Big Trouble For Copper: The Breakdown Of The Industry Has Begun

The king of base metals is in big trouble as indicators point to a breakdown of the global copper industry.  This goes well beyond the typical “slowdown” or “downturn” in the copper market.  Instead, we are going to witness what I refer to as “Copper Industry Carnage.”

While some readers may feel as if I am being a bit “doom and gloomy” here, the situation in the global copper industry is much worse than most analysts realize.  This is due to the fact that many analysts are forecasting copper supply deficits in the next few years, which would push the price of copper higher.

Unfortunately, this sort of industry analysis is well behind the curve or even worse, guilty of wishful thinking.  The world economy is slowing down… and this will likely pick up speed by the end of the year.  Which means, demand for copper will continue to weaken, pushing prices even lower.

Today, the price of copper is down 2%, impacting the copper miners.  Freeport’s stock price was hammered lower by over 7% today in market trading.

Low copper prices are already causing damage in the top two copper mining companies in the world.  The second largest copper producer, Freeport-McMoran, suffered an adjusted income loss of $214 million in the first half of 2016.  Part of the loss was due to their lousy shale oil and gas investments.

For some stupid reason, many base metal mining companies jumped into the oil and gas business with both feet when the shale energy bonanza took off in the United States.  For example, BHP Billiton reported a hefty $7.2 billion impairment (write off) on its onshore shale oil and gas assets last year (for their year ending Q2 2016).

While that may seem like one hell of a lot of money for BHP Billiton to write-off on its shale oil and gas assets, Freeport-McMoRan did one even better.  According to FreePort-McMoRan’s annual report, they reported a staggering $13 billion impairment on their oil and gas properties in 2015 on top of another $3.7 billion write off in 2014.

As they say… easy come, easy go.

So, not only are the big base metal miners suffering from low base metal prices, they are also enjoying a wonderful shale oil and gas enema from the other end.  I don’t mean to be harsh here, but who on earth was in charge of making these lousy shale energy investment decisions for these base metal mining companies??

And it gets even worse.  I just read this jewel of an article yesterday on the Financial Times, BHP Billiton Bets Long On U.S. Shale Assets:

Five years after BHP Billiton plunged $20bn into the US shale revolution, the wait goes on for shareholders.

Even if oil prices rally by one-third the fields will not generate significant free cash flow until the turn of the decade, the mining company cum oil producer revealed at investor briefings last week.

….. BHP’s acquisition of two US shale producers in 2011 was followed by $17bn of investment, beefing up an oil business that has long set the world’s most valuable mining company apart from its peers. About one-third of BHP’s group earnings before interest, tax, depreciation and amortisation have come from petroleum over the past five years.

The timing of its shale bet proved ill-judged. Following a savage market downturn that has seen oil prices more than halve, BHP has racked up $12bn of impairments and the US shale business is now valued at just $12.6bn. Output is expected to fall by a quarter this year, the consequence of a much reduced drilling programme.

So, the Einsteins at BHP Billiton acquired U.S. shale oil and gas assets that are now only worth $12.6 billion, after they racked up $12 billion of losses in impairments since 2011.  Furthermore, even if the oil price increases by one-third, they won’t generate any significant free cash flow until 2020.

Warning to BHP Billiton shareholders….. GET OUT WHILE YOU CAN.

I tell ya, it is amazing to see supposedly savvy businessmen in high-dollar suits making these sort of insane investment decisions.

Okay, let’s get back to the destruction of the copper mining industry.

The First Signs of the Gutting Of The Copper Mining Industry

We are we witnessing the first signs of the gutting of the copper mining industry when we see a collapse of mining truck purchases by Chile.   This is bad news as Chile is the largest copper producer in the world.  Chile produced 5.7 million tons of copper in 2015, way ahead of the second ranked country, China which mined 1.6 million tons.

According to a report by the Chilean Copper Commission, new mining truck sales fell to a low of 40 units in 2015, down from a peak of 392 in 2012.  As you can see, this is not a slowdown.  Rather, truck purchases have fallen off a cliff:

We have to go all the way back to 2004 to see a unit number that low.  Even with the huge downturn in the global markets in 2009, Chile still imported 122 new mining trucks that year… more than triple the figure for 2015.

