COLUMN-Copper market focus shifts back to unpredictable supply: Andy Home

(The opinions expressed here are those of the author, a columnist for Reuters.)

By Andy Home

LONDON, Jan 20 (Reuters) - Last year it was the strength of demand that caught the copper market by surprise.

Everyone had braced themselves for an expected hard metallic landing in China, the driver of global copper usage.

But that's not how things played out.

China itself, it seems, was not quite ready for the promised shift from the old model of fixed asset investment to what was touted as the "new normal" of slower, more consumer-oriented growth.

Infrastructure and property investment boomed again, as did the country's appetite for copper. Imports of both unwrought copper and mined concentrate probably hit record highs last year, judging by the preliminary figures released last week.

As for the supply side of the pricing equation, the biggest surprise was the relative lack of surprises.

The amount of global copper supply lost due to unscheduled production losses was 3.5 percent, compared with the historical norm of around 5-6 percent, according to research from Citi. ("Copper - a possible return to normal mine disruption in 2017", Jan. 10, 2017).

It was, in other words, a year of collectively good performance by the world's producers.

Can they keep it up this year against an expected backdrop of much slower, if not flat, mined supply growth?

Judging by the production guidance given by Rio Tinto , the answer would appear to be no.

The company, which has stakes in some of the world's biggest mines, expects to produce between 525,000 and 665,000 tonnes of mined copper this year, compared with actual output of 523,000 tonnes in 2016.

That's a wide range, wide enough in fact to encompass many analysts' global market balance calculations for the coming year.

Rio has given no further details but its own production uncertainty speaks to the potential for a more "normal" year, to quote Citi, in terms of mine supply disruption.

INDONESIAN UNCERTAINTY

One contributor to Rio's "mind-the-gap" production guidance may well be the Grasberg mine in Indonesia.

Export shipments from Grasberg are again suspended as the mine's majority owner and operator, Freeport McMoRan, navigates yet another rewrite of Indonesia's resource rules.

An existing requirement to build a copper smelter within five years has been supplemented with a proposed shift to a new operating permit and the need to sell a 51-percent stake to local investors.

A new export licence should be possible while talks are continuing but as of right now it's still sitting in the mining ministry's in-tray.

Underneath all this regulatory uncertainty is straightforward mining uncertainty.

Freeport downgraded its sales guidance at both its Q2 and Q3 quarterlies with third-quarter production at Grasberg below expectations due to "lower mining rates that affected the timing of access to higher grade ore and a deferral of production into future periods resulting from labor productivity issues and a 10-day work stoppage beginning in late September."

Rio has a complicated participation in Grasberg, being entitled to 40 percent of output above a pre-determined level of mine throughput from expansions since 1998.

It defers to Freeport in terms of reporting actual production at Grasberg but it noted that "productivity issues" continued in the fourth quarter to the extent that the mining threshold was not reached last year. Rio has therefore stripped 20,000 tonnes of notional attributable production back out of its January-September figures.

STRIKE THREATS

Two other pillars of Rio's copper portfolio are its 30-percent stake in Escondida, the world's largest copper mine in Chile, and the wholly-owned Kennecott operations in the United States.

Both have looming labour contract expiries.

And although Rio's guidance won't have factored in the potential for lost production due to strike action, the market is closely following events at Escondida, where the current contract expires later this month.

Union leaders are unhappy and already talking tough about the potential for a walk-out.

All part of the negotiating process or an ominous sign of things to come?

Time will tell but the sheer size of Escondida, which produced just under a million tonnes of copper last year, means potential price volatility, upwards in the event of a strike, however short-lived, and downwards in the event of a peaceful settlement.

The contract at Rio's Kennecott division expires in March by which time there will also have been contract deadlines at Vale's Sudbury and Teck's Highland Valley mines in Canada, according to Citi.

Indeed, Citi estimates that some 3.5 million tonnes of copper supply, equivalent to around 17 percent of expected output this year, is subject to labour contract renewal.

"We believe this represents the highest volume of mine capacity affected by contract renewals for 4-5 years, with the last year of significant strike-related losses being 2011 where around 170,000t of mined production was lost due to strikes."

The fact that copper prices are rising again brings potential negotiating gaps between unions anxious to keep the rewards earned in the good times and companies still in cost-cutting mode.

A DELICATE BALANCE?

The market's renewed focus on supply and specifically the potential for supply to under-perform relative to plan reflects a changed view about copper's underlying supply-usage dynamic.

The much-feared wall of copper supply, resulting from a combination of new mines and expansions, seems to have already peaked.

The International Copper Study Group is forecasting mine supply growth to drop from four percent in 2016 to zero this year. For its part, Citi is forecasting just one percent growth.

The raw materials part of the copper supply chain is starting to tighten again, evidenced by the drop in smelter treatment and refining charges on 2017 supply contracts, still the best indicator as to what is happening in the copper concentrates market.

This wasn't supposed to happen so fast but last year saw not just existing producers largely perform well but new capacity come on much more efficiently than might reasonably have been expected.

That was, with hindsight, the big supply surprise for the copper market last year.

This year the "surprise" could be a different one, if copper reverts to its past form of predictable unpredictability.

(Editing by Adrian Croft)