High Energy Prices Are Threatening the World's Copper Supply
By Matt Badiali, editor, S&A Prospector
April 26, 2008
Just imagine if gasoline cost $20 a gallon.
You'd start by cutting your driving in half. Then you'd almost never go out to restaurants, because food would become so expensive. You'd probably pull the old bike out of the closet. America would scream bloody murder and lynch the CEO of ExxonMobil.
A 400% increase in the price of a precious fuel source sounds outlandish, but that's exactly what's happening in the country that produces more copper by far than its closest competitor.
It's happening in Chile. Only it's not gas, it's electricity.
The price of electricity in Chile has jumped from about 3.5 cents per kilowatt-hour to 35 cents per kilowatt-hour in just three years. That's like gasoline spiking from $2 a gallon in 2005 to $20 a gallon today.
This situation – which has big implications for commodity investors – stems from a deal between Chile and Argentina a few years ago...
In 1995, Chile generated 57% of its electricity from hydroelectric dams, 28% from coal, and the rest from diesel fuel. The government sought ways to diversify its electrical generation. It settled on cheap, clean natural gas piped in from neighboring Argentina. The media hailed the project as a model of national cooperation.
Chile bet big on Argentine natural gas, which quickly came to produce 37% of the country's electricity. The switch lowered energy prices... for about 18 months. Then, like my junior prom date, the relationship went bad in a hurry...
Argentina proved to be a terrible partner. By 2004, it began violating its production contracts. To meet increasing Argentine demand, suppliers cut the gas coming into Chile.
Chilean electrical production shifted to diesel, which effectively tripled the cost. Companies had to bring many of the old diesel generators out of retirement. Where a natural gas turbine costs $50 per megawatt-hour to run, the old diesel turbines cost $250 per megawatt-hour... a 400% increase.
On top of all that, Chile is in the midst of its worst drought in decades. No water means no hydroelectric power. So the country is even more dependent on diesel than ever before.
This power crisis has rocked the global copper market. Chile produces 40% of the world's copper. That supply is at risk... so naturally, copper prices are going up.
Back in July 2007, analysts at Macquarie and Citigroup projected copper prices around $3.50 per pound in 2008. Credit Suisse analysts bumped up their 2008 price forecast to $3.50 in March. Despite their increased projections, these firms are still underestimating copper's stunning run, as you can see from the chart.
China is the world's biggest consumer of copper. A lot of analysts thought a U.S. recession would put a damper on China's demand, driving down the price of copper. But a stateside downturn only hurts China's exports... Much of the country's copper goes to internal development projects.
When it comes to choosing commodity stocks to buy, I'm not a big fan of relying on predictions. As my good friend Steve Sjuggerud says, the best indicator of tomorrow's price is today's close. In copper's case that's about $3.95 per pound, which is 33% higher than in December 2007.
Shares in copper producers have done well over the past year... But with China's voracious appetite for commodities and Chile paying through the nose to pull its copper out of the ground, I think an investment in this sector is still a terrific way to play the bull market in natural resources.
Good investing,
Matt
Editor's note: Matt Badiali is a regular contributor to DailyWealth, a free investment newsletter focused on the world's best contrarian opportunities. We write with a simple belief in mind: You don't have to take big risks to make big money with your investments.
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