Why is this such a big deal?  I took the total number of new trucks imported (purchased) by Chile and compared it to the annual average price of copper:

There seems to be a correlation between the copper price and new truck purchases by the Chilean Copper Industry.  When the price of copper fell to $1.34 a pound in 2009, Chile still imported three times more new mining trucks that year than in 2015, when the copper price was double ($2.70).   Sadly, Chile’s new mining truck purchases are down 90% from their peak in 2012.

Of course, there were new projects coming online to justify some of the large number of truck purchases in 2011 and 2012.  However, Chile’s copper production has only increased from 5.4 million tons in 2010 to 5.7 million tons in 2015.  Would a 5% increase in Chile’s total copper production justify the need for 322 new trucks in 2011 and 392 new units in 2012??

Regardless, demand for new mining trucks in Chile has fallen 90% from its peak.just a few years ago  I would imagine new truck sales in 2016 will likely be even weaker.  This is not a good sign for the largest copper producer in the world.

The Top Copper Mining Companies Are Getting Hammered

As I mentioned in the beginning of the article, Freeport-McMoRan suffered a $214 million adjusted income loss in the first half of 2016.  That’s pretty bad because “adjusted” income removes many items (such as impairments) from the bottom line to arrive at figure that represents a more realistic day-to-day cost of mining copper.

For example, Freeport also suffered an additional $4 billion impairment on its shale oil and gas assets in the first half of 2016.  So, if we add that to the $13 billion of shale asset impairments last year, Freeport has racked up a cool $17 billion in shale asset write-downs in just a year and a half.

Maybe it would have been a good idea for the management at Freeport to stick with mining copper, rather than blowing big money on the U.S. Shale Oil & Gas Black Hole.

If we look at Freeport-McMoran’s free cash flow for the past eight years, something is dreadfully wrong now.  For a quick refresher, free cash flow comes from deducting CAPEX (capital expenditures) from their cash from operations:

Here we can see that 2010 and 2011 were good years for Freeport as they enjoyed $4.8 and $4 billion respectively in positive free cash flow.  However, this took a turn for the worse in 2014 as free cash flow turned negative to the tune of $1.5 billion, then doubled in 2015 to a negative of $3.1 billion.

Even though some of that negative free cash flow can be blamed on losses from their  shale oil and gas assets (liabilities… haha), the majority of Freeport’s revenues are from copper and metal mining.  For example, of the $15.8 billion in Freeport’s net revenues in 2015, only $1.9 billion was from U.S. shale oil and gas proceeds.

While the change in Freeport’s balance sheet to negative free cash flow in the past two years is not a good sign, the situation is even worse when we add in their dividends.  From 2013-2015, Freeport paid out nearly $5 billion in dividends.  Thus, they forked out $8.8 billion more during the past three years than the cash they made from operations.

Now, if we look at the largest copper producing company in the world, their results aren’t any better.  In the first quarter of 2016, Chile’s Codelco mining company reported a $125 million net income loss.  This loss is purely on producing copper as Codelco doesn’t have any U.S. shale oil or gas assets.

According to Codelco’s financial highlights on their website, they enjoyed a $7.4 billion pre-tax profit in 2012, $3.8 billion in 2013 and $3 billion in 2014.  However, things turned south in 2015 as they suffered a $1.4 billion pre-tax loss that year.

Coledco produced 1.9 million tons of copper in 2015, while Freeport came in second at 1.5 million tons.  So, the two top mining companies that produced 3.4 million tons of copper in 2015… didn’t really make any money.  And it looks like 2016 will be even less fun for these large copper miners

The global copper mining industry is getting ready to face some serious hard times.  Again, the falling copper price and the financial trouble taking place in the world’s top copper producers is not the typical market correction awaiting a turnaround in the global economy.  Rather the copper industry is heading towards a disintegration to a much smaller size.

Unfortunately, investors and analysts who continue to believe the situation will recover in the global economy, will lose a lot of fiat money holding onto these copper and base metal mining companies.  Even though investors should have realized something was wrong when several base metal mining companies moved into the U.S. Shale Oil & Gas Ponzi, and lost a lot of money, they will continue to hold onto these stocks as we enter into the next phase… the Copper Industry Carnage.

Courtesy of SRSrocco Report.