Copper Supply Challenged, Who Will Fill the Gap?

We’ve written extensively at Capital 10X about the coming unprecedented rise in copper demand driven by renewables and electric vehicles; in this report we examine the fundamental challenges with copper supply keeping pace with record demand. We also highlight two high quality companies that are poised to benefit: Amerigo Resources (TSX:ARG) and Hot Chili (TSXV:HCH).

The new wave of demand presents a multi-year investment opportunity for investors, however there is an even more pressing near term opportunity we want to highlight today.

The decline of major sources of copper supply.

Demand will take years to play out, but the disappointing growth in copper supply is already happening.

Civil unrest in Peru and funding issues in Chile, two major copper producers, are taking a bite out of copper production growth. Combined these two countries account for 35% of global copper supply.

Chile Production Disappointing in 2023


Supply declines in Chile are being driven in particular by problems at Codelco, Chile’s state owned copper producer.

Codelco production, 31% of copper production in Chile, is now in its 8th year of decline and is back to where it was 25 years ago.

Codelco was also recently put on watch for a debt downgrade by Moody’s due to falling margins and the inability to hit growth targets.

Codelco, along with the whole mining industry, has seen significant cost inflation during COVID, which is now putting pressure on margins.

Moody’s expects Codelco will need to increase capital spending on new projects by 20% this year to hit future production targets.

A 20% increase is equal to $700 million dollars of extra spending, 50% of Codelco’s cash remaining. With Codelco on track to generate only $2.8 billion of cashflow this year, the extra spending means more debt, which already ate up all profits in 2023 so far.

Codelco’s ability to continue growing production will hinge on its ability to continue borrowing cheaply from international debt markets. A Moody’s downgrade could complicate things.

Shortfalls, Slowdowns & Supply Gaps driving an Uncertain Future

Chile isn’t the only country facing supply problems. The lack of supply visibility is a worldwide problem.

A 2022 S&P Global study found that significant copper shortfalls will begin in 2025, as a result of increased demand from the energy transition and limited new copper supply.

S&Ps rocky road scenario assumes that if current conditions continue, there will be a 10 million metric ton shortfall by 2035. Even in their high ambition scenario, which assumes significant strides in technologies for extraction and recycling techniques, a shortfall will continue until 2035.

Forecast Copper Supply & Demand Balance

Source: S&P Global

Unfortunately, the mining industry will not be able to meet this supply gap from new production without a frankly unrealistic increase in drilling capital expenditures.

Many of the world’s largest copper mines are facing dwindling reserves, depleted ore-grades and are slowing production due to capital-intensive major projects being moved underground in a bid to increase access to more ore.

Looking for new deposits (called greenfield exploration), is very costly and imposes inherit risks and difficulties. Not to mention, finding copper and putting it on production takes a long time.

The past decade has seen greenfield exploration slow dramatically, as the excess supply from 2006-2012 was worked down.

S&P Global estimates that new discoveries averaged 50Mt annually from 1990 to 2010. Moving to the present, discoveries have fallen by 80% to only 8Mt / year.

Current estimates expect a cumulative supply gap of 50Mt or over two years of global demand, between 2022 and 2030.

Mining project approval rates have stalled. In the first half of 2022, the volume of committed projects totaled just 260,000 tonnes of production per year, compared to 2x-4x that in a typical year.

Mining Project Approvals by Year (kt copper)

Source: S&P Global

The failure of current sources of copper to feed global demand, introduces opportunities for public market copper investors.

Lets explore what these opportunities look like.

Copper Producers and Developers Have an Opportunity to Fill the Void Left by Governments and Majors

The key implications copper stocks are twofold: higher long term copper prices and greater value for copper resources.

  1. New explorers with significant copper discoveries can fill the void. Copper demand is forecast to remain very strong over the next decade meaning new producers will have an easier time raising money to fund new projects and finding buyers to sign long term offtake contacts.
  2. Falling supply from major producers like Chile could lead to higher copper prices and significantly higher cashflow for producers who are maintaining or growing production.

Below we’ve highlighted one stock that fits into each opportunity bucket and the unique characteristics we think they offer investors.

Amerigo Resources (TSE:ARG, OTC:ARREF)

One of the names that screens the most attractive for cash return to shareholders within the copper universe is a small cap copper miner with a unique business model, Amerigo Resources.

Amerigo is a company with strong leverage to copper prices and the highest dividend yield in the sector at 8.5%, while shielding investors from the largest risk they take on when investing in the copper sector: Mining risk.

Amerigo produces copper without a copper mine: They recover copper from the waste stream of one of Chile’s largest copper mines, El Teniente.

