Copper: Price volatility and its impacts on the industry
Presentation to 23rd Regular Meeting of the International Copper Study Group Lisbon, 1 October, 2007
Robin Bhar, Base Metals Strategist [Link]@[Link] +44 20 7567 7850
Presentation agenda
Why invest in commodities? Speculative activity in the copper market Structural issues supply/demand over the long-term Long-term prices Conclusions Q&A
1
Why invest in commodities?
A secular shift in demand strength Emerging Asia
GDP US$bn and 2006 GDP growth
The developing world growing
faster, driving a take-off in materials intensity
14000 12000 10000 8000 6000 4000 2000 O 1st W Next 1bn Taiwan Brazil China India Russia Japan Sth Korea EU-7 0
Increased globalisation of markets Greater competition for limited
resources
10.0 9.0 8.0 7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0 US
2006 GDP US$bn LHS
2006 GDP growth RHS
Source: Datastream, EIU, UBS estimates
World copper intensity of use, 1950-2025E
World steel intensity of use, 1950-2025E
0.00065 0.00060 0.00055 0.00050 0.00045 0.00040 2000 2005 2020E 2010E 2015E 2025E 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 Cu int of use t/1000 US$
0.036 0.032 0.028 0.024 0.020
Steel int of use t/1000 US$
2000
2005
2020E
2010E
Int. of use (China & India)
Int. of use (China only)
Int. of use (China & India)
Int. of use (China only)
Source: AME, Brook Hunt, IISI, WBMS, UBS estimates
Source: AME, Brook Hunt, IISI, WBMS, UBS estimates
2015E
2025E
1950
1955
1960
1965
1970
1975
1980
1985
1990
1995
Why invest in commodities? (2)
Challenges in supply response
Global Mining discovery rates and exploration spend
Discovery rates have declined
in both energy and metals markets
Demand increasingly reliant
on older and lower quality resources
16 14 12 10 8 6 4 2 0
No. of discoveries
Too late?
US$m 2000 2002 2004 2006E 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998
8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0
Major deposit discoveries (LHS)
World class deposit discoveries (LHS)
Source: MEG, UBS estimates
Exploration spend rising
time lag consideration between discovery and production
Exploration spend US$m (RHS)
Global OilCo reserve replacement and reserve life
160% 140% 120% 100% 80% 60% 40% 20% 0% 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Reserve repl. (organic) Reserve repl. (Acqns)
Political risk remains a critical
aspect of supply dynamics
Environmental
12.2 12.0 11.8 11.6 11.4 11.2 11.0 10.8 10.6 10.4 10.2 Reserve life
drivers/considerations
Source: Company data, UBS estimates
Why invest in commodities? (3)
Long-term pricing reflects secular imbalances
Long-term pricing patterns: Real Brent oil price from 1900 (US$/bbl.)
Changes in global intensity of
use combined with delays in supply response contribute to periods of extended strength and weakness in commodities markets
100 80 60 40 20 1900 1920 1930 1940 1950 1960 1970 1980 1910 1990 2000
China, India and the next
Brent oil (real) US$/bbl.
UBS Forecast
Source: Bloomberg, UBS estimates
billion represent an unprecedented block of longterm demand as industrialisation/urbanisation trends build
Long-term pricing patterns: Real LME copper price from 1900 (USc/lb.)
500 400 300 200
Supply response hampered
by cost pressures, political risks and scarcity of quality resources
100 1900 1920 1930 1940 1950 1960 1970 1980 1910 1990 2000
Copper price (real) USc/lb.
