China regulation is key to copper pricing

In spite of the drop in commodity prices, western mining executives are sounding upbeat at the world's annual copper gathering in Santiago this week.

The good thing about the market for copper, they say, is it accurately reflects supply and demand.

But does it? Is the industrial metal really any different from other commodity such as iron ore and thermal coal?

In theory, pronounced weakness in raw material prices, should result in high- cost producers mothballing their mines and sending workers home.

But like the free marketeers who saw their theories exploded by the financial crisis, the current weakness in commodity markets is showing that clean theories of supply and demand do not necessarily work.

Take iron ore, a key steelmaking ingredient. Some analysts predicted that Chinese high-cost mines would stop production as prices fell below their cash costs. Instead, Chinese mines have kept on producing, and the government has stepped in this month to support them with a resource tax cut. That has added further to the glut of iron ore, pushing prices down further.

In coal, oversupply has meant that about 70 per cent of Chinese coal miners are operating at a loss, according to the China Coal Association. But instead of closing, the Chinese government introduced import taxes on coking coal and thermal coal, and reduced export taxes. It also placed limits on the quality of coal that was allowed to be imported, essentially putting a halt to coal from overseas lower-cost miners.

So will copper follow these real-world examples or will it follow the perfect theory?

Like coal, that might depend on China's environmental policies, as the country's growth runs up against the limits of nature as well as its own people. That will increase capital costs for mining and smelting projects. However, it remains to be seen how effectively will the country's strict new environmental laws be enforced?

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Anecdotal evidence suggests Chinese producers have average costs between $5,600 a tonne to $6,400 a tonne, with the highest cost producers at $7,200 a tonne. This places China - through its domestic copper output - as the "marginal" producer in the sector.

Capital costs for Chinese smelters would disappear if they reached the same environmental level as western smelters, Harry Liu, vice-president of the Xiangguang Group, a Chinese smelter with a capacity of half a million tonnes, said in his speech to Santiago's World Copper Conference. They have been providing global miners with smelting at cheaper costs than they should, he said.

He also made an important point about the nature of the copper market. China's government has a restrictive policy on the export of refined copper, he said, which blocks the outflow of copper that could balance the global market once an arbitrage situation emerges.

"The world's largest consumer of copper accounting for more than 40 per cent of the global demand is not fully aligned with the international market from a free trade point of view. So we can hardly call the global copper market an efficient one as nearly half of the resource is not freely allocated without tax or non-tax barriers," he said.

The Commodities Note is an online commentary on the industry from the Financial Times

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