COLUMN-Pan Pacific officially opens copper "mating season": Home

(The author is a Reuters columnist. The opinions expressed are his own.)

By Andy Home

LONDON, Sept 10 (Reuters) - The copper "mating season", when terms are negotiated for next year's shipments of both raw materials and refined metal, has just been declared officially open by Japan's Pan Pacific Copper.

Senior company executives laid out their starting positions at a press conference on Monday.

Pan Pacific Copper's views count.

Not just because with 710,000 tonnes of refined copper capacity it is one of the world's largest producers.

But also because its views are implicitly those of the rest of the Japanese copper smelter pool, still a powerful enough entity to determine "benchmark" prices.

And Pan Pacific's views are that both raw material conversion terms and refined metal premiums should rise next year. And substantially so.

To some extent this is no more than a smelter wish-list, the opening shots in what, based on previous years' experience, are likely to be protracted and fiercely-contested talks.

And to some extent the company's stance reflects no more than the current reality in the spot market for both copper concentrates and refined metal. Treatment charges for the former and physical premiums for the latter have soared in the last couple of months.

But there is an inherent contradiction between implied surplus in the raw materials market and tightness in the refined metal market, or at least sufficient tightness to justify Pan Pacific's call for a 50-percent hike in premiums.

Can the two apparently contradictory trends be reconciled? Yes, but probably only for a highly limited period of time.

TREATMENT CHARGES: AIMING HIGH

Pan Pacific Copper and, by implication, its fellow Japanese smelter-refineries, are setting their sights high in terms of raw material terms next year.

The target is a treatment charge (TC) of $95 per tonne and a refining charge (RC) of 9.5 cents per lb. These are the conversion costs deducted from the price of copper in purchases of concentrates from miners.

They mark an extremely sharp jump from the TC/RCs of $70 per tonne and 7 cents per lb negotiated last year and from the mid-year terms of $72 and 7.2 cents.

Indeed, they would be the highest conversion charges since at least 2006, although any direct comparison over that time-frame becomes difficult since key components of the contracts, such as price participation clauses, have largely vanished in the interim.

******************************************************* Graphic on "benchmark" copper TCs: http://link.reuters.com/ref92v *******************************************************

That TC/RCs will rise should not be in doubt. Spot market terms are already over $80 and 8 cents, reflecting much improved availability.

BUILDING SURPLUS

Global copper concentrate production soared by 10.5 percent over the first five months of this year, according to the International Copper Study Group.

That figure is flattered by a low comparison base in 2012 but the underlying trend from historical famine to future feast is undeniable.

Years of collective under-investment by the world's miners underpinned a bull copper market that began in 2006 and, bar a brief interlude during the Global Financial Crisis, is still running. The current copper price of $7,200 per tonne may be a long way off the 2011 peaks above $10,000 but it's still comfortably above the cost curve, in stark contrast to most of the other base metals.

High prices incentivised miners to expand existing mines and build new mines and the cumulative impact is now starting to make itself felt.

The supply surge is still only building with most observers expecting the peak some time next year.

Which is why, along with rising costs, Japanese smelters are aiming high. They will find common cause with their Chinese counterparts, whose negotiating position will be much enhanced by the start-up of the Oyu Tolgoi mine just across the border in Mongolia.

That said, headline terms are almost certainly not going to match smelter ambitions. Miners will resist what would be a near unprecedented annual increase.

But next year's "benchmark" deals will tell only part of the copper raw materials story.

Just as with other metallic raw materials such as iron ore and alumina, pricing is migrating away from annual "benchmarks".

The process is far less advanced in the copper raw materials markets but increasing tonnages are being priced on half-yearly, quarterly and spot pricing.

The headline 2014 TC/RCs will capture the shift towards market surplus. But the size of that surplus will become more apparent in the shorter-term deals that are concluded as the year unfolds.

In other words, Pan Pacific may not get its $95 and 9.5 cents now. But it may get there or at least close to there later in 2014.

REFINED METAL PREMIUMS - AIMING HIGHER

Pan Pacific Copper is aiming even higher when it comes to premiums on 2014 metal sales to China.

It's targeting $130 per tonne over LME cash (CMCU0>. That compares with this year's double "benchmark" of $85 per tonne for Japanese shipments and $98 per tonne for Chilean shipments.

As with concentrate treatment terms, some sort of increase next year looks inevitable.

Chinese physical premiums recently spiked to over $200 per tonne, an extremely high level by any historical yardstick. They have eased since then but at around $150-160 per tonne, the gap with this year's term premiums is still a yawning one.

Even Chinese buyers seem reconciled to some sort of increase but of a much lower magnitude than that targeted by Pan Pacific.

However, just as the upwards trend in raw material terms is likely to continue beyond any 2014 "benchmark", there is good reason to believe that refined metal premiums will trend lower from the headline deals for next year.

PREMIUM SPIKE

There have been two core drivers of the recent spike in Chinese metal premiums.

The first has been what might politely be termed the queue dynamics of London Metal Exchange (LME) stocks in the Asian region.

Most of the LME inventory in Asia is located in Johor, where it has been drawn by "freight incentives" offered by warehouse operators.

The Malaysian port currently holds 215,600 tonnes of exchange-registered copper. The three South Korean good delivery locations, by contrast, hold just 11,950 tonnes.

Most of that Johor tonnage, 160,875 tonnes, is in a load-out queue. That has set a floor underneath regional physical premiums, which meant that when the second driver of the premium spike kicked in, Chinese restocking, it did so from an elevated base.

China has been on a major stocks-building exercise after domestic inventory, particularly the statistically opaque stocks sitting in Shanghai's bonded warehouse zone, was severely depleted over the first half of this year.

The result can be seen in the accelerated flow of copper into the country, a trend that is expected to last at least a couple more months.

That restocking impetus, however, will fade over the coming months. And, given the regulatory scrutiny of LME load-out queues, the Johor backlog should dwindle. It certainly seems highly unlikely it will grow further.

DIMINISHING TIGHTNESS

Both developments can be expected to take some of the recent heat out of the Chinese premium market.

But the longer-term reason to expect lower metal premiums is the flip-side of the trend in raw materials pricing.

As concentrate availability builds and treatment terms continue to improve, Chinese smelters will be incentivised to increase their own production.

They certainly have the capacity to do so.

Indeed, there is already a noticeable disconnect between the 37-percent rise in Chinese copper concentrate imports over the first eight months of 2013 and the 12-percent rise in national refined copper production in August.

Less copper scrap supply and/or lower domestic mine production might help explain the gap but there is also a suspicion that the country's smelters are merely biding their time, possibly with one eye also on the 2014 mating season.

At some stage there is the potential for a step-change in Chinese smelter utilisation rates which will see raw materials surplus flow through to refined metal surplus.

In other words, Pan Pacific may well win higher premiums on its term sales of refined metal to China next year, although not necessarily to the extent it's hoping for.

But both higher raw materials terms and higher refined metal terms will only be achievable for a limited period of time. Over the longer term Pan Pacific and other smelter-refineries will get the one at the price of the other. (Editing by William Hardy)