Can the U.S. Brass Industry
Survive the Perfect Storm?
(Editor’s note: Jeffrey Haferkamp was a keynote speaker April 8 at the Copper and Brass Servicenter Association’s annual convention in San Diego. Haferkamp is president of Olin Brass, East Alton, Ill. Olin Brass is a division of Olin Corp., a $2.4 billion producer of specialty copper-based products, chlorine and caustic soda, and commercial and military ammunition. Following is an edited transcript of his remarks.)

As you may remember, in the book and movie “The Perfect Storm” a confluence of factors caused a cataclysmic storm almost impossible to survive. In our case, the U.S. brass industry is under siege in at least three different areas: U.S. consumption has declined, metal costs are rising, seemingly without end, and energy costs are continuing to skyrocket. It is a very difficult business environment in which to be successful.

Let’s discuss U.S. consumption trends for brass strip, rod and tube first. Strip consumption grew steadily through the 1990s to about 1.6 billion pounds in 2000. In 2001, demand declined sharply to about 1.2 billion pounds, and has been relatively flat ever since.

The picture is the same for rod consumption: a good run-up in the ‘90s to about 1.4 billion pounds, then a fall to 1.1 billion pounds, followed by flat demand for the past five years.

U.S. copper tube consumption, both plumbing and commercial, is a different story. After a nice run-up in the ‘90s to about 1.4 billion pounds, followed by a gradual softening in 2001-2002, the market made a fairly strong comeback to nearly 1.5 billion pounds last year. So conditions are not quite as bad in the tube segment of the copper industry.

One trend of particular concern is the relationship between copper product consumption and the general economy. Through the 1990s, there was a fairly good correlation between copper industry growth and U.S. GDP. But since 2001, there has been a disconnect: the economy is continuing to grow while copper demand is not. Our industry has flattened out, and that’s troubling.

What happened to create this disconnect? Global trade has increased, and that’s the biggest issue. Thomas L. Friedman’s book, “The World is Flat,” really puts globalization into perspective. Friedman says that in the late ‘90s, the U.S. was asleep at the switch. Globalization was accelerating, and we were not on top of the trends. Things were happening behind the scenes with our customer base, even though the economy was rolling along well, and we just didn’t see it.

Everybody says the U.S. trade deficit is because of China, China, China. But if you study the government data, you see that the oil market and trade with Canada, Japan and Germany, among others, also contribute to the deficit. Last year the United States’ trade deficit approached $800 billion, which is unbelievable, but only $200 billion of it was with China. This is obviously very disturbing for anyone in U.S. business.

Switching to issue No. 2—metal costs—copper prices have increased dramatically over the past three years and are currently 141 percent above the long-term average. Prices averaged 94 cents a pound for roughly 13 years and are now in the $2.65 per pound range [as of early April]. It’s outrageous!

The same trend can be seen in other metals, such as zinc, nickel and lead. All these key metals were relatively flat for years, then started creeping up in the 2003 timeframe. Moving into 2006, their prices are running off the charts.

Even the experts are having trouble predicting future copper prices. In June 2005, Reuters issued a report accumulating the predictions of 29 trading companies. Their average prediction for the price of copper in 2006 was $1.22 per pound. Six months later, the same 29 experts upped their predictions to $1.72 as the average for 2006. [Editor’s note: As of April 27, the Comex price for copper was $3.26 per pound.] I don’t think anybody—even the experts—knows where copper prices are going.

The obvious question is: What has happened? Two factors: declining stocks on the LME, Shanghai and Comex exchanges, and funds investing in commodities.
Looking at industry data, one can see a good supply-demand correlation between stock levels and the price of copper. In 2000-2001 when copper stocks declined, prices increased. Likewise in 2004, prices increased as stocks declined. Yet today, as copper stocks have built back slightly, the price is continuing to rise!

One obvious factor is the rapid growth of China. China has been growing at an 8 to 10 percent rate, while the U.S., Europe and Japan have been growing in the 0 to 3 percent range. China accounted for about 20 percent of world metals production and consumption in 2004, including copper, aluminum, lead, tin, zinc and nickel. In copper, their consumption exceeds their production. To feed this deficit, China is sucking up the world’s scrap, pulling it out of the U.S., possibly at unfair prices.

