An econometric analysis of the world copper market

An Economietric Analysis of the World Copper Market C. Suan Tan 0 2I H 4 00 5  World Bank Staff Commodity Working Papers 1. The World Tin Economy: An Econometric Analysis (out of print) 2. International Cotton Market Prospects 3. An Econometric Model of the World Rubber Economy (out of print) 4. Industrial Processing of Natural Resources 5. The World Sugar Economy: An Econometric Analysis of Long-Term Developments 6. World Bank Commodity Models (2 volumes) 7. Analysis of the World Coffee Market 8. Analysis of the W'Vorld Cocoa Market 9. The Outlookfor Primary Commodities 10. World Rubber Market Structure and Stabilisation: An Econometric Study 11. The Outlookfor Primary Commodities, 1984 to 1995 12. The Outlookfor Thermal Coal 13. Jute Supply Response in Bangladesh 14. Prospects for the World Jute Industry 15. The World Copper Industry: Its Changing Structure and Future Prospects 16. World Demand Prospects for Jute 17. A New Global Tea Model: Specification, Estimation, and Simulation 18. The International Sugar Industry: Developments and Prospects 19. An Econometric Model of the Iron Ore Industry  WORLD BA-NK STAFF COMMODITY WORKING PAPERS Number 20 An Econometric Analysis of the World Copper Market C. Suan Tan The World Bank Washington, D.C.  The International Bank for ReconstrTuction and Development / THE WORLD BANK 1818 H Street, N.W. Washington, D.C. 20433, U.S.A. All rights reserved Manufactured in the United States of America First printing October 1987 Commodity Working Papers are not formal publications of the World Bank, and are circulated to encourage discussion and comment and to communicate the results of the Bank's work quickly to the development community; citation and the use of these papers should take account of their provisional character. The findings, interpretations, and conclusions expressed in this paper are entirely those of the author(s) and should not be attributed in any manner to the World Bank, to its affiliated organizations, or to members of its Board of Executive Directors or the coumtries they represent. Any maps that accompany -`Ae te-xt have beomn prepared solely for the convenience of readers; the designations andrpresentation of material in them do not imply the expression of any opinion whatsoever on the part of the World Baik, its affiliates, or its Board or member countries concerning the legal status of any country, territory, city, or area or of the authorities thereof or concerning the delimitation of its boundaries or its national affiliation. Because of the informality and to present the results of research with the least possible delay, the typescript has not been prepared in accordance with the procedures appropriate to formal printed texts, and the World Bank accepts no responsibility for errors. The most recent World Bank publications are described in the catalog New Publications, which is issued in the spring and fall of each year. The complete backlist of publications is shown in the annual Index of Publications, which is of value principally to libraries and institutional purchasers. The latest edition of each is available free of charge from the Publications Sales Unit, The World Bank, 1818 H Street, N.W., Washington, D.C. 20433, U.S.A., or from Publications, The World Bank, 66, avenue d'Iena, 75116 Paris, France. C. Suan Tan is an economist in the International Commodity Markets Division of the World Bank's International Economics Department. Library of Congress Cataloging-in-Publication Data Tan, C. Suan (Choo Suan) An econometric analysis of the world copper market. (World Bank staff commodity working papers, ISSN 0253-3537 ; no. 20) Bibliography: p4 1. Copper industry and trade--Econometric models. 2. Copper industry and trade--United States--Econometric modtlls. I. Title. II. Series: World Bank staff commodity working paper ; no. 20. HD9539.C6T36 1987 382'.4243 87-29552 ISBN 0-8213-0978-1  ABSTRACT The prolonged economic difficulties since the late 1970s have thrown into sharp relief the structural changes in the world copper market since the mid-1960s and the resulting changes in competitiveness among the major producing countries. This paper analyzes the developments in the world copper market since the mid-1960s. It also describes the specification, estimation and simulation of an econometric model of the world copper market based on this historical understanding of the market. The econometric model focuses on the copper market in the market economies, with the influence of excess supply;>from the centrally planned economies accounted for through their net exportfs to the market economies. Since mine capacity data for producing countriesi are not available for the pre-1964 period, the model is based on data for the 1964-83 period. To allow for flexibility in analyzing alternative future scenarios, mine capacity expansions are treated exogenously. The results give support to the notion that copper demand and supply are price-inelastic. Copper demand has been influenced primarily by the industrial production of the consuming countries. Mine capacity expansions up to the 1970s were premised on expectations of continued demand growth. Moreover, the nationalization of the copper industry in some of the developing countries precipitated concern over their future production capabilities and led to some unwarranted investments in capacity expansions in industrial countries. Aside from these unrealized expectations, the decline in the comparative advantage of North American mines, because of declining ore grades, was exacerbated by higher production costs resulting from the imposition of stringent pollution controls and inflationary increases in labor and energy costs. The shift from a unified domestic price for US producers in 1978 to a producers' price equal to the world price plus a premium reflects the reduced North American bargaining strength: the North American share of world