December, 2011
Diego Hernández, Codelco

Digging Holes for China

By Julian Dowling
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Codelco's CEO, Diego Hernández, analyzed the world copper outlook at an AmCham breakfast in November.

With global economic uncertainty continuing to cause volatility in commodities prices and Chile’s state-owned copper company Codelco facing a drawn-out legal dispute with Anglo American, you might expect Codelco’s CEO, Diego Hernández, to be concerned.

But Hernández, a former BHP Billiton executive named as Codelco’s chief executive in April 2010 to lead the company’s resurgence, appeared relaxed and even optimistic at an AmCham breakfast on November 30.

Speaking at a packed Club Manquehue, Hernández told members that despite slower global economic growth in 2011, the long-term copper demand fundamentals are strong, especially if China maintains its GDP growth rate above 8% per year.

Although the copper price fell to less than US$3.50 a pound in November from a peak of $4.60/lb in February, Chinese demand has kept the price up and it is still a far cry from the low of US$1.46/lb reached in January 2009, noted Hernández.

“The current global economic situation seems much less serious than in 2009,” he said.

In fact, with the exception of 2008/9 when the financial crisis caused commodities prices to slump temporarily, Codelco has enjoyed relatively high copper prices for the last seven years. The main reason is rapid demand growth, especially in Asia and other emerging economies, said Hernández.

World demand has grown an average 2.8% a year in the last five years as higher consumption in Asia and Latin America has more than compensated for lower demand in Europe and North America.

China, in particular, accounts for 38% of world copper demand. Even though rising inflation is a concern and economic growth is projected to slow to around 8.5% in 2012 from slightly over 9% this year, China’s rapacious construction industry will continue consuming huge amounts of copper.

“The sheer scale of China’s population means it has much more influence than other countries in previous centuries,” said Hernández.

On the supply side, strikes and technical problems in the world’s main copper mines have restricted output since 2006, which has helped support higher prices. This includes a drawn-out strike at Escondida, the world’s largest copper mine owned by Codelco, earlier this year which dented output.

As a result, total stocks of refined copper have declined to around 600,000 tons, which is only enough to meet world demand for about two weeks, warned Hernández. “There is a deficit of copper in the market and any supply interruption has an impact on the price.”

Partly as a result, projecting the long-term price is notoriously difficult with analysts’ estimates tending to vary wildly, but the copper deficit in the market should keep the price over US$3.50/lb in 2012, said the executive.

From 2013, the start-up of new projects will increase the supply of copper and bring the price down, but strong world demand, which Codelco expects will continue to grow around 3% a year, should keep the price relatively high.

While the development of cheaper substitutes for copper in the construction and electronics sectors could dampen demand for the metal going forward, these materials are not competitive yet, noted Hernández.

Meanwhile, new products to increase energy efficiency and combat climate change, such as hybrid cars and efficient motors, use more copper than traditional technologies. In addition, Codelco is investing to develop innovative applications for copper which harness the metal’s antimicrobial properties such as fish farming cages.

“Copper is not just a commodity for developing countries, but also for developed countries,” said Hernández.

However, it is a commodity that is becoming more difficult and costly to produce copper. The average investment required to extract one ton of the metal has nearly doubled in the last eight years and producers are being forced to develop reserves in countries with higher levels of risk, said Hernández.

“There will keep being new copper but in more difficult conditions than before and at a higher cost,” he warned.

As a result, it can take eight years or more to develop a new project and obtain the necessary permits, which means Codelco must keep a long-term perspective. “Short-term results are important but we have to survive in the long-term,” said Hernández.

And that means investing in new production. Codelco has embarked on a plan to invest around US$3.5 billion a year through 2015 in new and existing mines to boost its annual production from around 1.4 million tons to nearly 2 million tons. This includes the Ministro Hales project that will start producing 160,000 tons a year by 2013.

Most of this additional production will end up in China. Around 1.5 million Chinese are migrating to cities every month, which means the country’s construction industry needs enough copper to build a city equivalent in size to Santiago every three or four months, said Codelco’s chief executive.

An increase in consumption of just one kilo per capita would increase China’s annual consumption by 1.4 million tons, equivalent to Codelco’s total annual output.

But copper is a cyclical business and Codelco should take advantage of its record profits to prepare for periods of lower prices which will inevitably arrive, said Hernández. In other words, digging holes for China is Codelco’s best insurance.

Julian Dowling is Editor of bUSiness CHILE