UBS forecast
Source: Bloomberg, UBS estimates
Why invest in commodities? (4)
Asset allocation advantages are also important
Diversification advantages
Expected return
Expected returns over next 5 years
8% 7% With real estate 6% 5% 4% 3% Cash 2% 0% 2% 4% 6% 8% 10% 12% 14% 16% 18% Standard deviation of return Corp bonds Govt bonds Inflation-linked With inflation-linked With commodities Real estate Commodities Equities
for portfolios holding commodities diversified commodity exposure augments this benefit
Commodities seen as a
compelling inflation hedge
Currency implications US
dollar weakness is inflationary
0.8 0.6
Source: UBS estimates
Correlation of US asset class total returns and core inflation
Correlation coefficient
Commodities appear
0.4 0.2 0.0 -0.2 -0.4 Commodities US equities Monthly US REITs Quarterly US corp bonds Yearly US govt bonds US cash
attractive in a wider asset allocation context competes effectively for marginal investment dollar
Liquidity read-through
5-yearly
Source: UBS estimates
Traditional commodity indices - Background
Commodity Index Investment
Equity like returns Diversification benefits Inflation hedge Market event risk hedge Low correlation to equities and bonds (and perform best when others do worst)
Negative returns recently
The Investment Universe
There is an estimated $120bn
tracking commodity indices globally several years is partly attributable to equity underperformance and the desire to have well diversified portfolios
Huge growth in the industry over last
Investing challenges
CRB
7 5 19 89 19 8 19 8
GSCI
1 3 7 19 9 5 19 9 19 9 19 9
RICI, DJ-AIG
20 0 19 9 20 0 20 0 20 07 1 9 3 5
Purpose
RJ-CRB: Reuters-Jefferies CRB Index; GSCI: Goldman Sachs Commodity Index; RICI: Rogers International Commodity Index; DJAIGCISM: Dow Jones-AIG Commodity IndexSM
The indices are aimed to establish an investable benchmark for investors taking commodity exposure, by balancing market representation and liquidity
How?
The indices take long commodity positions, through futures contracts on the relevant commodities Size of the allocation to each commodity is usually set according to a weighting engine driven by a combination of global production/consumption and/or traded volume
Rolling front-month contracts
The front-month futures contracts are rolled into the next contract shortly before they expire
Why rolling front contracts?
A number of commodities historically have had limited liquidity beyond the front-month contracts Historic performance of rolling the front contracts was positive
Limited involvement of financial investors
The key players were consumers and producers with no material market impact from commodity index investments
Investing challenges
General roll process
1. Buy short-dated futures 2. Hold for 1 month 3. Roll back to the new short-dated
futures contract
Oil Price 60 59 58 57 56 55 54 53 52 51 50 1 6 12 18 24 30 Futures contracts months to Expiration 36 42 3 2 1
Two fundamental shortcomings with this process:
1.
Buying High/Selling Low: when curves are upward sloping like above
Current negative roll yield on GSCI ~ 1.50%/month (18% p.a.)
2.
Lack of Diversification: only invested on one point of curve
High Volatility Short-end of curve tends to exhibit the most negative roll yield
Deconstructing index returns - components
Contango Full carry curve and arbitrage potential
forward contract, pocket the yield
Contango: cost to the investor Physical availability Arbitrage: buy physical, sell the
Backwardation Full carry curve and quasi-arbitrage potential
Source: UBS
forward contract, pocket the yield
Backwardation: return to the investor Physical scarcity Arbitrage: sell physical, buy the
Source: UBS
Curve asymmetries
Forward curve, Brent Crude Oil
74 72 70 68 66 1 13 25 37 49 61 Brent Crude Oil (21 June 2007)
Source: Bloomberg Source: Bloomberg
Forward curve, Comex Gold
Negative convexity 800 750
Point b Point a
700 650 600 1 2 3 4 5 6 7 8 9 10 11 12 13
Comex gold (21 June 2007)
Changing slope along the curve (convexity) can create
differentiation in returns achieved
Creates opportunities for outperformance Lack of convexity generates a lower performance differentiation
10
Curve asymmetries the evidence
Brent Crude Oil avg. shape of the forward curve (from the one month to 12 month contract)
110 105 100 95 90 85 80 1 Greater curvature observed in contango market 2 3 4 5 6 7 8 9 10 11 12
Brent Crude Oil avg. vol and vol of vol (from the one month to 12 month contract)
35% 30% 25% 20% 15% 10% 5% 0% 1 2 3 4 5 6 7 8 9 10 11 12
Backwardation
Source: Bloomberg, UBS estimates
Contango
Average Vol
Source: Bloomberg, UBS estimates
Vol of Vol
Weekly data from 1994 using the first 12 months contracts Contango definition: 1m<2m<3m Backwardation definition: 1m>2m>3m R2 for best fit line; 75% in contango market, 90% in
backwardated markets
11
Curve asymmetries the evidence
LME copper avg. shape of the forward curve (from the one month to 12 month contract)
105 100 95 90 85 80 1 Greater curvature observed in contango market 2 3 4 5 6 7 8 9 10 11 12
LME copper avg. vol and vol of vol (from the one month to 12 month contract)
25% 20% 15% 10% 5% 0% 1 2 3 4 5 6 7 8 9 10 11 12
Backwardation
Contango
Average Vol
Source: Bloomberg, UBS estimates
Vol of Vol
Source: Bloomberg, UBS estimates Note: Weekly data from 1997
Weekly data from 1997 using the first 12 months contracts Contango definition: 1m<2m<3m Backwardation definition: 1m>2m>3m R2 for best fit line; 83% in contango market, 98% in
backwardated markets
12
Frequency of contango and backwardation
Over the last 10 years, most commodities have spent more time in
contango than in backwardation.
