August 2006:

MCN editors report back from the Copper Development Association’s Global Market Trends Conference Sept. 6-8 in suburban Chicago, where experts forecast the effects of global economic shifts, China’s emergence and record high prices for red metal. Despite some product substitution, demand for copper and brass in such major end-use markets as energy, automotive and construction remains relatively healthy.

Copper Faces Ongoing
Substitution Threat
With the price of copper around $3.30 per pound—three to four times higher than the historical average—some end-users are looking for cheaper alternatives. While such product substitution should concern the copper and brass industry, it’s not reason for panic, analyst Jon Barnes, principal consultant with London-based CRU, told executives at the CDA conference.

“Substitution has always been with us. Substitution will always be with us. It’s nothing new. But, of course, such high copper prices are,” he said.

Analyzing copper substitution losses in today’s market is not easy, he added. Separating pure substitutions from larger trends such as globalization and demand migration requires some interpretation.

The most commonly cited example of copper market erosion is in the plumbing industry, where plastic tubing is supplant-ing some copper tubing applications. Reports of copper’s death in plumbing are greatly exaggerated, however, Barnes said. “I am here to tell you that there is still a huge market for copper plumbing tube. A decade from now there will still be a big plumbing market for copper.”

While copper is very costly compared to past pricing levels, copper parts still represent a relatively small portion of the total cost of a new home or automobile. “Just because the price of copper is high doesn’t mean they are going to stop building houses or cars,” Barnes noted.

An individual company’s vulnerability to product substitution depends on its geographic location, product line and customers. A copper plumbing specialist is more at risk to losses from plastics, for example, than a maker of electronic components, which don’t have such a ready substitute.

In addition to plumbing products, copper faces its most significant substitution threat in the market for telecommunications cables. Markets partially threatened include: power cable, winding wire, sheet and strip, commercial tube, and rod and bar.

“Copper faces its biggest challenges from areas where it is becoming technologically inferior relative to its substitute products,” Barnes said, noting that fiber optic telecom cables are not only more affordable than copper, but superior in performance.

The price differential between copper and aluminum has been low and fairly stable since 1975. In the decade previous, it was the big difference between the cost of the two metals (and aluminum’s lighter weight) that prompted the shift from copper to aluminum automotive radiators. The question today is whether we at the beginning of a similar phase, Barnes said.

Various forces combine to accelerate the substitution of other materials for copper, and the erosion of copper demand in North America. They include: copper’s price volatility; copper’s technological inferiority in certain applications, such as telecom and fiber optics; competing product designs, like those from manufacturers seeking to replace copper heat exchangers with aluminum ones; regulatory changes, including new building codes that allow use of plastics where copper was formerly required; labor cost advantages in installing plastic vs. copper plumbing; lobbying and intense R&D by plumbing and other industry trade groups; and the effects of globalization, such as the shift of manufacturing to China.

The trends are not all negative for copper suppliers, however. Many other factors are slowing the substitution of red metals, Barnes noted. Long-held standards and practices, and ongoing relationships between suppliers and specifiers, are slow to change. The high cost of retooling and retraining employees discourages manufacturers from switching to aluminum or plastic. Copper tubing suppliers are producing products with smaller diameters and thinner walls, which use less copper and are more economical. Copper has natural antimicrobial properties that other materials lack, giving copper the edge in markets such as health care and food service. Don’t forget that the prices of competing materials have risen substantially, as well, Barnes added.

According to CRU, copper substitution losses in 2005 equaled approximately 1 percent of world demand or 225,000 metric tons. Losses are concentrated in a few product lines, mainly in North America and Europe, including plumbing tube (38 percent), transformers and motors (14 percent), telecom cables (10 percent), automotive heat exchangers (8 percent), roofing strip (6 percent) and various other areas (24 percent).

Substitutions have accelerated in 2006. By the end of the year, CRU predicts copper will have suffered at least another 275,000 to 300,000 tons of lost demand.

“I think we need to be realistic and say these losses are permanent. If we get anything back, it’s going to be a bonus,” Barnes said. “Clearly, it’s a mandate to CDA and the industry to continue their efforts to defend existing markets and promote new markets.”

Supply constraints coupled with strong demand will keep copper inventories low and prices high in 2007, Barnes predicted. The average price for copper will remain around $6,750 per metric ton next year. Such high prices may cause further substitution losses in vulnerable markets and encourage R&D efforts in sectors where alternative materials or technologies are considered feasible but not yet proven. Continuing pressures to economize could cause fabricators to seek new, cost-effective solutions for customers.

