Copper Supply Constrained, but China Destocking Puts Damper on DemandRefined copper production fell short of demand in 2011 and will likely continue to do so through this year, Fitch Ratings said in a report on the outlook for base metals. That could bode well for the industry, but at the same time, China — which accounts for nearly half of global copper consumption — is expected to put downward pressure on prices by destocking its inventories for the remainder of 2012. 

Global refined copper production fell 241,000 metric tonnes short of consumption in 2011, the International Copper Study Group said last week. Fitch forecasts a shortfall of 237,000 metric tons this year and a surplus of 360,000 metric tons in 2013.

China’s copper consumption grew by about 26 percent in the first six months of the year, according to Fitch. And Standard Chartered analyst Judy Zhu was quoted by The Wall Street Journal as saying that copper stocks grew by 20 percent from July to August alone.

Copper supply is expected to fall short of demand again this year, but as China sits on large amounts of stock built up over the first half of the year, it may take some time for the shortfall to translate into stronger demand for copper. At the same time, building starts and sales volumes have turned upward in China, suggesting the construction sector has bottomed, according to a Credit Suisse report cited by Seeking Alpha. That could help prices rise in the longer term.

Worldwide copper consumption is seen growing up to 3 percent annually in 2012, in line with supply, according to Fitch estimates. By 2014, consumption growth is seen at about 4 percent annually, based on demand in China and economic recovery in developed nations, with the automotive industry in the US carrying demand there. European consumption is expected to be at “depressed levels” through 2014.

BHP Billiton (NYSE:BHP,LSE:BLT,ASX:BHP), the third-largest copper producer in the world, expects copper prices to remain high as supply struggles to keep pace with demand, chief commercial officer Alberto Calderon said Wednesday at a conference in Canberra, Australia, Bloomberg reported.

According to Fitch and Bloomberg estimates, the copper spot price is expected to average $3.57 in the second half of 2012 and will rise to $3.67 in 2013. That compares with the closing price of $3.75 per pound for New York copper for December delivery on Thursday, a one-week low.

Meanwhile, Australia’s Bureau of Resources and Energy Economics said in its quarterly report this week that while global consumption will grow this year, the average price of copper will be $7,837 per tonne, about 11 percent below the 2011 average. For 2013, it is projected to be lower still, at $7,579, as increased production — from Vedanta Resources’ (LSE:VED) mines in Zambia and Freeport-McMoRan’s (NYSE:FCX) Grasberg mine in Indonesia — outpaces demand.

By 2014, “substantially all the mine production growth” will come from new projects that are at higher risk of production shortfalls, Fitch notes. Especially in Africa, where infrastructure is less developed, there is a risk of shortfalls due to power disruption. If new supply can’t keep up with economic recovery in industrialized nations, that could also help drive prices up in the long run.

Copper prices rose this month on the back of central banks’ efforts to boost the economy, including the European Central Bank’s announcement that it will buy back bonds, news of planned infrastructure projects in China and a third round of quantitative easing by the US Federal Reserve. This week, the Bank of Japan followed suit, boosting asset purchases by double the usual amount, Reuters reported. Still, prices have eased as data Thursday showed a downturn in business activity in the Eurozone and as manufacturing in China contracted for the 11th month in a row.

“In the long-run you need fundamentals to recover and we need to see an improvement in China,” VTB analyst Andrey Kryuchenkov told Reuters. “I am still upbeat on China’s prospects towards the end of the year.”

In base metals overall, production costs have increased on competition for labor and supply bottlenecks for equipment. Fitch expects producers to focus on cutting costs and deferring capital expenditures to safeguard dividends for shareholders.

Turning to to other base metals, global demand for aluminum is expected to grow up to 6 percent annually, but supply surpluses will remain “persistent” through 2015, putting profitability at risk. The first half of the year also saw a surplus of nickel, which is mainly used to manufacture stainless steel for kitchen appliances and cars. Demand has slowed down and will continue to be lackluster. For zinc, excess capacity will persist through 2013, but in the longer term, closure of mines that are at the end of their reserves will bring the market into balance, Fitch said.

“Investing in base metals today is giving a vote of confidence toward China’s managed economy not entering a hard landing,” Elliott Orsillo, co-founder and portfolio manager at Season Investments, told The Wall Street Journal’s MarketWatch. If the expectations for a bounce in the Chinese economy, a mild pickup in Eurozone demand and stable demand in the US turn out to be “a damp squib, then copper and other industrials will pare all the last two months’ gains.”

 

Securities Disclosure: I, Ragnhild Kjetland, hold no direct investment interest in any company mentioned in this article.