We recently posted several threads on Twitter about copper futures, positioning within the copper futures market, and the copper concentrate market. We received a question from several followers: how do copper smelters lose money with a strong copper price? The question reminded us that although we all use metals daily and collectively depend on copper about as much as we do any metal, most people still do not understand where it comes from.

The copper we use in our computers, electrical wires, batteries, etc., does not come straight from the ground; in fact, ~50% of copper mining globally is mining for Chalcopyrite (CuFeS2), an iron sulfide mineral from which we then smelt and refine a copper cathode.  Globally, more than two hundred copper minerals exist, and native copper (99% pure copper dug out of the ground) is not particularly common.[1] Of the two hundred known copper minerals, only about ten are typically found in concentrations greater than 0.2% and large deposits, with Chalcopyrite being the most important.

Other essential copper minerals include Bornite (Sulphide), Malachite (Oxide), and Cuprite (Oxide). Some minerals, such as Chalcopyrite, are primary or hypogene minerals, forming deep below the earth's surface through geological processes involving ascending thermal fluids.[2] Others, such as Malachite, are secondary minerals formed near the surface due to the interaction of multiple environmental variables and diverse elements.

There are also two “flavors” of minerals in which copper is found: oxides and sulfides.  Sulfides, which account for about 80% of the global copper supply, are minerals built around elemental sulfur, and oxides are minerals built around oxygen. The distinction is crucial because it shapes how different ores are processed and who is processing them.  An independent copper smelting industry exists because of the high percentage of copper produced from sulfides.

Oxides tend to be processed via hydrometallurgical extraction. The hydrometallurgical process involves dissolving copper in an aqueous liquid containing sulfuric acid (heap leaching) and then running that solution through a solvent extraction (SX) and electrowinning (EW) process. The result of this process is a finished copper cathode. Smelters are less critical in SX-EW copper production; they deal primarily in sulfides.

Sulfides, unlike oxides, cannot typically be processed via a hydrometallurgical method; they must be processed via a pyrometallurgical process.  This means using a lot of energy to generate heat and roasting the ores. Some mines have integrated smelting operations (notably bigger mines in difficult locations where the logistics of moving a copper concentrate that is only 30% copper and 5% to 7% water is cost-prohibitive), but many miners require third-party refiners and smelters to convert their copper concentrates into copper cathodes.  The smelters offer a service to the mining firms by converting copper concentrates with a copper content of usually 30% into 99% pure copper products.  The smelters run like tolling facilities, and the copper price is not essential to the smelter’s bottom line. In this way, smelters operate business models similar to some LNG terminals.

The tolling business model means the most critical revenue stream for copper smelters is the treatment and refining charges (commonly referred to as TC/RC) the smelters charge the miners. Smelting firms may derive added revenue from producing premium high-grade cathodes; they also generate income from sulfuric acid production, but the value of that revenue stream is highly geographically dependent on having a consumer close to the smelter.  The final significant revenue stream comes from the recovery of free metals; for example, a copper miner and a smelter may have a contract that allows for a loss of 1% of copper; if the smelter can recover some of that lost copper, they can keep it for resale.

Given this business model, smelters' earnings depend on the assay of the concentrate mix received from a mine, the TC/RC charge, fees for producing premium cathodes, free metal recovery, and sulfuric acid prices. The physical copper market is currently short of copper concentrate and long spare copper smelting capacity. The result has been a smelter squeeze, in which smelters have sought to aggressively undercut their competition with reduced TC/RC charges to attract concentrate to their smelting operations.

The concentrate squeeze has come at a terrible time for smelters. Not only has China added significant spare capacity in recent years, but several other countries (such as Indonesia) are also adding copper smelting capacity. According to Fastmarkets, spot smelter charges for CIF Asia concentrate have plunged 97% since the 2023 peak. The collapse began in November 2023 with the closure of First Quantum’s Cobre Panama mine but was worsened due to lower copper mine production for 2024 from companies including Anglo American, Vale, and Southern Copper.

Looking to the future, it seems unlikely that the smelter strain will ease anytime soon.  The reasons are three-fold:

• Upsetting the Apple Cart: Freeport McMoRan, a significant user of Chinese smelting capacity, has begun ramping up a new smelter in Indonesia called the Manyar Copper Smelter.  When fully operational, it will consume 1.7 million tons of concentrate that would have previously gone to China. 

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  In the grand scheme of things, the loss of concentrate is concerning, but the longer-term issue is that Chinese smelters have long used the TC/RC charges agreed to between Freeport and the Chinese Copper Smelters Purchase Team, a group of the country's most prominent players, as the benchmark contract on which all other smelting contracts are negotiated. The contract has historically had the size and predictability necessary to serve as an industry benchmark. The new FCX smelter (built because Indonesia put in place a concentrate export ban) is upending a process that has been in place for 30 years to negotiate TC/RC contract rates.  The result of this outcome is unclear, but there are already rumors of disagreement between Chinese smelters as to what will take its place.  