production fell from 30% in 1970 to 16% in 1983. Model simulations give weight to the view that overinvestment and expansion of mine capacity in the 1970s and prolonged world economic recession from the late 1970s to early 19809 precipitated the current oversupply. The situation has been aggravated by the loss of market shares to material substitutes, such as aluminum, owing to a lack of marketing and promotion efforts and to the trend toward miniaturizateion. This conclusion is substantiated by the results of a simulation with aluminum prices set at one- and-a-half times that of copper. Thus, low and regulated aluminum prices effected a royalties squeeze on the copper industry. Exchange rate variations and inflation were also seen to influence price determination. While the invention of fiber optics has been frequently cited as a major new threat to the copper industry, the simulation results suggest that fiber optics will displace slightly less than 0.5 million tons out of a total of 9.0 million tons of copper consumption by 1995. Given the crucial role of industrial activity for copper demand and the abundance of copper reserves,  i 1v - the viability of mine capacity expansions was shown to depend ultimately on copper's ability to withstand competition from other substitutes and to mwintain growth in existing and new uses. Thus it may be that growth and development in highly populated and fast-growing countries such as China and India could provide important markets. Io  TABLE OF CONTENTS ABSTRACT .............................................................. iii ACKNOWLEDGMINTS ........................................................... x I. INTRODUCTION ........................................................1 1.1 Background to the Study ...................................1 1.2 Outline of the Study ...................................... 2 II. DEMAND FOR COPPER ................................................... 5 2.1 Diversity of Derived Demand for Copper ................... 5 2.2 Demand for Copper and Input Substitution .................8 2.3 Specification of Copper Input-Demand Functions ..........13 2.4 Estimation of the Consumption Functions ................. 16 III. PRIMARY AND SECONDARY COPPER SUPPLY ................................ 23 3.1 Changing Shares of Major Producing Countries ............23 3.2 Specification of the Primary Supply or Mine Production Function .................................. 25 3.3 Data Used in the Mine Production Equatiorns .............. 27 3.4 Estimation Results for Mine Production Equations ........ 29 3.5 The Secondary Supply of Copper ..........................34 3.6 Secondary Copper Supply Equations.......................37 3.7 Refined Copper Supply Equations.........................43 IV. COPPER TRADE OF THE UNITED STATES AND COMECON COUNTRIES............46 4.1 Reasons for Partial Analysis of Trade in Copper.........46 4.2 The United States as a Net Importer of Copper ...........46 4.3 The Net Exports of Comecon Countries ....................51 V. STOCKHOLDINGS AND PRICE FORMATION .................................. 52 5.1 The Key Issues ........................................... 52 5.2 Transactions, Precautionary and Speculative Stockholding ............................................ 52 5.3 Specification of the Price Equations....................55 5.3.1 The LME Price .................................55 5.3.2 The US Producers' Price.62 5.4 The StockEquations......................................66 5.4.1 US Producers' Stocks ..........................66 5.4.2 Deficiencies in the Stock Data..........67 5.4.3 Total Stocks Equation......................... 73  - vi -s VI. M0DEL STRUCTURE AND EMPIRICAL VALIDATIOU .......................74 6.1 The Model Structure ........ s*o*.*.. ......o........ o74 6.2 Empirical Validation of the Model ....................... 85 6.2.1 Alternative Specifications of US Producers' Pricing Behavior ................... .86 6.2.2 Higher Aluminum Price.s e.. ......see.......0.0.. 91 6.2.3 Impact of the US DolIar Held at 1984 Rate throughout 1971-1983.................96 VII. ANALYSIS OF COPPER CONSUMPTION BY END-USES .................. .. 105 7.1 Introduction ................00 ..00 ..............0. 105 7.2 Copper Consumption in the Electrical Industry..........106 7.3 Copper Consumption in the Construction Industry ........ 108 7.4 Copper Consumption in the Transport Industry ........... 111 7.5 Copper Consumption in the General Engineering Indtustry ...........................*.....................e00000 114 7.6 Copper Consumption for Domestic and Miscellaneous Uses .......... .................0. .116 7.7 Integrating End-Use Consumption Equations into the Model ........................... e 0000 e 00 em 66600 119 VIII. FIBER OPTICS AND LONG-TERM COPPER MARKET PROSPECTS ................. .122 8.1 Advantages of Fiber Optics. .......................e 122 8.2 Fiber Optics and the Telecommunications Industry ....... 124 8.3 Impact of Fiber Opfics on Copper Market Prospects ...... 125 8.3.1 Assumptions for Long-Term Projections ........ 126 8.3.2 Base Case Projections ........................ 128 8.3.3 Fiber Optics Scenarios. ................. 129 IX. DISCUSSION AND CONCLUSIONS..0 .............. ........................ 137 9.1 Important Features of the Copper Model..o......., ..... 137 9.2 Empirical Findings from the Copper Model ......... e......139 9.3 Some Implications of4the Results ............ ............. 142 9.4 Conclusions .................... .60000 0....... e...... 144 BIBLIOCRAPHY ...........0 .e.e ....... 0 ..... ...... ... 147  - vii - LIST OF FIGURES AND TABLES Figure 2.1 Technology of Primary Copper Production ...................7 Figure 3.1 Occurrence of Secondary Copper in the Copper Processing Manufacturing Chain ............. 35 Figure 5.1 Time Paths of LME, Comex and US Producers' Price for Copper, 1960-1983 ..................64 Figure 5.2 Time Paths of Published Versus Computed Total Stocks, 1960-19