Electric vehicles not so bullish for copper
Copper is a key part of operations for BHP and RIO and investors are counting on increased demand from EVs.
Investors are often tempted by compelling narratives. A compelling narrative takes a trend that is widely accepted to be inevitable and attaches investment opportunities to that trend. A thematic investment is born.
The issue with thematic investing is that the relationships between trends, profits and returns are often assumed to be linear in a world that is anything but. Another issue is that what appears inevitable today may prove to be illusionary.
One of the themes that has griped investors lately is the ascendance of electric vehicles. In resource rich Australia the focus has been on the commodities used to make electric vehichles and the batteries found in electric vehicles. The lithium boom has turned into a bust which my colleague James Gruber recounted in a recent article.
Yet lithium is not the only material used in an electric vehicle. There is also copper.
In many ways copper mirrors the demand forces behind other commodities. China’s large construction and manufacturing sectors and significant infrastructure spending are a big driver of copper demand.
China is reliant on imported copper, accounting for less than 10% of mined supply but more than half of refined copper demand. Given it accounts for more than half of global copper demand, we think China’s likely transition to more consumption-focused economic growth is a headwind for copper. Yet many investors are only focused on coppers use in electric vehicles.
Electric vehicles not so bullish for copper
Electric vehicles currently use much more copper than internal combustion engine vehicles. However, driven by cost, we think EV manufacturers are likely to re-engineer vehicles to reduce copper use. For example, the adoption of smart vehicle architecture is likely to reduce copper use in electric vehicles.
Similarly, we think car manufacturers are likely to reduce copper use in EV batteries to lower vehicle weight and increase range.
On the supply side, increased use of technology to find new copper deposits, as well as the adoption of new technology to process existing resources, will likely add supply over the medium term in our view.
For example, BHP is testing leaching technology that economically processes low-grade copper resources at its 58%-owned Escondida copper mine in Chile, the world’s largest. The company and other major copper miners, including Codelco, Rio Tinto, Freeport, and Glencore, are also studying or testing other technologies that could increase copper production from existing resources.
Copper supply is concentrated in South America, led by Chile and Peru, and is likely to remain so for the foreseeable future, given their significant copper reserves.
Based on our estimate of the marginal cost of production, we assume a midcycle price of around USD 3.70 per pound from 2027. Copper is currently trading at USD 4.10 per pound.
ASX listed miners with major copper operations
For more on the mining article please see our recent article outlining the industry.
BHP (ASX: BHP)
BHP is the world’s largest miner by market capitalization. Its main operations span iron ore and copper, with smaller contributions from metallurgical coal, thermal coal, and nickel. It purchased copper miner Oz Minerals in fiscal 2023.
While our analyst does not believe that BHP warrants a narrow or wide moat rating we view the copper operations differently. As a standalone operation we view BHP’s copper assets as a business with a narrow economic moat.
BHP’s Peruvian operations in Antamina sits comfortably within the bottom half of the cost curve, BHP’s other copper mines including Escondida, Pampa Norte, and Olympic Dam are higher cost and don’t currently enjoy a cost advantage.
However, we forecast copper production to rise materially at these three mines, led by Escondida returning to an average of about 1.2Mt of payable copper production per year and also returning to sit around the 25th percentile of the cost curve.
Copper production will also rise as the Spence Growth Option at Pampa Norte ramps up, helped by higher grades, and as Olympic Dam’s Brownfield Expansion Option is developed, allowing BHP to mine higher grades here too.
In our view, this will result in BHP’s overall copper production sitting comfortably within the bottom half of the cost curve. At our forecast midcycle copper price of roughly USD 3.70 per pound from 2027, we forecast the copper segment will produce around 40% of midcycle earnings before interest and taxes (“EBIT”) and generate a midcycle return on invested capital (“ROIC”) of about 13% in 2027, comfortably above BHP’s weighted average cost of capital (“WACC”) of around 9%. As such, we also deem BHP’s copper business moat worthy.
We believe that BHP shares are currently trading as fair valued.
Rio Tinto (ASX: RIO)
Rio Tinto is one of the world’s largest miners with operations in iron ore, aluminum (including bauxite and alumina), copper, and minerals (mineral sands, borates, salt, diamonds). Commodity demand is tied to global economic growth, China’s in particular.
We do not believe Rio or their copper operations warrants a moat. The majority of Rio’s current copper operations are represented by its 30% stake in the Escondida mine in Chile, the world’s largest copper mine.
At full capacity, Escondida sits around the 25th percentile in the cost curve, with Rio’s smaller, 100% owned Kennecott (KUC) copper mine near the middle of the cost curve. The existing open cut mine at Oyu Tolgoi is much higher cost but we think that once the underground expansion at Oyu Tolgoi ramps up, this mine will move toward the lowest quartile on the cost curve.
However, the inflated capital base of the copper segment means we think the copper segment is unlikely to generate ROIC above Rio’s WACC for at least 10 years. As such, we don’t deem the copper segment moatworthy.
We believe that Rio shares are currently trading as fairly valued.
