The State of the Copper Industry

The following is excerpted from the recently published book, The World Copper Industry: Structure and Economic Analysis, by Raymond F. Mikesell.

The past several years have not been happy ones for the world copper industry. The threefold rise in the London price of copper between early 1973 and April 1974, followed by an equally precipitous decline, and the maintenance of low prices in the face of rapidly rising producing costs throughout the 1975-78 period have created serious dislocations in the industry, including periods of low earnings or of losses for many mining firms, and serious balance-of-payments deficits for those developing countries that are heavily dependent upon copper exports. By the fourth quarter of 1977, both U.S. producers' prices and the London Metal Exchange price in 1957 dollars were at their lowest levels since 1963. These prices did not cover operating costs for some firms, and few firms, if any, covered their full costs, including an adequate return on capital. In view of the sharp increase in capital costs for new capacity, 1977-78 copper prices were well below long-run marginal costs.

U.S. copper producers were subject to government price controls until May 1974, followed by increasingly costly pollution abatement regulations and uncertainties regarding their application. Much of the foreign producing capacity of international mining companies was nationalized during the 1960s and 1970s, and a poor investment climate in most developing countries has discouraged foreign mining activities in these countries. Rapidly rising capital and production costs in the face of low prices and demand uncertainties have made planning capacity for future growth of the industry exceedingly hazardous. The advances in technology in both copper producing and consuming industries have added to these uncertainties. The copper glut experienced in the 1975-77 period is likely to give way to one of capacity shortage and excessively high prices in relation to long-run costs unless there is an appropriate expansion in copper producing capacity over the next few years. On the basis of some demand forecasts and of present plans for expanding both mine and smelter producing capacity, which are likely to be realized in the next few years, it is quite possible that the sharp rise in copper prices that took place in 1973-74 will be repeated by the mid-1980s.

Some part of the problem of world imbalance in the copper industry may arise from the existing market organization and from U.S. government price controls prior to mid-1974. Although during most periods the differential between prices set by U.S. producers and those on the exchanges (London Metal Exchange and Comex) has been fairly narrow, there have been long periods during which one of these prices has been 30 to 50 percent higher than the other. Such differentials are undoubtedly destabilizing for the world market as a whole and lead U.S. consumers to accumulate inventories rather than meet their future requirements through the forward markets.

A world price system in which all major primary copper producers would sell at prices more or less in line with one another seems unlikely to be achieved in the near future. In any event, it would be rash to argue that the unification of the world's copper markets, either on the basis of a world producers' price or on the basis of a system of integrated free copper exchanges, would provide an adequate solution to the problem of wildly gyrating copper prices.

The outlook for an international stabilization agreement in copper is not encouraging because of apparently irreconcilable differences between Third World governments and the governments of the industrialized countries on both the objectives of an agreement and the mechanisms to be employed. There is a danger that any arrangement agreed upon might try to support a price above the long-run equilibrium level, with serious consequences for the future economic welfare of the industry. Nevertheless, it is not concluded that a well-managed international buffer copper stock, adequately supported with both financial resources and copper stocks, would be incapable of moderating future price fluctuations and of facilitating the growth in world copper producing capacity in line with the expansion of consumer demand. The essential conditions for a successful buffer stock operation include adequate funding, flexibility in adjusting upper and lower price support levels, political independence, and a high degree of competence of the buffer stock manager; but there are serious political barriers to the realization of these conditions.

An international producers' cartel consisting of members of the Intergovernmental Council of Copper Exporting Countries (CIPEC), perhaps joined by other developing countries, would not be capable of improving the export earnings of its members by means of export restrictions for more than a year or so. Individual CIPEC members are in competition with one another for shares of the world market and are unlikely to agree on limiting the growth of their productive capacities. Even if they were able to do so, they might encourage the expansion of copper producing capacity in the United States, Canada, and other countries outside the cartel, since the developed countries are relatively well endowed with copper resources and their reserves continue to expand with new discoveries.

Recent U.S. legislative proposals, supported by some mining industry spokesmen, for the creation of a U.S. government copper stockpile would provide U.S. producers little, if any, benefits. Such action would be inappropriate while the U.S. government is participating in international negotiations on a copper buffer stock agreement. Moreover, the high degree of U.S. self-sufficiency in copper scarcely warrants the inclusion of copper in a national strategic mineral reserve.

Copper modeling. Econometric commodity models are useful tools for handling the large number of variables and their interrelationships, for understanding the dynamics of the copper industry, and for dealing with such questions as: (1) the effect on copper prices of changes in prices of substitutes for copper, or of new technological developments in copper consuming industries; (2) the nature and decision rules for a copper buffer stock program designed to promote price stability; or (3) the impact of various government regulations on the future output of the U.S. copper industry.

