Is Indonesia's Export Ban on Copper Bauxite Nearing Resolution?

Indonesia moved to ban the exporting of unprocessed minerals in January bringing the expectation of a -$3Bn decrease in annual exports:

Nickel: +36% YTD

Copper: -8% YTD

Recent developments concerning Indonesia’s largest copper producers, Freeport McMoRan and Newmont Mining, suggest that the two companies may be at the negotiating table with the Indonesian government. This apparent optimism, coupled with China’s move to seek additional sources of production, suggest the market needs to continue absorbing a multi-year supply increase.

  • A shipment of 10,000 tons of copper concentrate left Indonesia for China on Aug. 8.

By the end of June, talks between Freeport McMoRan and the Indonesian government appeared to breakdown, fueling speculation over whether the country’s biggest miner even had a future in Indonesia.

Simultaneously, Newmont also reached an impasse as the U.S. miner decided to file for international arbitration. Jakarta retaliated by threatening to terminate Newmont's contract if the company did not withdraw its legal challenge.

Freeport chose to continue negotiations…

The government agreed to a framework valid for at least six months that could be used to renegotiate the contract under the next administration.

Now Newmont appears to be following suit to begin friendly negotiations…

Newmont announced Tuesday it has withdrawn an international arbitration claim against the government after a breakthrough in negotiations with the government.

Just how important is Indonesian mineral production?

Without a doubt, more important for nickel than copper…

Nickel +36% YTD (ETF: JJN)  

  • Indonesia accounts for 20% of global production
  • China and Japan are two of the largest buyers of Indonesian nickel ore

Government officials have emphasized they have no plans to lift the ban on unprocessed nickel ore….

Defending his case, chief economic minister, Chairul Tanjung said that producing and refining and smelting within Indonesia is much more productive and lucrative than doing the same for unprocessed copper.

A recent report from Indonesia’s Investment Coordinating Board showed that they are in fact investing in the second-leg of the production process:

  • $8Bn was being spent to build three alumina refineries and two ferronickel projects
  • 102 Nickel Smelters were in the process of being constructed

Indonesia’s share of global copper production is smaller but still significant…

Copper -8% YTD (ETF: JJC) Bullish TREND ($3.16 Spot Resistance)

  • Grasberg copper mine in the Papua province is one of the top ten largest copper mines
  • Proximity to China and Japan provides is an advantageous supply source

According to the Copper Development Association the 2012 global production rankings are as follows:

Chile: 5.37MM tons (36% global total)

Reserves: 190MM tonnes

 

China: 1.5MM tons

Reserves: 30MM tons

 

Peru: 1.2MM tons

Reserves: 76MM tons

 

United States: 1.1MM tonnes

Reserves: 39MM tonnes

 

Australia: 970K tonnes

Reserves: 86MM tonnes

China is one of the largest producers, but it doesn’t have nearly the reserves compared to the rest of the top 5 which explains their sense of urgency in moving to secure supply lines elsewhere:

  • China’s MMG closed on a $7Bn acquisition of the Las Bambas copper project in Peru in July
  • Chinese backers are now behind one-third of all Peru’s new mining investments by value

Copper Quant Set-UP --> Testing the Trend line On Heavy Selling

Is Indonesia's Export Ban on Copper Bauxite Nearing Resolution? - Copper Levels Chart

  • BULLISH @Hedgeye Trend set-up --> $3.16 support (CURRENTLY TESTING)
  • Today’s close marks the fourth consecutive close in the RED
  • Volume +30% d/d in the active contract month
  • Volatility +90%, +116%, +105.8% above 1/3/6-month averages

WHY WE NEED TO TURN TO THE QUANT:

  • So much of understanding of the base metal outlook is to develop a view on the demand outlook for the larger EM countries, namely China, which is a very difficult space to navigate (see below for China’s share of global base metal consumption)

Near-Term Expectations

  • Copper basis between front and second month is currently +70 bps (expectation for 0.70% higher prices in 1-month)
  • Copper basis between front and 1-year is +1.64%     
  • The largest copper basis is Sep 14-Aug15 basis which is slightly wider than spot-1Yr

Copper continues to trade on the outlook for the Chinese economy, and for good reason based on their share of global copper consumption. We published a note on July 28th, outlining the uncertainty behind the China catalyst.

An excerpt from that note is included below along with the link:

Copper: A Scary Short

“Consensus macro leans on the strength of the Chinese economy as a leading indicator for base metal demand (as it should). China consumes over 40% of the world’s industrial metals (up from 5% in 1980).

2013 Consumption (% global demand):

  • Nickel: 47.4%
  • Aluminum: 46.1%
  • Zinc: 45.6%
  • Copper: 42.4%

An equally weighted index of Chinese GDP and industrial production to industrial metals prices (CRB metals index) is running an r-squared of 0.50 currently, down from a December 2011 peak. Although diverging from the 2011 highs, the relationship cannot be ignored as a market catalyst.”

Conclusion:


We will be watching the following factors in the coming weeks for a read-through on the supply outlook:

1)      Chinese economic outlook takes a more definitive turn positive or negative

2)      The Indonesian copper bauxite export picture reaches a long-term resolution

3)      Continued confirmation in a late-cycle mining cap-ex push from the largest miners

4)      A continued positive Trend for the USD

With these fundamental factors in play, copper may be interesting on the short-side if our @Hedgeye $3.16 TREND line breaks and confirms.

Please feel free to ping us with comments or questions.

Ben Ryan

Analyst