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Why Is BHP Management Still Positive on Copper’s Fundamentals?

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Aug. 19 2016, Updated 10:04 a.m. ET

Copper costs

Unit cash production costs are a key metric for investors in the metals and mining space (XME). This assumes additional significance in the face of the current low commodity price environment. BHP Billiton (BHP) (BBL) and its peers in the copper space are improving productivity in order to lower unit costs.

In this part of the series, we’ll explore this topic in detail. Copper contributes 25% to BHP revenues.

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Lower unit production costs

  • Total copper production declined by 8% to 1.6 million tons in fiscal 2016. Most of the decline was due to the Escondida grade decline. The company expects fiscal 2017 production to increase by 5% to 1.7 million tons.
  • Cash costs for copper increased by 9% YoY (year-over-year) in fiscal 2016 to $1.20 per pound due to the Escondida grade decline. This was 6% lower than the company’s previous guidance of $1.27 per pound. Improved unit costs were due to a significant reduction in costs on an absolute basis.
  • These improvements were particularly visible at Olympic Dam, where unit costs declined by 29% YoY to $1.38 per pound. Productivity-led cost improvements and further reductions in labor and contractor costs led to this decline.
  • Escondida’s unit costs increased by 11% to $1.12 per pound.
  • The copper division’s underlying EBITDA (earnings before interest, tax, depreciation, and amortization) declined by 57% YoY to $1.7 billion in fiscal 2016. The EBITDA margin fell to 36% from 52% last year. Lower realized prices and a grade-related volume decline were the reasons for this decline.

What will drive copper costs?

In fiscal 2017, BHP expects Escondida’s unit cash costs to decline by 11% to $1 per pound. This will mainly be driven by higher concentrate throughput as a result of Escondida Water Supply commissioning and ongoing productivity improvements.

In the longer term, BHP management sees a deficit emerging in copper supply. This could happen as grades decline and scarcity of high-quality future development opportunities keep the industry’s supply constrained.

In the short to medium term, however, copper prices seem to be under pressure due to weaker-than-expected demand and the strengthening US dollar (USDU). This will impact companies such as Freeport-McMoRan (FCX), Teck Resources (TCK), and Southern Copper (SCCO).

The slowdown in China (MCHI) (FXI), the biggest copper consumer, has weighed heavily on copper prices. FCX forms 3% of the SPDR Metals and Mining ETF (XME).

In the next part of this series, we’ll see how BHP is progressing on the cost front in its petroleum division.

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