Contango B a c k w a r d a t io n
-1 0 0 .0 %
-8 0 .0 %
-6 0 .0 %
-4 0 .0 %
-2 0 .0 %
0 .0 %
2 0 .0 %
4 0 .0 %
6 0 .0 %
8 0 .0 %
1 0 0 .0 %
Source data: Bloomberg. Using weekly data between July-1997 to June-2007, the definition for contango and backwardation are defined on Slide 10. Unclear cases have been excluded.
13
Read-through to performance bias
Brent crude oil: average roll yields on different points of the fwd curve for both contango and backwardated markets
2.0% 1.5% 1.0% 0.5% 0.0% -0.5% -1.0% -1.5%
LME copper: average roll yields on different points of the fwd curve for both contango and backwardated markets
1.5% 1.0% 0.5% 0.0%
Lower threat of underperformance with higher tenor 2 3 4 5 6 7 8 9 10 11 12
-0.5% -1.0% Lower threat of underperformance with higher tenor 2 3 4 5 6 7 8 9 10 11 12
Backwardation
Source: Bloomberg, UBS estimates
Contango
Backwardation
Source: Bloomberg, UBS estimates
Contango
The oil curve shows that a higher tenor will achieve better performance
in a contango market, but more importantly, only modest underperformance in a backwardated market
The copper curve shows that a higher tenor will achieve better
performance in a contango market and in fact outperformance as well in a backwardated market
14
Financial investors in Cu a new phenomenon?
Copper spot price trend (nominal) from 1900
8,000 7,000 6,000 US$/t 5,000 4,000 3,000 2,000 1,000 0 1900 1909 1918 1927 1936 1945 1954 1963
Increasing spec/fund activity
Little or no spec/fund activity
1972
1981
1990
1999
2008
Source: USGS, LME, UBS estimates
15
Speculators influence short-term prices
Copper daily LME 3m price trend (nominal) from 1990
8,000
Speculative/fund activity affects prices in short-term Supply/demand fundamentals determine prices in long-term
6,600
US$/t
5,200
3,800
2,400
1,000 02-Jan-90
02-Jan-94
02-Jan-98
02-Jan-02
02-Jan-06
Source: LME, UBS estimates
16
but no impact long-term
12000
Copper prices (real)
9000 US$/t (2005$) 1950-1960 + 6% pa
6000
3000 33 years - 3.5% pa 1915 1930 40 years + 3.7% pa 1945 1960 1975 29 years - 4.8% pa 1990 + 4.0% pa F 2005 2020E
0 1900
No escape from cyclical decline
Source: Brook Hunt, USGS, UBS estimates
17
Stronger for longer implied by far forward prices
LME 3m & 63m copper prices
8,400 7,400 6,400 5,400 $/t 4,400 3,400 2,400 1,400 02-Jan-04
Forward curve
02-Nov-04 02-Sep-05 LME 3m 02-Jul-06 LME 63m 02-May-07
8,800 7,800 6,800
$/t
5,800 4,800 3,800 2,800 1,800 Cash 5M 10M 15M 20M 25M 30M 35M 40M 45M 50M 55M 60M Current Sep-06 Feb-05
Source: LME, UBS
18
Why has copper been so strong?
Demand, demand, demand
Synchronized global economic growth
Strong growth in China allied with cyclical economic recovery in the OECD countries. Underpins robust copper consumption growth.
Demand surprises
Robust end-use demand. Strong Chinese demand growth has raised global demand growth far above expectations. The market deficits have become so large that demand destruction has been necessary to reduce actual consumption to below potential consumption.
