage with a couple of months’ lag for shipping time.
That shipping hiatus dovetailed with what was historically a highly unusual flow of copper from the US to China, totalling almost 82,000 tons between April and August.
LME stocks at US locations fell by 86,000 tons over the same time-frame, facilitating a cash-date squeeze in late April, which itself led to the mass delivery of metal by Chinese smelters against distressed short positions.
Tuticorin is a bigger smelter than Pasar with capacity of more than 300,000 tons per year. It is also by some measure the largest supplier of copper to the Indian market.
Vedanta Resources, the ultimate owner of the plant, has vehemently rejected the allegations of gas leaks that caused the Tamil Nadu Pollution Control Board to order the smelter’s closure last week.
Well, at least there’s no shortage of metal sitting in LME warehouses around the world to fill any temporary shortfall.
The distribution of LME stocks themselves is a hot topic at the moment, given the largest concentrations of copper are at New Orleans, Johor and Antwerp, all of which have load-out queues.
That copper is going to have to be substituted, which means either trying to tap the LME warehouse system or the spot market.
In either case, it’s going to be at a high premium, since European spot market premiums are, inevitably, gravitating up toward the $ 100 per ton over LME cash incentives being offered by trader-warehouses. This is how a surplus market operates.
Supply disruptions that mean less metal coming out of the ground lose their price impact power because of the abundance of metal above ground. But in an LME system where more equals less, supply disruptions that alter the timing and distribution of that surplus can have very real impact on both physical premiums, and, potentially, on LME time-spreads.

— Andy Home is a Reuters columnist. The opinions expressed are his own.