Why supply cuts don’t matter (yet) - Capital Economics
Metals

Why supply cuts don’t matter (yet)

Industrial Metals Update
Written by Kieran Clancy
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Several producers outside China have reduced operations in the past week, most notably in Latin America. But much like policy support, lower supply will do little to boost prices so long as measures to contain the coronavirus keep demand comatose. In any case, our estimates suggest that cutbacks on the scale announced so far will fail to prevent huge oversupply in 2020.

  • Several producers outside China have reduced operations in the past week, most notably in Latin America. But much like policy support, lower supply will do little to boost prices so long as measures to contain the coronavirus keep demand comatose. In any case, our estimates suggest that cutbacks on the scale announced so far will fail to prevent huge oversupply in 2020.
  • Given the fast-evolving nature of events, we are once again revisiting our forecasts for demand and supply. To recap, we started the year expecting most industrial metals to be undersupplied in 2020, and for that to lead to higher prices. (see here.) In contrast, we now think that industrial metals will be significantly oversupplied, and that prices will end the year far below where they began. (See here.)
  • In China, what began as a virus-related dent to demand eventually hit the supply side of the equation too. As we argued back in February (see here), though the primary impact of virus containment measures is a huge decrease in demand, they also make it harder for producers to source inputs and shift products. As a result, the longer such measures remain in place, the more likely that producers must cut output.
  • Now, the rest of the world is following in China’s footsteps. Mining operations in South Africa have been suspended for three weeks, while a two-day lockdown has been imposed in key mining regions of the DRC. Perhaps most significantly, several major copper miners in Chile and Peru have had to reduce operations. Although the scales vary, the durations are generally in the region of two weeks.
  • We have pencilled in a 5% contraction in global copper demand in 2020. Before factoring in reduced supply outside China, that translates into a surplus of over 1m tonnes of refined copper. After totting up the cutbacks announced, we now expect a slightly smaller surplus of just over 800,000 tonnes. (See Chart 1.) By our records, that would still be by far the largest surplus in the copper market since 2001.
  • To illustrate the sheer scale of this surplus, even if every copper mine in Chile and Peru – which account for two-fifths of global production – shut for a fortnight, the loss of output wouldn’t come close to the fall we expect in demand. A two-week shutdown in those countries equates to just over 300,000 tonnes of copper concentrate, which we assume leads to a similar decline in refined output at copper smelters. (In reality, the loss of smelter output is likely to be less as they can draw down existing concentrate stocks.)
  • Just to balance the market (i.e. where lower supply exactly offsets the fall in demand), copper mines in Chile and Peru would have to come to a complete standstill for over a month.
  • Therefore, until containment measures are fully lifted, the best that can be hoped for is that these supply cuts put some sort of a floor under prices. That said, once lifted, and demand starts to recover, lower supply may aid a swifter recovery in industrial metals prices than we currently anticipate. (See Chart 2.)

Chart 1: Copper Market Balance (Th. Tonnes)

Chart 2: S&P GSCI Industrial Metals Index

Sources: WBMS, Capital Economics

Sources: Refinitiv, Capital Economics


Kieran Clancy, Assistant Commodities Economist, kieran.clancy@capitaleconomics.com

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