[Music] Hello and thank you for joining. I'm Helen Amos, commodities analyst at BMO Capital Markets. Welcome to our Metal Matters podcast where I'll be discussing the big development sun debates and metals and mining with plenty of guests along the way too. [Music] Welcome back to Metal Matters. It's eight weeks since the Iran conflict started and we're also now over two weeks into the ceasefire which has also been extended. The straight-of-formoos is essentially still closed with both the US and Iran staging blockades and vessels trying to pass through. Include oil prices, active futures contract has returned above $100 a barrel in recent days and that's maintaining some upward pressure on US dollar and treasury yields. But despite all of this, copper prices have returned to pre-conflict levels just in the last few days. We've seen the LME three months futures price rising back above $13,400 a ton. In the last few days, albeit we're still a little bit below the brief spike we had in January above $14,000. And in other metals, aluminium that's continuing to outperform the base metals complex as broadly expected, given that about 5% of global supply has been directly impacted by the conflict, potentially even more accounting for the cutelman to the passage through the straight. Nickel prices have benefited a bit from the sulfuric acid story of course, which will come on to later in the podcast. And also helping as this new pricing formula in Indonesia, which incorporates higher minimum pricing for nickel or as well as also a value for byproduct metals. That's all adding additional cost there. Now thermal coal, that's also holding above pre-conflict levels, but has lost a little bit of momentum after the pullback we've seen in gas prices. Although that could change as we move out of the shoulder season in the coming few weeks. IONOR is trading very range bound still and that's despite the news that BHP and CMRG have reached a supply agreement, which is ending this months-long standoff. And that has potentially released some poor inventory to the market again. Now one of the reasons we think IONOR is holding up is cost push. Now the IONOR benchmark price, that's CFR China, and obviously ocean freight rates have gone up a lot in the last two months with rising. A bunker fuel costs. And on that note, the cost of diesel, sulfuric acid, explosives, they're all getting an increasing mention by mining companies in the latest rounds of reporting. And I wonder when will start to hear more concrete examples of volume impact as well as cost. And particularly thinking about the bulk here, coal especially, which is by far the biggest consumer of diesel in volume terms across the mind commodities. China, Indonesia, and India are the biggest global producers here. So why are copper prices so high then despite being nearly eight weeks now into the conflict and seeing elevated energy prices? Well, this was one of the major talking points at Cisco week, which we recently come back from, along with a lot of other big themes. And this is going to be the focus of this episode. So I would say we can broadly divide the big talking points and debates into five or six different topics and we'll tick through a high level each of those in turn. The first one, which did take center stage that was very much in the foreground was sulfuric acid shortages, what that means for copper volumes and costs. Second one was demand damage from the Iran conflict. So a lot of concern from conference participants we we heard. And the third one is the fact that the US price arbitrage is back. So that's the CME, LME price differential. And then the fourth one is what's happening with TCRCs looks like more pain on the horizon there. So lots of talk around the merchant concentrate market. And the topic is what we're hearing from the Western mining companies and the challenges that they're facing in their pursuit to deliver growth in copper production. And then the final thing I would say is how people generally are feeling about the structural case for copper. And I would say there was broad agreement amongst the conference that the structural case for copper has perhaps never been better despite perhaps these near term conflict headwinds. So on the first topic the big sulfuric acid debate. Well, there is no doubt about it sulfur and sulfuric acid are in short supply. Since the Iran conflict put around 40% of global exports at risk. That was compounded by a decision by China a couple of weeks ago to hold it's around four or five million tons of sulfuric acid exports. And we've seen prices move to reflect these developments. So recent spot quotes that we've heard for sulfur and up to around a thousand dollars a ton that's about double where it was pre-conflicts and sulfuric acid prices were hearing quotes of around three or four hundred dollars a ton that compares to around 150 dollars a ton pre-conflict. Now the debate around how much copper supply could be impacted if any and then the impact on operating costs. I would say that reach real fever pitch over the sesco gatherings. But overall our takeaway from having had lots of discussions over the week is that although copper as an industry is only a small proportion of global sulfur demand. The fact that it's got very wide operating margins today, especially versus other users, means that the copper miners are probably able to bid high enough for now to pull the units away from others along the demand curve. So that could mean that there is volume taken from the likes of phosphate fertilizers and nickel where there might where the margins might be thinner. So overall it seems that for now it's likely to be more of a cost impact than a volume impact on the copper side. And this theory was really supported by anecdotes we've been hearing like traders taking sulfur from the likes of Canada and the US and bringing that to copper operations in the DRC. Now as always there's important regional nuances to bear in mind. For example the DRC that was the initial focus after the Iran conflict started given the vast majority of its sulfur imports come from have previously come from the Middle East. And there is a very high import dependency as well. Now our understanding is that most DRC SXEW uses tank leaching that's actually a much quicker process than heat bleaching. So that might imply there's less flexibility to taper down acid usage before having to hold production. However there are some short term fixes that might be found like moving to higher copper and lower magnesium content oxides and also to bear in mind that because of the much higher grades that the operators are using the intensity. So the sulfuric acid intensity pattern of copper is fairly low in the DRC. And that also means that there's a greater ability to pay for the higher cost of sulfuric acid as well. Now in Chili's SXEW sector it is less import dependent than the DRC at around 40%. But most of this is in the form of sulfuric acid and a lot of this comes from China and also Peru. Now Chili's import dependency has actually grown over the last decade because there's been a couple of smelters to shut down. And that means that Chili is particularly vulnerable to disruptions and sulfuric acid in the international trade. Now on the one hand, Chili primarily uses heat bleaching that's got a very long process time maybe as high as eight to 12 months. So that does imply that there might be some flexibility to reduce application of sulfuric acid and that there could be a reasonable lag before any potential shortages start to manifest in volume loss. But on the other hand, the grades are much lower than in the DRC, which means the sulfuric acid intensity pattern of copper is much higher. And that means that overall the SXEW operations there are going to have a lot higher cost sensitivity to changes in the sulfuric acid price. Now there's a lot of debate around whether China's proposed ban on sulfuric acid will even last because we're hearing reports that some smelters are already advocating for the government to change their mind on the ban. And there is a sense that actually it could lead to an accumulation of excess onshore sulfuric acid where the exports are being restricted. So it could well be that in the future there is a bit of flat.