Investor/speculative buying
Attractive returns Portfolio diversification
Further Industrialization & Urbanization of Asian countries
China and S.E. Asia as a whole, is likely to become a longer term global economic power that will lead to massive raw material and processed goods consumption. Developed world less important.
19
Why has copper been so strong? (2)
But where is the supply response?
Lack of Capital Investment
Last major investment cycle was in the 1970's. Incentive pricing continues to rise. Deterioration in the quality and quantity of available resources. Exploration spending has picked-up but discoveries are few. Long lead times to develop a mine.
Supply response much slower than expected
Supply delays/disappointments, opex/capex cost increases, equipment and spare parts shortages (trucks, tyres), more militant labour. Industry consolidation has led to better supply side discipline leading to preservation of higher prices for longer. Cash generation put to use in M&A rather than in the ground. It is not easy building or expanding new capacity. Analysts continue to over-forecast supply.
Inventories under pressure
Strong demand growth and very muted supply response has resulted in running down of inventories to historically low levels causing shortages (or risks of shortages). Most visible LME inventories being drawn down to within days of consumption but trends occurring also throughout industry.
20
Global economic readings showing breadth & resilience
China physical index and Big 3 GDP
17% 15% 13% 11% 9% 7% 5% 3% 1% -1% -3%
17% 15% 13% 11% China physical index % y/y 9% 7% 5% 3% 1% -1% US,EU, Japan Real GDP % y/y -3% 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 US EU Japan China physical index
21
Source: Thomson Financial, CEIC, US DoC, UBS
US slowdown in context
OECD GDP growth and commodity prices
70 60 50 40 30 20 10 0 -10 -20 -30 Mar-68 Mar-71 Mar-74 Mar-77 Mar-80 Mar-83 Mar-86 Mar-89 Mar-92 Mar-95 Mar-98 Mar-01 Mar-04 Mar-07 8 7 6 5 4 3 2 1 0 -1 -2
Strong historic correlation
between western world growth and commodity prices to get?!
How weak is global growth likely Asian dominance of materials
CRB all commodities index, % y/y (lhs)
OECD 25 GDP, % y/y (rhs)
UBS IP growth projections selected regions
2006 Advanced economies China India Russia Brazil Eastern Europe Global 4.0 16.6 11.0 3.9 2.8 6.6 6.5 2007E 2.5 17.0 9.7 6.0 4.5 7.3 5.7 2008E 2.7 15.1 11.0 7.0 4.5 7.2 5.6
consumption a key consideration; questioning of relevance of US slowdown markets appear strong
Global bulk materials, steel
Source: Haver, UBS estimates
22
Economic sensitivity of metals demand
Regional split - global base metals consumption
100% 80% 60% 40% 20% 0% 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005
Magnitude of Asia vs. US the
gap is widening
Our assumptions include: a 24%
contraction in US housing starts and destocking
Euro
US
Jpn
Other Asia
China
Other world
Metals growth remains firm
Output from economic sensitivity model metals demand read-through
IP Growth f'cast (2007) Western Europe US Japan Asia ex-Jp/Ch China Other global Total global IP 2.3% 2.1% 2.4% 7.0% 17.0% 3.0% 5.8% Global weight 20.4% 16.0% 6.3% 16.4% 28.0% 12.9% 100.0% Sensitivity* 1.52 1.40 1.26 1.22 0.80 1.24 1.20 Calc'd cons growth 3.5% -2.4% 3.0% 8.5% 13.6% 3.7% 6.2% Global growth contribution 0.7% -0.4% 0.2% 1.4% 3.8% 0.5% 6.2% Growth with inventory change 1.4% -6.8% -3.0% 8.5% 14.2% 1.6% 4.6%
Source: Brook Hunt, UBS estimates
23
How important is the US?
