Has the Recent Drop in Oil Prices Created an Impact on the Copper Trade?
Copper has long been a barometer of economic health and historically its price movements have been tracked by economists who are seeking insight into the robustness of industrial activity as it is heavily used in new construction and development projects across several sectors. In the past few months the price of the prized commodity has followed the steep decline in crude oil prices and weakened to rates not seen in several years. Pundits are taking the drop in copper prices, combined with the decreased price of bonds and crude oil as a sign that a global slowdown may be on the horizon. The concern regarding copper is that the drop in crude oil prices could be spreading to other commodities and that the crisis might be much deeper and not just limited to the energy market. Like oil, copper has a deep impact on the global economy as both are used for infrastructure projects and are vital to the economies of several countries.
“The classic supply and demand story plays strongly into the pricing scenarios of both crude oil and copper as the global market is experiencing a cumulative demand weakness”
Given this comparison, many are quick to correlate the relationship between dropping oil and copper prices without considering that the volatility in raw material commodity prices has been a result of many complex factors. For copper specifically, the decline has a lot to do with the lowering of global growth forecasts by World Bank. The Bank recently lowered its forecasts and stated that they expect the global economy will increase by 3 percent this year, down from a forecast of 3.4 percent made in June. World GDP is projected to ramp to just 3.3 percent in 2016, lower than the previously forecasted 3.5 percent. Additionally, a strategic decrease in demand from China has further and some would argue more heavily, impacted copper’s pricing. The classic supply and demand story plays strongly into the pricing scenarios of both crude oil and copper as the global market is experiencing a cumulative demand weakness and an ever increasing commodity supply glut.
Whether the price of oil is directly correlative or even terribly impactful to the price of copper in particular is debatable but it is clear that the turmoil seen in crude oil pricing has had at the very least a rippling effect on the commodities marketplace as a whole. It is likely, however, that this impact has more to do with investor confidence, demand and other multifaceted factors than with the price of crude oil itself. So what role does the dropping price of oil play in copper?
It’s true that copper miners have already experienced a direct benefit to the drop in oil prices. The Wall Street journal reports that many miners will see value in the form of a reduction in production and transportation costs tied into energy pricing. These reductions do have the potential to provide a substantial positive benefit for miners, depending on their energy use. Some economists however, speculate that this kind of financial incentive may further expand the commodity glut citing the inventory increase of copper, which has climbed 5.4 percent since the start of this year. This argument does carry a valid point as stockpiles have and will most likely continue to increase though it’s important to note that most miners are already producing at near or full capacity and won’t be able to drastically ramp up their copper production without significant investment. Significant investment in an uncertain market is not likely to happen.
Others argue that energy, as a proportion of total costs, is much lower in copper than many other metal commodities such as nickel and aluminum and thereby provides less of an overall benefit and in turn argue that price of oil has more of a minimal impact to copper.
It’s also important to note that while some metal miners may have higher energy use wrapped into their production costs that oil isn’t necessarily the source of that energy. For instance, Bloomberg reports that aluminum, with energy accounting for nearly 40 percent of the cost of production, uses mostly coal and hydro-electric power for fuel which has little to do with crude oil prices.
During the decade long energy boom, U.S. producers worked hard to boost their output substantially which in turn, also increased their debt loads. As the price of oil falls, many are finding it difficult to turn a profit on poorer performing wells and are attempting to read just their strategies. In addition, many are amending their capital spending plans for this year in an attempt to weather the financial storm.
While the metal mining industry certainly doesn’t possess the debt load that the oil and gas industry does, in the short term it may face some similar challenges due to a stronger U.S. dollar and higher supply. The Wall Street Journal reports that many large miners have already cut their outlook for copper production this year and are preparing for the possibility of dealing with similar financial hurdles as stock prices also drop. The good news is that most economic forecasters suggest that the price slump in copper is temporary and the long term outlook looks positive. According to Goldman Sachs, a price rebound in copper will depend on government stockpiling in China this quarter and the pace of demand growth. Even with copper’s expected rebound, it still makes sense for miners to take this opportunity to consider implementing processes and new technologies in 2015 that assist in curbing costs as well as those that drive efficiency and boost productivity. The year ahead will be a challenging one for professionals and companies who deal in most commodity markets but it also stands to be an opportunity for companies to focus on how they handle adaptation in volatile environments.