“It’s unlikely we have seen the full magnitude of the effects of substitution loss and economization that will arise due to the current period of high prices,” Barnes concluded. “But so far, the overall threat from substitution has not proven as serious as feared.”

Renewable Energy to Generate Future Demand
Copper executives at the CDA conference didn’t need to be told about the high costs of energy. But Melissa Lapsa, solar technologies program manager at the Oak Ridge National Laboratory, gave them some news for the future that could help their businesses on two fronts.

Lapsa detailed seven forms of renewable energy that are being pursued, most of which employ copper products to varying degrees. The three forms most likely to grow in the next 25 years—biomass, geothermal and wind energy—all make extensive use of copper products.

Renewable sources now provide 2.5 percent of the United States’ energy supply—a figure expected to increase to 5 percent by 2030, or even higher if cost reductions in power generation can be implemented.

In sheer size, biomass (the use of plant materials and animal waste as a source of fuel) will account for the largest share of the renewable energy market at 66 gigawatts—an increase of about three times its 2004 production. Copper wiring and windings are significant components of biomass-based electricity generation, and copper-stabilized metal catalysts improve methane and hydrogen gasification of wet biomass.

Geothermal production is expected to see a 40 gigawatt increase by 2030, quadrupling its 2004 output. Copper suppliers stand to benefit the most from an increase in this form of energy generation, as geothermal heat pumps make extensive use of copper piping. Copper wiring is also used in geothermal electric generators.

Lapsa projects wind energy will increase fourfold to 50 gigawatts by 2030. Copper is used in coil windings and rotor portions of wind generators.
Compared to other forms of renewable energy, however, “wind energy growth has the most uncertainty associated with it,” Lapsa cautioned.

Defending intellectual property rights, not currency exchange rates, is the United States’ greatest challenge when it comes to dealing with China, asserted Oded Shenkar during his remarks on “The Chinese Century.”

A leading authority on China and a professor at Ohio State University, Shenkar noted that debate on Capitol Hill has focused almost entirely on China’s pegging of its currency, yet the fixed value of the yuan represents only a small portion of China’s trade advantage over the United States.

Shenkar compared the labor costs for manufacturing in the United States and China, noting that workers earn an average of $33.60 an hour in the U.S. vs. just $1.30 in China. “Is even a 50 percent revaluation [of the currency], more than anyone is even dreaming about, going to make a huge difference [in that wage disparity]?” he asked.

The impact of China’s labor cost advantage can be seen in numerous cases, such as automotive sparkplugs. Each sparkplug costs Delphi $2.10 to make. To get General Motors’ business, Delphi must sell them to GM for $1.70 each. Yet that figure is still 60 cents higher than sparkplugs produced in China.

He cited a recent labor negotiation in which management’s initial offer was for far less in worker wages. “Can you recall the last time that management has put in front of a union, as a starting offer, a proposal that includes a reduction of 65 percent in wages. There is no precedent. This is part of the China impact,” he said.

Besides labor, China’s lower prices are the product of little investment in research and development, lax regulation, low cost of capital, government preferences, low margins and the favorable exchange rate. China’s miniscule investment in R&D concerns Shenkar the most.

“China is the No. 1 violator of intellectual property rights,” he said. “It’s the first case where you have a high-capability copier. In the past, those who copied had very little capability; they could maybe knock off a cigarette lighter or a Gucci bag.

“It’s not so simple to knock off a car, but the Chinese can,” he continued. “So for the first time we have someone with the technical ability and also the willingness to use other people’s property.”

Shenkar predicted that by 2025, China would overtake the United States as the world’s leading economy. His projection is earlier than most, due to three factors: China’s enormous latent purchasing power; its underreported economy; and other experts’ mistaken belief that China’s growth will follow paths similar to Japan’s in the 1960s and Korea’s in the 1980s.

The global environment that China is entering is radically different than previous economies, he said, citing the mobility of production and the ease of foreign investment as two examples.

“By 2005, close to 60 percent of China’s exports really came from foreign-invested enterprises,” he said. “This was never the case with Japan and Korea, which were reluctant to permit foreign investment.”

While foreign investors continue to pour into China, Shenkar is uncertain how long the Chinese government will allow this to continue. He expects officials there to erect more barriers to prevent foreign companies from taking too much of the export market.

U.S. companies have a few ways to remain competitive in an economy increasingly dominated by China, Shenkar said. They include following customers wherever they go and restructuring the value chain. But chief among the mechanisms is to reclaim the innovation advantage still held by the United States.

“You have to protect your knowledge base,” he urged. “You need to run a company a little bit more like an intelligence agency, sharing information on a need-to-know basis. It’s a revolution, and we’re not there yet.”