China trade balance (US$bn)
45% 40% 35% 30% 25% 20% 15% 10% 5% 1960
US share of global apparent consumption
1965 1970 1975 1980 1985 Steel Aluminium Copper
1990 1995 2000 Nickel Oil
2005
What if US consumption of Chinese products slows? China trade not very heavy 2001/2002 trade dip left materials relatively unaffected Urbanisation/industrialisation insulating materials consumption
Source: CEIC, IISI, US Census Bureau, USGS, UN, UBS estimates
24
US decline and China rise in materials consumption
US metals/oil consumption of world total % to 2007E
45% 40% 35% 30% 25% 20% 15% 10% 5% 0% 1960 1965 1970 Steel
China metals/oil consumption of world total % to 2007E
45 % 40 % 35 % 30 % 25 % 20 % 15 % 10 % 5% 0% 1990
1975 1980 1985 1990 1995 2000 Copper Nickel Oil
2005
1993
1996 Steel
1999 Copper
2002 Nickel
2005 Crude oil
Aluminium
Aluminium
Source: IISI, US Census Bureau, USGS, United Nations, WBMS, CEIC, UBS estimates
25
Composition of global growth and materials demand
GDP US$bn and growth 2006
14000 12000 10000 8000 6000 4000 2000 0 O 1st W Brazil India China Sth Korea Next 1bn Taiwan Russia Japan EU-7 US
Source: Datastream, EIU
26
10.0 9.0 8.0 7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0
2006 GDP US$bn lhs
2006 GDP growth rhs
Developing world growing faster with greater materials demand
elasticity
Aggregate Next 1 bn (Middle East, Mexico, Turkey, Indonesia, Poland,
South Africa, Thailand, Argentina, Venezuela, Malaysia, Chile, Czech, Philippines, Hungary, Egypt, Algeria) the surprise in 2006
Demand has been the biggest surprise, not only in China
Regional GDP in real and PPP terms
14,000 12,000 10,000 8,000 6 6,000 4,000 2,000 0 US EU-7 China Next Billion Japan Other 1st world India Brazil Russia South Korea Taiwan 4 GDP US$bn lhs GDP PPP US$bn lhs GDP real growth rate rhs 12
10
Source: IMF World Economic Outlook Database, 6 September, UBS
27
Next Billionthe hidden materials driver
Profile of the next billion, 2005
Pop. GDP/cap 2005 Consumption mt/y m US$ Cement Steel Ally
Mexico Turkey Saudi Arabia Poland Indonesia Sth Africa Iran Argentina Thailand Venezuela Malayasia Czech Chile Gulf States* Philippines Egypt Vietnam Total % of world
106 73 25 38 242 45 68 39 64 27 24 10 16 9 88 78 84 7183 5000 12593 7827 1233 4993 2895 4736 2563 5222 5110 11990 7074 25517 1111 1283 568 33 30 25 12 29 12 37 6 28 3 18 4 4 11 13 25 29 18 19 12 8 6 5 16 4 12 3 8 5 3 7 5 5 3 0.2 0.4 0.1 0.2 0.3 0.2 0.2 0.1 0.3 0.2 0.2 0.1 0.0 0.1 0.1 0.1 0.1
Cu IOU
Aluminium IOU
0.010 Aluminiumr consumption/capita 0.008 0.006 0.004 0.002 0.000 0 2,000 Japan 1952-72 Korea 1970-90 4,000 real GDP per capita US$ 6,000 8,000 10,000 China 1990-2007E PPP GDP Nex t billion 2000-2009E
2012E
1034
16%
3644
320
17%
137
13%
2.7
8%
Source: US Census, USGS, IISI, CEMBUREAU, UBS
28
Materials growth projections for +5, +15 years
Growth projections +5, +15 yrs
2002 Next Billion Steel Cement Copper Aluminium Crude oil Paper & board China Steel Cement Copper Aluminium Crude oil Paper & board India, Russia, Brazil Steel Cement Copper Aluminium Crude oil Paper & board Developed and other World Steel Cement Copper Aluminium Crude oil Paper & board World Steel Cement Copper Aluminium Crude oil Paper & board 882 1832 15.0 25.5 3537 331 1292 2292 18.5 36.2 3953 387 1612 2530 23.5 47.5 4258 441 2386 3084 30.1 67.0 4704 576 8% 5% 4% 7% 2% 3% 5% 2% 5% 6% 1% 3% 4% 2% 2% 3% 1% 3% 501 660 9 17 2420 235 586 659 10 20 2560 244 560 639 10 21 2632 256 501 601 9 19 2640 272 3% 0% 1% 3% 1% 1% -1% -1% 1% 1% 1% 1% -1% -1% -1% -1% 0% 1% 84 184 0.8 2.2 320 19 98 232 1.7 3.2 367 26 137 296 2.1 4.5 415 31 246 483 3.5 8.8 532 42 3% 5% 15% 8% 3% 6% 7% 5% 5% 7% 2% 4% 6% 5% 5% 7% 2% 3% 186 719 2.8 4.2 247 43 440 1115 4.6 9.8 371 68 647 1356 7.5 17.2 452 91 957 1823 11.6 30.7 607 163 19% 9% 10% 19% 8% 10% 8% 4% 10% 12% 4% 6% 4% 3% 4% 6% 3% 6% 111 269 2.0 2.0 550 47 2007E million tonnes 168 354 2.5 3.3 655 64 284 430 3.7 5.1 759 80 591 579 6.6 8.2 925 126 9% 6% 5% 11% 4% 6% 2012E 2022E 2002-2007E 2007E-2012E CAGR change in % 11% 4% 8% 9% 3% 5% 8% 3% 6% 5% 2% 5% 2012E-2022E
Next Billion % world cons.