As more information becomes available on the various sectors of the industries supplying and using copper and on the behavioral patterns of decision makers in various sectors of the industry, econometric models will undoubtedly do a better job of portraying the operations of the copper market. However, our examination of the leading copper models shows rather wide discrepancies in their estimates of short- and long-run price elasticities of demand, of demand elasticities with respect to the index of durable manufactures, and of cross-price elasticities with respect to substitutes for copper, such as aluminum. In addition, the track record of current models for projecting copper prices has been notoriously poor. This has been due in part to difficulties with the models themselves in estimating equations from historical data, and in part to the fact that projections must be based on projected exogenous variables, such as industrial production, which rarely conform to expectations.

The modeling of copper supply is full of difficulties. In the short run, producers may cut back output, produce for inventory, or continue producing at capacity in response to a reduction in price. Given a period of a year or so it is possible to expand capacity somewhat by installing additional units at certain stages of production or delay partial curtailment of production for normal maintenance. Long-run supply, involving a major expansion of existing mines or smelters, or of developing new mines, or delaying plans for new productive capacity is not simply a function of current or expected price at some point in time, but of a host of factors governing investment decisions and the opportunities for new investment as determined by discoveries of reserves and the political and other constraints on exploiting them. Some models have used announced plans for additions to capacity as the basis for long-run supply projections, but plans are continually revised for reasons that cannot be anticipated.

Recognition of the shortcomings of existing econometric models and the obstacles to improving them should not be interpreted as a recommendation that work in this area be abandoned or that models are incapable of producing useful results. Progress in quantitative analysis offers the hope of increasing our knowledge of the copper industry and of providing the empirical basis for problem solving and policy determination.

Outlook for world copper demand and primary producing capacity. The disappointing rate of economic expansion in the industrialized countries and the large copper inventories have led to a reduction in the rate of growth in demand for copper since 1974, and most analysts foresee a lower rate of growth for the remainder of the twentieth century than the 4.2 percent rate for the 1964-75 period. Estimated annual rates of growth in world demand beyond 1980 range from less than 3 percent to over 4 percent. Moreover, the UN forecast of a 4.3 percent growth rate in world demand for the period 1976-90 was heavily influenced by an expected high annual rate of growth in consumption (10.3 percent) by the developing countries, as contrasted with a projected annual rate of growth of 2.9 percent for the developed countries.

Projections of copper producing capacity for the market economies for 1980, based on plans for capacity expansion that were made in 1977, differ by as much as a million metric tons. Hence, it is hazardous to project the balance between mine capacity and the demand for primary copper for 1980 or 1981. Nevertheless, in view of the large inventories, it is difficult to believe that there will be a shortfall of copper supply which would warrant a sharp increase in the real price of copper by 1980. Beyond 1980 the outlook is less clear. Much depends upon the expansion of productive capacity in the developing countries. Although publicly announced plans for increased capacity for 1985 indicate substantial additions, only two large mines in the developing countries, namely, La Caridad in Mexico and Sar Cheshmeh in Iran, are likely to come onstream between 1978 and 1985. For most of the other announced large projects, the feasibility studies have not been completed nor the financing arranged. However, an expansion of several large mines in the developed countries could take place within two years if market conditions were favorable.

Investment requirements for additions to copper production capacity in the market economies for the period 1977-2000 are estimated to average about $2.7 billion per year in 1977 dollars, and, if the developing countries are to maintain their share of world copper production, at least half of the investment expenditures should go for projects in these countries. There should be little problem in mobilizing the financial resources for investments in the developed countries, but, for reasons already indicated, the mobilization of $1.3 billion per year for copper projects in the developing countries, of which about $1 billion per year will be required from foreign sources, will depend on the outlook for foreign investment.
In time, production of copper from the seabed nodules may contribute significantly to the world's supply of primary copper, but this source is unlikely to provide more than 5 percent of the world's demand for copper by 1990.

There may be a problem of providing sufficient copper smelting capacity, particularly in the United States. Part of the problem lies in the uncertainties regarding pollution abatement requirements. Failure to expand copper smelting capacity in the United States could also retard the growth of U.S. mine producing capacity, since it probably would not be economical for the United States to ship concentrates abroad for processing. Undoubtedly there will be a shift in smelter output from the developed countries to the copper production countries in the Third World that seem willing to accept more pollution in order to increase their value-added from copper production. Whether the copper smelters will be built in line with demand depends again on the flow of financial and other resources to the developing countries.