The price of our key metals is being driven by more than just China, however. Probably the most important factor right now is the trading activity of various funds. An analysis of LME volumes by Man Financial of New York compared the number of commodity trades by funds vs. individual traders. In 1990, the funds played a relatively small role in the market, but by 2005 funds accounted for almost two-thirds of the LME volume vs. one-third by normal traders. That is a major concern.

There are three different types of funds: hedge funds, CTA funds and index funds. More big hedge funds are moving into metals, as are commodity trader advisory funds, which work off small differentials mostly through computer-based transactions. Passive investors who have used index funds to invest in stocks and bonds are now putting their money into commodities. Experts estimate that perhaps $120 billion will be invested in commodities in 2006—a major increase over recent history.

Consequently, Man Financial recently changed its official copper forecast for 2006 to an average of $2.30 for the year—up from its January prediction of $1.98. As I said, even the experts are having difficulty figuring out what’s going on.

What is the potential impact of copper prices staying so high? Obviously, there is pressure on customers to seek lower-cost substitute materials. The good news is that all the normal substitutes—the aluminums and plastics—have seen their base prices increase as well.

For the mills casting the product, there are flue loss issues. There is a huge difference between the shrinkage cost when copper is at 94 cents a pound vs. $3.26 or more. This is very expensive to all mill operations.
High copper prices mean higher capital costs and increased cash flow risks from carrying inventory. Obviously, these are costs that both mills and distributors must absorb.

Because it is so difficult to anticipate the movement of copper and other key metals, you need sophisticated hedging mechanisms in place or you are at risk—particularly if prices drop quickly. We all know the price will come down; it’s just a question of when.

As if stagnant consumption and high metals costs were not enough, more recently we’ve been dealt the final blow of increased energy costs. Gasoline costs have risen 150 percent in the last three years. Likewise, natural gas costs have jumped 156 percent since 2002. The good news is that natural gas has settled back a bit since fourth-quarter 2005, but it is still very costly to our operations.

Like in the exchanges for copper, the normal supply-demand relationship is not holding true for gas, either. Natural gas stocks are up, so normal fundamentals would suggest prices should be down. Yet we’re still buying gas at $7, not $2, per thousand cubic feet.

The final blow of concern is electricity. Electric power rates vary regionally from under 4 cents to over 7 cents per kilowatt-hour. Deregulation is occurring on a state-by-state basis, causing electric rates to follow the same trend as other energy costs. Regulated states will see price increases, but less volatility. Deregulated states will most likely see not only higher electric rates, but even more volatility in the coming years.

To complete the sad story, even though President Bush is pushing for energy self-sufficiency, our own government’s energy outlook predicts U.S. energy consumption will continue to outpace energy production. Given our economy and our needs, we’re going to become a greater importer of energy.

So, can the U.S. copper industry survive this perfect storm? We think it can. Going back several years, the oil embargo of the 1980s was going to be a disaster. The industry pulled through. Japan Inc. was going to take over the world. We weathered that one, too.

To help each other, we need to support a strong domestic economy. We need to appeal for access to international markets, free and fair foreign trade with no currency manipulation, no dumping and equivalence on environmental restrictions. Regulators need to provide oversight into markets that are not transparent and where competition is blocked. We should support all energy initiatives, and work to reduce consumption and improve the nation’s energy efficiency.

To remain competitive, our industry needs to remain productive with its assets, relative to players in China, and also India, Eastern Europe and Russia. Competitive forces may trigger consolidation in our industry. The steel industry went through it and, quite frankly, has come out the better for it.

The U.S. red metals supply chain needs to be efficient—all the way from the mill through rerollers, platers and distributors to the end customer. We need to support the customers that are still here, and want to stay here. Our industry needs to maximize our logistical advantage in serving the domestic customer base.

Though it’s a daunting task, especially for smaller companies, we need to stay on top of metal and energy trends. There are risk management tools out there that may be appropriate for some companies, especially if high prices persist. All of us need to be aware of the inevitable future fall in metals prices and manage our businesses accordingly.

Finally, we need to continue supporting consumption initiatives in our markets. Architectural copper is a great example of a product that has grown even though the overall market has been flat. We need to resist substitution pressures and continue to work with organizations like the Copper Development Association to fight the movement toward plastics and aluminums. We need to support exciting new growth initiatives such as products that take advantage of copper’s antimicrobial properties.

The copper industry has weathered storms before, and I’m confident it can survive this one as well.

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