The spot price for copper had been in the doldrums for years before recently rebounding to a 16-month high as investors bet that global manufacturing and infrastructure spending will increase. That is great news for the largest copper companies, which will benefit from rebounding prices. But while the rising tide of higher copper prices will lift all miners, successful investing in copper takes more than just blindly choosing a company based on copper production.
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Image source: Vale.
Digging into the copper sector
Despite the recent surge in copper prices, the consensus view in the industry is that current copper prices are insufficient to meet future demand because they are not high enough to incentivize producers to invest in enough new projects to offset declining output. As a result, analysts at research firm Wood Mackenzie believe that production from existing mines will fall by 4 million tons through 2025. That is a substantial amount of copper. For perspective, the world's top 10 mines only produce 5.5 million tons of copper per year.
To reverse this trend, Wood Mackenzie believes that copper needs to average about $3.30 per pound to incentivize producers to increase output. However, given that copper is currently around $2.50 per pound, it means prices need to go meaningfully higher to fuel new investments. That outlook will certainly benefit the world's top copper companies:
Data source: Southern Copper investor presentation.
However, while the group as a whole will benefit from that future, five copper producers stand apart as the biggest beneficiaries:
Image source: Southern Copper investor presentation.
As that chart shows, Southern Copper, BHP Billiton, Rio Tinto, Vale, and Freeport-McMoRan have the lowest costs in the sector putting them in the best position to capture rising copper prices. That improving market will provide them with the cash flow they need to invest in the plethora of low-cost production growth opportunities embedded within their portfolios.
Highest reserves at the lowest costs
Mexican-based Southern Copperis currently the largest holder of copper reserves and has the longest mine life at 94 years. More importantly, it has the lowest costs in the sector at just $0.91 per pound after factoring in by-product credits. Also, while Southern Copper is currently only the fifth-largest copper producer, it has several growth projects underway that will boost its output by more than 50% through 2020. In addition to that, it has several large potential projects in the pipeline to expand production even more, including two world-class greenfield projects. Investors looking for a low-cost, high-growth copper company need to look no further than Southern Copper.
Following the leader
Freeport-McMoRanis the world's leading copper producer thanks to its a world-class copper portfolio, including stakes in three of the four largest copper mines in the world. These are also some of the lowest-cost mines, with its crown jewel Grasberg mine in Indonesia boasting unit costs of just $0.62 per pound this year. Furthermore, in addition to more than 25 years of reserve life at its current production rate, Freeport-McMoRan controls a large inventory of development projects that it can use to boost production when market conditions improve. In other words, this leader is not about to lose its crown.
Image source: Getty Images.
A copper-colored future
Diversified global mining giant BHP Billitonproduces several important metals and energy products. However, copper is one of its most important commodities in both the near and long term. In the near term, the company has several compelling opportunities to expand production across three of its copper mines by 10% through the end of the decade. Meanwhile, longer term, it has two potential major projects to expand production further depending on market conditions, including the $2.2 billion Spence Growth Option and the capacity to nearly double the output at Olympic Dam. Finally, BHP Billiton has not given up the search for new Tier 1 greenfield copper discoveries. So far this year, it has invested capital to acquire and test a sizable amount of acreage Peru and the U.S. Southwest. Suffice it to say, BHP Billiton has ample copper growth potential in the future.
A world-class discovery about to reach its full potential
Aside from being one of the lowest-cost producers, Rio Tintoalso has compelling copper upside. A major part of that is the development of the Oyu Tolgoi copper and gold mine in Mongolia. Initially discovered in 2001, Oyu Tolgoi holds one of the largest known copper and gold deposits in the world. Currently, Rio Tinto is literally just scratching the surface of this mine's potential by using open-pit mining when 80% of the mine's value lies deep underground. To capture that value, the company and its partners just started construction on a $5.3 billion underground mining project, which is expected to be operational by 2020. When fully ramped up by 2027, it will more than double the mine's output while producingin the top quarter of the copper cost curve.
Image source: Vale.
There's more to this story
As the world's largest producer of iron ore, investors tend to forget that Valeis about more than just that one metal. In fact, it is a significant producer of low-cost copper and currently a top 10 holder of copper reserves. While Vale is not investing capital to grow copper production at the moment, it does have significant opportunities to expand should prices improve. For example, the company is considering a third expansion phase at its massive Salobo mine in Brazil that could boost output by 50% while more than doubling the output of its Zambia mine. When conditions warrant, Vale will likely allocate capital to these projects to take advantage of higher prices.
For those looking to invest in copper over the long term, the top stocks are those that operate at the low end of the cost curve. That is because these companies can earn the most money at the currently low prices, which gives them greater capacity to expand when prices improve. Each of these companies has enormous growth potential as well, thanks to projects underway and those currently in the pipeline.
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Matt DiLallo owns shares of BHP Billiton. The Motley Fool owns shares of Companhia Vale and Freeport-McMoRan Copper and Gold. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.