By Marco Mencini, Head of Research of Plenisfer Investments SGR
The Basic Resources Europe index, which includes major listed mining operators, was trading at the lowest levels recorded in the last twenty years compared to the MSCI World as of last December (Source: Bloomberg).
This is a surprising trend, considering that some metals are essential in electrification process. This process is crucial for the energy transition, a new structural driver of long-term demand for certain metals.
Copper is certainly among these metals.
Currently, copper is priced at around $8,400 per ton, down approximately 11% from 12 months ago (Source: Bloomberg).
Copper has discounted the effects of the lack of structural recovery in the Chinese economy - particularly in the local Real Estate sector - which represents up to 50% of its global demand (Source: Bloomberg).
On the other hand, 2023 witnessed a substantial balance between copper demand and supply, resulting in price compression.
The year 2024 has opened with a significant change in the scenario. Until a few weeks ago, despite expected growing demand, it was estimated that the current year would be the last characterized by an excess of supply. Today 2024 is poised to be the first year of a copper supply deficit.
Indeed, growing challenges on the production front have materialized in the meantime.
All major producers have revised their guidance downward for 2024. Panama First Quantum managed the fifth-largest copper mine in the world: after lengthy negotiations leading to the renewal of the concession, it was cancelled by the government, a unique and unprecedented case in modern history. Anglo American has cut production by 20% across all metals, from copper to palladium, due to rising extraction costs and complexities associated with production processes and their sustainability. A similar choice was announced by Escondida in Chile (-10%).
In this delicate context, the deficit in 2024 could rapidly increase if the Chinese market were to contribute more to demand, or if an economic cycle recovery were to materialize. The growth in demand for key raw materials, such as copper, is indeed strongly correlated with global GDP growth in the long term. Assuming a global GDP growth of 2%, Wood Mac estimates that copper demand could grow by over 4% annually for the next decade.
Looking beyond 2024, at Plenisfer we think that the supply of copper is likely to remain limited due mainly to the complexities and risks involved in starting new mining projects and the low expected return on the investment required to start them up.
Among the risk factors, there is the uncertainty - political, regulatory, and fiscal - that characterizes the countries where extraction sites are typically located (from the Republic of the Congo to Peru). Moreover, these Countries often suffer from the lack of adequate infrastructure (water, energy, transportation), and increasing constraints, especially on the ESG front.
ESG has become an absolute priority in the sector: the mining industry has a history of environmental issues ('E'), challenging relations with local communities ('S'), and corporate governance matters ('G'). The industry has focused for years on improving ESG-related performance, working towards reducing the environmental impact of extraction and processing operations, and investing in the local communities of mining districts. Today, the mining industry is perceived as part of the ESG solution, as it provides the minerals necessary for the energy transition.
Looking at the financial sustainability of projects, it should be underlined that the commencement of a new extraction site does not generate any cash benefits for years and reduces the ability to return capital to shareholders. The increase in costs and timelines for developing new mines has raised the target price of copper needed to generate a return above the typical rate of 15%: the target price is currently around $12,000 to $13,000 per ton, a value well above the current market prices. With the current copper price, companies are likely to prefer using cash flows to provide a return on capital rather than investing in new mines.
Only an increase in prices can convince companies to initiate new projects, necessary to meet the growing demand for copper. However, the price will need to rise substantially to incentivize supply or disincentivize demand, ensuring market equilibrium.
The price is therefore the mechanism capable of correcting the current structural market imbalance. At Plenisfer, we expect it to experience cyclical highs and lows but to trend upward in the long term, reaching the target price of $12,000 to $13,000 per ton. Therefore, we remain optimistic about the prospects of this strategic commodity.
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