Though production from state copper miner Codelco hasn’t been meeting government expectations, production at El Teniente remain stable and the waste tailings from the mine are still far in excess of what Amerigo needs to continue operating through at least 2033 according to the company.

El Teniente has over a 70 year history of reliable mining operations, and Amerigo simply processes the waste to recover the copper along with other metals like molybdenum. The copper concentrate produced is largely the same concentrate produced by traditional mining operations.

Source: Amerigo Resources

Amerigo isn’t a mining company, their core business proposition is a better analogy with a wastewater treatment company. The real differentiator is that a wastewater plant receives a flat fee, while Amerigo has full leverage to the copper price.

Amerigo has minimal sustaining capex requirements and therefore can focus on return of capital to shareholders. The company has three tools they utilize for their capital return policy: quarterly dividends, performance dividends and share buybacks.

Amerigo Resources’ unique value comes from its peer leading dividend yield and conservative balance sheet. Amerigo’s 8.5% dividend yield puts it ahead of all but
one of the highest yielding companies in the S&P 500 and well above TSX Index and
the TSX Dividend Aristocrats Index.

Amerigo’s yield is in-line with the average high yield bond, even though the company is in a net cash position, putting its credit quality far above the typical high-yield company.

While a debt holder has no upside except to be paid back once the bond matures, Amerigo stock holders are being paid 8.5% of their money back every year while still having upside to the price of copper.

If Amerigo generates additional cashflow, the company has historically returned most of it through a dividend increase or stock buyback, which we like.

Amerigo has set the dividend at a conservative level, that can be sustained in all but the most distressed copper price environments in our view.

Amerigo’s lack of production risk and industry leading dividend yield make it a very unique way to benefit from strong copper demand and prices. If Chile production disappoints, driving copper prices higher, Amerigo investors benefit. If production rebounds and prices fail to head higher, investors still are generating a very attractive 9% annual return from the dividend alone.

Amerigo is the only “non-mining” company with upside to copper prices, making it a truly unique vehicle for copper investors.

Hot Chili Limited (TSXV:HCH, ASX:HCH)

Hot Chili is one of those upstart copper players poised to replace supply from struggling Chilean mines.

We are highlighting the company due to its deep discount to the value of its major project, Costa Fuego, fully funded development and drill program, large resource and backing from mining giant Glencore.

Hot Chili’s Costa Fuego project is the third largest copper resource in Chile not owned by a major mining company. Costa Fuego is at a low elevation, close to the ocean for export, which means it has a cost advantage over other projects at higher elevations and with questionable water access.

Costa Fuego Resource vs Other Global Projects

Source: Hot Chili Investor Deck June 2023

The current preliminary economic assessment puts the post-tax net present value at US$1 billion at a copper price of $3.85/lb compared to a current market cap of only US$122 million.

And most mining analysts expect closer to $4.00/lb copper over the next five years. The upside potential from lagging supply is far higher than the downside, judging by the estimates below.

Analyst Expectations for Copper Prices

Source: Hot Chili, Bloomberg Estimates

At a copper price of $3.85/lb, Hot Chili will be generating significantly more EBITDA and free cashflow than the market is currently giving them credit for.

Based on the company’s cashflow estimates below, Costs Fuego would generate free cashflow equal to more than 2x the current market cap every year. 

Costa Fuego Copper Sensitivity

Source: Hot Chili Investor Presentation June 2023

Hot Chili recently closed a royalty deal for US$15 million that will fund a 30,000 meter drill campaign plus operations for the next 12-18 months. The drill campaign could expand the resource at Costa Fuego and will be instrumental a coming resource estimate upgrade scheduled before the end of 2023.

Hot Chili owns one of the few projects ready to provide near term, large scale copper supply to a market that can’t get enough. Trading at a ~70% discount to the project based valuation of major mining peers, Hot Chili offers significant upside potential with a strong balance sheet and the backing of a major global mining operator.

The fact that a recent North American roadshow drove the stock up 25%, gives us confidence, Hot Chili is an underfollowed name among both mining and generalist investors, meaning it won’t take much good news to close the large valuation gap to other miners.

Hot Chili Trades at a ~70% discount to Peer Projects

Source: Public Reports, Hot Chili Estimates

Hot Chili Limited is a market awareness client of Capital 10X. For more information, including potential conflicts of interest please see our Content Disclaimer.

Amerigo Resources is a market awareness client of Capital 10X. For more information, including potential conflicts of interest please see our Content Disclaimer.

Capital 10X gets down to the real money business, actionable financial insights for traders and investors. We analyze company earnings, interview management teams and help teach the fundamentals of financial analysis and options trading. Our mission is to hunt for genuine 10 baggers.


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