flexibility around that ban and sulfuric acid could start to flow again from China. Next big topic at the conference was demand destruction from the higher energy prices stemming from the Iran conflict. Now a lot of debate around this, I would say there was a lot of concern. One thing that we've been looking at is what does history tell us. Now when we look back at the major oil shocks of the 1970s, it is clear, like it's very visible that in the media after the after, they've won or two years after the oil shock, it wasn't good for copper demand and you could see like visible depressions in global copper demand intensity for a couple of years. Then we did after those oil shocks in the 70s did see a bit of a recovery. Although arguably the severity of those oil shocks was so bad that it actually triggered, as we know, this multi-year period of the global economy seeking out efficiency gains. We saw that not just in terms of energy efficiency, but that involved a degree of dematerialization as well. We can see that in actually a flattening of the copper demand intensity curve over the 70s, 80s and into the early 90s, at which point by the mid 90s, those effects had broadly run their course. Now when we look at the demand impact from the last major energy shock of the Russia invasion of Ukraine in 2022, that actually looks much less adverse than the earlier shocks. That's not just because of the smaller magnitude of the oil price increase, but also the fact that the impact I think was obscured by the fact that we were in the aftermath of the pandemic, as well as we were hitting up against at the same time the initial very aggressive phase of China's property downturn. History tells us some important lessons, but I'd argue that today's demand context is actually very different from the 70s. Few reasons here, firstly, the oil intensity of global economic output has fallen dramatically since the 70s. It's fallen by about 2/3, actually, since the early 70s, which means that the global economy is going to be much less sensitive to changes in the oil price than it used to be. The second thing is that we're seeing an increasing proportion of global copper demand being tied to strategic uses, like AI and power infrastructure, that are arguably less sensitive to global macroeconomic weakness anyway because of policy support. And then the third thing is that we are moving deeper and deeper into global fragmentation. That's something we've been talking a lot about. For the Iran conflict is just another reminder of this. And this is pushing regions to hoard energy and materials. So we can't actually see, we hear that this concern, but we can't actually see any reason to believe that this hoarding stockpiling process should actually come to an end anytime soon. So for those reasons, we're not certainly not dismissing the negative impacts from highly energy prices on the demand side, but we think probably demand and prices are likely to fare better than historical instances of prior energy shocks. Now the next big topic was the return of the US price arbitrage. Now this was basically consistently narrowing over most of this year. And what triggered the CME LME to start to widen again was actually when the US issued a new presidential proclamation two, three weeks ago. So right before the CESCO week conference. And in that proclamation, they modified the way steel and aluminium tariffs are applied by product type. But they also included copper for the first time alongside steel and aluminium. Now this did on the day and the few days of create a few investor questions and a little bit of confusion. This didn't supersede the previous copper specific proclamation that we had in July last year. And that differentiated of course both product type and specified that at that time only CMEs and derivative products would be tariffed at 50%. But it did remind the market that there is still a significant chance of refined copper tariffs being introduced. And we are expecting an update on copper tariffs at the end of June. That's going to be the next major catalyst. But in the meantime it does look like with the our opening again we can expect the pace of cathode arrivals into the US to accelerate in the next few weeks. Which on its own is a bullish factor for CME and LME prices. So if US is continuing to build inventory again, the question is where does inventory end up? Some people think that the inventory level is already very high. So today it stands we think at about seven or eight months worth of consumption. That's around one million tons of of inventory. But as we looked at in an earlier research piece from early in the year, when you look back at historic periods of elevated geopolitical uncertainty, like in the 60s and the Cold War era, the US actually held a lot higher level of inventory of copper back then. And when we speak to different participants along the value chain, there is some that would still believe that the US inventory levels could rise a lot more. And I wouldn't be surprised if we start to move towards the years worth of inventory rather than the months worth of inventory. And that would certainly give the US a much bigger buffer to play with if the US does at some point in the future decide to impose refined tariffs. Now as always, there was lots of vigorous debates around TCRCs. Now with flat lining, global concentrate supply essentially since 2024. And then this ferocious growth that we've had in global smelter capacity over the last two years, no one can argue against the fact that the concentrate market is tight and getting tighter, giving the miners the balance of power when it comes to that value transfer equation of copper units between concentrates, producers and smelters. But it's not just that the mine supply growth in total is lagging the