On Friday night, just days after Rio boss Jakob Stausholm hailed what he described as a “definitive” deal to buy 100 per cent of copper miner Turquoise Hill, a minority shareholder called Pentwater Funds announced that it was prepared to block the move.
Turquoise Hill owns 66 per cent of the Oyu Tolgoi copper mine in Mongolia, a project key to Rio’s plans to become a force in the copper sector. Rio owns a tick over 50 per cent of Turquoise Hill and wants to mop up the rest; it has presented three separate offers to minority shareholders, the latest of which has won the approval of the company’s board.
But Pentwater has launched a rearguard action, announcing on Friday night that it had bought 1.73 per cent of Turquoise Hill stock to take its stake to 11.67 per cent, and declaring that Rio’s offer “significantly undervalues” the Toronto-listed company.
“The proposed price implies an equity value of $C8.65 billion [$9.7 billion], which is a fraction of the free cash flow that Pentwater expects Turquoise Hill to generate over the next decade,” the firm said.
The copper price might have fallen more than 25 per cent this year to about $US3.60 per pound on fears of a global economic slowdown, but that’s not what investors such as Pentwater, or indeed miners such as Rio and BHP, which last month launched an $8.4 billion bid for local copper pure-play OZ Minerals, are focusing on.
A new report doing the rounds of the global mining sector, which was compiled by S&P Global and funded by Rio, BHP, Glencore and a host of other global miners, paints a dramatic picture of the explosion in demand that will occur over the next 13 years, and the shortfalls that will emerge in just two years and extend for decades.
Indeed, such is the scramble that S&P sees coming in the copper sector that it predicts the metal “may emerge as a key destabilising threat to international security”.
Whether the world ends up going to war over copper remains to be seen. But what is guaranteed is that the battle for every copper asset will be hard-fought – as Rio and BHP are finding out.
At the heart of the supply-demand picture described by S&P is copper’s role as the metal of electrification; copper is vital to everything from electric vehicles to power infrastructure (that is, the rewiring of the electricity grid that most developed countries require) and renewable generation.
“Unless massive new supply comes online in a timely way, the goal of net-zero emissions by 2050 will be short-circuited and remain out of reach,” S&P says.
The raw numbers are startling. S&P expects copper demand will jump from 25 million tonnes in 2021 to 50 million tonnes in 2035; this can be largely attributed to the fact that renewable power and electric vehicle applications will need to be in place by 2035 to meet net-zero targets in 2050.
The trajectory of supply looks very different. S&P sees a supply shortfall emerging by 2025, and beyond that, it considers two scenarios: the “rocky road” scenario, under which the current trends in copper scrap recycling and refinery utilisation remain the same, and a “high ambition” scenario, under which the world experiences advances in recycling and utilisation.
Under the “rocky road” projection, a 9.9 million tonne shortfall opens up by 2035, equivalent to 20 per cent of demand projected to be required for a 2050 net-zero world. By way of comparison, the largest shortfall as a percentage of refined copper demand between 1994 and 2021 was 2.5 per cent.
Even under the “high ambition” scenario, shortfalls exist up until 2035, although there would be surpluses in the 2040s thanks to improved scrap recycling.
The supply gap identified by the report is likely to push prices higher for longer, which will encourage investment. But that’s not so easy in copper. Essentially, all the low-hanging fruit in the sector has been picked, and future generations of projects are likely to be more complex and increasingly expensive to mine. Throw in social licence and environmental issues, and the difficulties of increasing supply mount further.
So what does this mean for investors such as Pentwater and miners like Rio, BHP and OZ? In theory, existing copper tonnes – whether that’s BHP’s vast reserves, Rio’s big Mongolian opportunity or OZ Minerals’ well-run portfolio – should be worth more in the future than they are now, and potentially much more.
On Friday night, Pentwater argued that Turquoise Hill would generate $C10.5 billion ($11.75 billion) of free cash flow through to 2030 at a copper price of $US3.50 per pound and $C14.2 billion ($15.9 billion) at a copper price of $US4.
But it believed that “as the world transitions to a green economy, the demand for copper will continue to increase and that there is a high probability that the price of copper will exceed $US4 over the next decade”.
It would appear Rio has a bit more work to do over the coming weeks to win over Turquoise Hill minority shareholders and Pentwater in particular.
Over at OZ Minerals, a stalemate continues – it won’t engage with BHP unless it increases its offer, but BHP believes its offer was good enough to warrant engagement and is happy to remain disciplined, given the copper price and the macroeconomic environment.
But as the S&P report makes it evident, copper’s long-term story looks clear: the collision of surging demand from the energy transition and constrained supply might be very bad for international stability but should be very good for prices.
The puzzle for the likes of Rio, BHP, OZ Minerals and Pentwater is what those future prices mean for today’s valuations.