100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Cement Aluminium Steel Crude Oil Paper& Board Copper 2002 2007E 2012E 2022E
Next Billion + BRICs % world consumption
90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Aluminium Cement Steel Crude Oil Paper& Board
29
2002
2007E
2012E
2022E
Source: IISI, USGS, Brook Hunt, BP statistical review, RISI, FAO, UN, IMF, UBS
Copper
Materials growth projections for +5, +15 years
Cu consumption estimates for the Next Billion constituents
Projected Cu consumption estimates of Next Billion and BRIC as % of world totals
Next Billion % of w orld total Copper Next Billion + BRICs % of w orld total Copper 2002 13% 2007E 14% 2012E 16% 2022E 21%
37%
47%
57%
70%
30
Source: IISI, USGS, Brook Hunt, BP statistical review, RISI, FAO, UN, IMF, UBS
Mining companies remain positive on demand
Cumulative consumption of copper to 2030
World refined copper consumption
40000 35000 30000
2007-2030 1900-2006 Total = 585 Mt Total = 620 Mt*
000 tonnes Cu
25000 20000 15000 10000 5000 0
1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 2020 2030
At a hypothetical world average growth rate of 3% p.a. Source of data: CRU, BHP Billiton
BHP Billiton at 3% growth rate in copper, the world to consume more
in the next 25 years as it did in the past 100 10%, and c9% until 2015E
Rio Tinto upgraded its Chinese GDP forecasts by 2% for 2007/08E UBS forecasts for Chinese GDP forecast - 8.9% and 9.4% in 2007E and
2008E; IP growth forecast 15.7% and 14.8% in 2007E and 2008E
31
Less exploration; fewer discoveries
14 12 10 8 4,000 6 4 2 0 1980 1984 1988 1992 1996 2000 2004 Major discoveries (LHS) World class discoveries no data on discoveries 2,000 6,000 No. of discoveries US$m 8,000
0 Exploration $m (RHS)
Source: MEG, UBS estimates
32
Paucity of new copper projects
Copper mine by discovery and production year
2010 year of production 2000 1990 1980
Antamina El Abra
Oyu Tolgoi Spence Alumbrera Batu Hijau Collahausi Los Pelambres
Olympic Dam
Escondida
Grasberg
1970 1970 1975 1980 1985 1990 1995 2000 2005 2010 year of discovery
Source: MEG, UBS estimates
33
Resource quality falling grades lower, mines deeper/remote
Grades for most mined materials are falling; copper, iron ore, gold Mines are becoming more geologically challenging; deeper, underground, etc. Future mines are likely to be located in remote, higher risk areas; Congo/Russia Quality issues will result in rising costs; marginal cost are likely to become an
increasingly important component in determining longer-term commodity prices
2.0 1.8 Head Grade Cu % 1.6 1.4 1.2 1.0 0.8
Initial production of world class copper mines; from key regions such as Chile/Indonesia/etc. Forecast Actual and hypothetical trend in head grade decline for the global copper mining industry Hypothetical trend
1940
1950
1960
1970
1980
1990
2000
2010
2020
2030
Source: Brook Hunt, UBS estimates
34
2040
Resource quality falling grades lower, mines deeper/remote
Trend towards a decline in
global reserves over the past 30 years
70 60 50 40 30 20 10 0 As mines age, both the quantity and quality of reserve tends to deteriorate
Both quality and quantity of
supply being impacted
1930
1935
1950
1955
1960
1965
1970
1975
1982
1984
1990
1995
1998
2002
2003
Years of global copper reserves
Cash production cost $/uni