growth in the total bid for concentrate units from smelters. It's that more and more concentrate is becoming internalised i.e. integrated into captive smelter systems. And that's leaving less material available for the merchant concentrate market. And I was quite surprised actually to see the scale of new internalised smelter capacity that is being added outside of China in the next five years. So we've got around according to CRU numbers, 4.2 million tonnes from Indonesia, 1.3 million tonnes from the DRC, 1.3 million tonnes from Kazakhstan, 0.8 million tonnes of Mongolia and also some capacity being added in the Philippines, the US and Uzbekistan. And not only that, but it was also clear that traders are growing their relative share of the merchant concentrate market and that adds new complexity as well. Now it is true that TCRCs have continued to come under downward pressure, particularly since the conflict started because sulfuric acid prices and that's one of the main byproducts that smelters enjoy have gone up, which consequently puts downward pressure on TCRCs. But the fact is that because of this higher byproduct revenue, that means that on average cash margins for smelters have actually improved in recent months. They went from negative last year back to around $50 a ton today. Now as the main source of byproduct revenue, what we actually see is a fairly reliable inverse relationship between sulfuric acid prices and TCRCs. So it's no wonder really that in the near term with sulfuric acid prices going up, probably does mean further downward pressure on TCRCs. Now I think it's clear as everyone in the industry is expressing that there are increasing limitations to the old, particularly the annual benchmark TCRC system and it seems that both sides to the miners and smelters are indeed gaining a greater understanding of the economics of each side and that might mean that more components are getting folded in to negotiations over time, maybe free metal, maybe sulfuric acid prices. One European smelter made a very good point though, which is that it's not just about the concentrate smelter value chain, it's about the entire manufacturing regional supply chain as well. And if Europe doesn't have smelters, it doesn't have complete supply chain security for
the regional manufacturing base. And finally, lots of discussion and debates around the challenges facing the western listed mining companies. Now there's no doubt about it. These mining companies like Copper and they want to grow their footprint in it. It's just that their share, their equity share of the total supply side is actually falling over time. And meanwhile, China's share has been growing. Now I think largely this divergence that we're seeing is fundamentally rooted in the fact that western shareholders increasingly prefer companies to be cautious on major CAPEX deployment, particularly on the the higher risk greenfield projects given the historical president for for CAPEX overruns. But they're also clearly expressing a preference for inorganic growth via M&A. Now the thing about M&A is that it makes the companies bigger but it diverts capital and management time away from pursuing organic project growth, at least in the near term anyway. And meanwhile, Chinese backed miners are often willing to develop projects in what are traditionally seen as riskier jurisdictions, with often lower capital intensity. They also have a wider set of financial and strategic metrics that are used for project valuations. Now the perspectives that were shared by the miners on stage at CESCO Week. In my view, they showed no real change in mindset from previous years. You know, the question on by or build, well both. What are the barriers to pursuing major projects? Well, it was cost of capital, execution, risk, lack of skilled workforce and engineering resources that was also mentioned. So nothing really fundamentally new to see here that though one thing we are hearing a bit more of those is this willingness to partner with other mining companies on projects. And also, you know, we're hearing I think two big buzzwords we're hearing is partnerships and modularization, modernization is obviously much more akin to the Chinese development model and a model that has essentially taken DRC's copper output in a very short space of time just a couple of decades from nearly zero to three and a half million tons. We've been doing some work looking at the flow of Chinese mining equipment to mining regions. And at the moment to us, it doesn't look like that flow of capital is going to plateau anytime soon. That brings us to the end of this episode. As I said in the beginning, I did find basically universal agreement at the conference that the structural case for copper demand has any strength and further following the Iran conflict. And it does obviously give renewed ammunition for the molecules to electrons transition. And that might be why we saw China come back in and buy the dip at relatively high price level of $12,000 a ton. Or be it, you know, concerns around the potential negative impact on demand from high oil and fertilizer prices and the impact this has on monetary policy are all valid concerns, particularly over the next year or two. It's just that we don't think it's going to be as damaging this time on copper for the reasons that we laid out versus the oil shocks that we saw in the 70s. That was Metal Matters, presented by BMO Capital Markets' Equity Research. You can subscribe to Metal Matters on Apple podcasts and other podcast providers or visit our website at research.bmo.com to listen to more episodes, including our other podcast series, BMO Equity Research in June. If you had feedback or suggestions for upcoming podcasts, please do share it with me at
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