Monday, April 4, 2011

Geology and risk hinders new copper supplies

(Reuters) - It will take more time, and lots more money, to bring new copper supply online, as miners venture into more challenging geographies and geologies to meet soaring demand.

Passion for the red metal, used in wiring and construction, has surged on rapid urbanization in China, India and Brazil. This thirst, coupled with project delays around the world, sent LME copper prices soaring 260 percent over two years to a record high of $10,190 a tonne in February.

Rising copper brings rising profits, prompting everyone from junior explorers to diversified giants to spend increasing amounts of cash in search of the next motherlode.

"Where we sit today, we're well above the incentive price to bring on new supply," said BMO Capital Markets analyst David Radclyffe. "It's a question of when, not if, that new supply arrives."

The first new wave of copper projects and expansions is set to roll out over the next two to three years, with more than 60 percent of this supply coming from Latin America.

And while the copper price has dipped 7 percent so far this year, and is expected to fall further as big Chinese stockpiles soften short-term demand, analysts say there is still enough of a shortfall to make challenging projects worthwhile.

"At the end of the day, we're still short copper assets," said Radclyffe. "The companies are spending a lot more on exploration this year and hopefully that does lead to some more discoveries."

The biggest challenge for the sector is not that there is no copper left, but that all the "good" stuff is gone.

"There's no 'peak copper' theory," said Fidelity Investment Canada portfolio manager Darrel Lekkerkerker. "The problem is the easy-to-get stuff, we've already got."

Lekkerkerker, who co-manages a resource fund with copper equity investments, said producers need to either take a second look at challenging, high-cost projects, or start exploring in countries that may be less politically stable.

With copper prices expected to rise further in the third quarter, there should be plenty of cash to bring higher-cost projects online, he added.

But moving into new regions is more challenging. Companies face major risks in places where government royalties and mining taxes may be unclear, and, in extreme cases, assets may be nationalized.

Infrastructure may also be poor or non-existent.

Ivanhoe Mines' (IVN.TO) $5 billion Oyu Tolgio project in Mongolia, some 80 km (50 miles) from China's northern border, is a perfect example, said Lekkerkerker.

The mine was delayed repeatedly as the company negotiated an investment agreement with the government, and then put roads, power and water into the remote Mongolian desert.

"They discovered it in 2001 and they're going to start producing next year. That's 11 years later," Lekkerkerker said. "It just illustrates how long it takes."

GOING GREENFIELD

Global exploration spending jumped 45 percent in 2010, and about 20 percent of that went into copper projects, according to independent research firm Metals Economics Group.

Most of the overall exploration is happening in North America, but Peru and Chile are both in the top 10, primarily due to copper exploration.

"There's no question that people are spending money on the ground," said Macquarie Research mining analyst Pierre Vaillancourt.

But the traditional copper supply regions are saturated, and big producers are spending more money further afield.

Southern Copper (SCCO.N), which owns projects in Peru and Mexico, is exploring for new deposits in Ecuador, while First Quantum (FM.TO) is focusing on Africa, with projects in Zambia and Mauritania. Global giant Rio Tinto (RIO.L) has invested in Mongolia.

Still, even if someone announced a massive new discovery tomorrow, it would be years before the copper hits the market -- especially if the project is in a more risky region.

"It's a big effort to bring on new production," Radclyffe said. "Any exploration success that occurred this year would be very hard to bring on production until the next decade."

(Reporting by Julie Gordon; Editing by Lisa Shumaker and Diane Craft)

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