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• New smelter capacity in China has been growing at a double-digit pace recently.  According to Fastmarkets, twelve copper smelting facilities/expansion projects will come online in China between 2023 and 2026, with a capacity of 3.4 million tons annually. 2022 China produced 10.4 million tons of refined copper, combining primary and secondary output. According to the International Copper Study Group (ICSG), this accounted for 41% of 2022 global refined copper demand.  The additional new supply will increase China’s capacity to 52% of the 2023 global refined demand.

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  Further growth is also likely for Chinese copper smelting capacity, as economics do not appear to be the deciding factor. As one executive at a major state-owned copper producer noted to Fastmarkets, investing in copper smelting is the “politically correct” thing to do, and the projects are “easy to finance.” [3]

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  The Chinese smelters have a limited supply of domestic copper, so the majority of refined copper they produce must come from imported concentrate.  A net increase of three million tons per year of primary copper smelting capacity translates into demand for twelve million tons per annum of additional copper concentrate demand.[4] This leads to the third and final reason the smelter challenges will continue.

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• New smelter capacity outside of China is growing; much of it, like the Indonesia example presented above, is in countries with domestic copper production. Besides growth in Indonesia, major copper-producing countries like the DRC, Zambia, and several LatAm producers are considering or already working on expanding smelter capacity. The result of copper-producing countries building smelters will be an even tighter copper concentrate market for Chinese smelters, even in a healthy supply/demand environment.

A secondary impact of the smelter squeeze and the growth of non-Chinese smelting capacity will be a more aggressive effort by Chinese miners to secure copper assets. When final investment decisions about copper smelting capacity expansions were made in recent years, one of the primary arguments in favor of expansion was the Chinese Communist Party’s (CCP) stated goal of refined copper self-sufficiency. With the growth in non-Chinese smelting and reduced access to concentrate, this goal looks increasingly difficult to accomplish, risking turning some smelters into stranded assets. The only solution for the Chinese to address this issue is to be increasingly aggressive upstream of the smelters and be aggressive in ways sufficiently favorable to the governments of mining nations to allow for the export of unrefined copper concentrate, even if the goal of those governments is to move downstream into more value-added segments of the copper supply chain.

While the concentrate market is currently tight, creating issues for smelters, an interesting situation regarding warehouse inventories of refined copper in the West continues to evolve. As of the end of May 2024, copper stocks held at the major metal exchanges (LME, COMEX, SHFE) totaled 452,478 tons, an increase of 238,628 tons (+112%) from stocks held at the end of December 2023. The aggregate masks interesting geographic divergences, with stocks up at SHFE and down at COMEX (-14%) and the LME (-30%).

The weak demand for copper in China and robust domestic smelter capacity have resulted in a substantial buildup of inventories at the SHFE. At the same time, there has been a weak buildup of deliverable copper in warehouses in the West and a meaningful percentage of the copper in LME warehouses is tied to Russia, so it cannot be moved into the COMEX system.

Although we are now off the price highs we saw in May, the situation has not yet been fully resolved. COMEX inventories are at roughly one-year lows, while shorts by Producers, Processors, Merchants, and Users (PMPU) as of June 11th are slightly below the one-year max reached in May. Market participants correctly question whether there is enough metal inventory to satisfy outstanding physical shorts.

What does this all mean for investors looking for opportunities in copper? First, if you do not know all of this already and are digging around copper miners, especially juniors, looking for opportunities, call us; we can save you a lot of heartache.

On the other hand, if you want to go it alone, be patient; while many miners have moved aggressively to the upside with the recent spikes in copper prices, do not panic; you will get another chance to buy in at more favorable prices. The move in copper has run ahead of itself based on technical industry factors, not fundamental supply and demand issues. This was a strong move in copper despite weak near-term macroeconomic fundamentals. The real opportunity in copper for the long-term will present itself, but we are still in the first innings.

If you are trading copper futures, local outperformance of COMEX copper could create an attractive tactical opportunity in the near term. On the other hand, long-term copper bulls executing ideas via the futures market need to be mindful that there is a high potential for more selling. Various short-term sell-side CTA momentum models turned negative in May, but the medium and long-term models remain positive.

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[1]. The largest native copper deposit (that we are aware of) is the Keweenaw native copper deposits in Upper Michigan, which were the site of major copper mining operations in the 19th and early 20th centuries.

[2] Hypogene minerals are formed deep below the earth's surface through geological processes involving ascending thermal fluids.

[3] In March of this year, the Chinese government said they would take steps to control the expansion of smelting capacity, but it is not yet clear what exactly that means.

[4] https://www.fastmarkets.com/insights/china-new-copper-smelting-capacity/