Marginal costs rise vigorously as the future resource base is inferior to the current base. Older assets remain highly competitive as this quality dilution occurs
Potentially very significant
longer-term impact on resource industries
Future cash-cost curve
Old cash-cost curve Cumulative tonnage/volume Growth in market size
Dilution of quality impacts
marginal cost; supports longerterm increase in pricing
Source: USGS, Brook Hunt, UBS estimates
35
2005
Long-term prices: Structural pricing
Forecasting the structural price environment 2010 - 2016
07E Aluminium Copper Nickel Zinc Lead Iron ore Coking coal Platinum Thermal coal Uranium USc/lb. USc/lb. USc/lb. USc/lb. USc/lb. USc/ltu US$/t US$/oz US$/t US$/lb. 128 324 1765 159 102 80 95 1250 56 127 08E 140 300 1150 150 100 101 115 1350 70 196 09E 105 190 900 100 65 111 100 1250 75 150 Structural* 145 225 700 80 60 51 68 1200 45 50 Long-term 90 130 700 60 27 45 60 800 40 27 Structural vs. LT 61% 73% 0% 33% 122% 13% 13% 50% 13% 85%
Acceptance that industrialisation/urbanisation trends are long-lived Parallels with previous structural cycles
36
Long-term prices: Structural pricing (2)
Global intensity of use in base metals and price patterns in real terms (from 1930)
8% 6% 4% 2% 0% 2010E 2020E 1955 1995 2015E -2% -4% -6% Change in Intensity of use (global) LHS
Source: UN, UBS estimates
1955-75: Western world industrialisation / urbanisation impact
1980-2001: Western economies shifting to services based economy
2002-16E: Es'd Asian urbanisation / industrialisation impact
110 100 90 80 70
2025E
1930
1935
1940
1945
1950
1960
1965
1970
1975
1980
1985
1990
2000
2005
60 50 40 30
Real metal prices indexed to 1930 RHS
UBS now looking for a 15-year heightened price environment Strong pricing follows a 20-year period of real declines
37
Long-term pricing - quantification
Calculations for incentive pricing
Commodity Aluminium Copper Nickel Zinc Gold Platinum Iron ore Thermal coal Coking coal Units US$/t US$/t US$/t US$/t US$/oz US$/oz US$/t US$/t US$/t Capital cost 3,750 5,145 35,222 1,870 814 1,352 65 70 58 Required return 450 772 5,283 281 122 264 10 11 9 Depreciati on 188 343 1,761 125 54 90 3 5 4 Cash cost 1,316 1,676 7,937 882 265 443 15 25 45
Calc'd incentive price 1,953 2,790 14,981 1,287 441 797 28 40 58
Old long-term price 1,500 (USc68/lb.) 2,100 (USc94/lb.) 9,900 (USc450/lb.) 1,150 (USc52/lb.) 340 490 21 40 60
New long-term price 2,000 (USc90/lb.) 2,900 (USc130/lb.) 15,500 (USc700/lb.) 1,300 (USc60/lb.) 440 800 28 40 60
Source: Brook Hunt, AME, UBS estimates
Upside risks still exist for many commodities on long-term pricing Is incentive the appropriate methodology or is marginal cost superior?
38
Conclusions
Commodities are an attractive source of return and portfolio diversifier Long/short strategies reflect the shape of the forward curve Structural supply/demand issues in copper market contributing to price volatility which is being exacerbated by financial investors Financial investors affect short-term price cycles but have no impact on long-term prices Price volatility to remain a marked feature demands more risk management products (hedging) Long-term price assumptions have been raised with structural pricing used for 2010 - 2016
39
Disclaimer
This report was produced by: UBS Limited, an affiliate of UBS AG (UBS). Head Office: UBS Limited, 1 Finsbury Avenue, London, EC2M 2PP, UK Phone: +44-20-7567 8000
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