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A few weeks ago, China’s National Energy Administration made an announcement that may have caught the interest of copper investors. The regulator released nationwide industrial standards for the use of low-voltage aluminum alloy cables, meaning that China’s state power grid could use aluminum alloys instead of copper for some types of wiring.
The change, effective in September, means that China could use aluminum alloys instead of copper for some types of electrical wiring. A research note from Goldman Sachs (NYSE:GS) has been making the rounds, suggesting that a switch could mean big problems for copper demand.
As the Financial Times points out, China has ample aluminum supply, but needs to import most of its copper. Furthermore, copper is over three times more expensive than aluminum, making for an attractive price difference.
“An increased rate of substitution to aluminium alloy, from copper, is highly likely … the China price of copper is 3.4 times that of aluminium (and substitution becomes profitable at a ratio of 2.5/1),” the news outlet quotes the note as saying.
Aluminum issues
The low-voltage cables referred to by the NEA are mainly used to connect buildings to substations. Previously, such cables were made with copper as users were unsure about the quality of aluminum alloys.
And certainly, while aluminum wiring is sometimes used in planes due to the metal’s high conductivity to weight ratio, the use of aluminum in electrical wiring has had its issues.
For example, aluminum wiring has been linked to house fires. Aluminum was used extensively in electrical wiring for homes in Canada and the US in the 1960s and 70s, and while there are solutions to the safety problem, houses with aluminum wiring will still often garner more expensive home insurance.
Stefan Ioannou, mining analyst at Haywood Securities, noted that copper has greater tensile strength than aluminum while being less prone to thermal expansion. While he admitted that the much higher cost of copper is “one of the major offsetting considerations,” he still suggested that copper would be the better choice for larger electrical projects.
“[Copper’s] physical properties are much more favorable for big grid infrastructure,” he said. “You still can use aluminum, but it’s not ideal from a physical point of view.”
Still, according to Goldman, China’s state power grid — and perhaps other consumers — is likely to make the switch now that industry standards for aluminum cables are in place. “We estimate that between 100kt and 250kt (100,000-250,000 tonnes) of copper demand could be lost owing to this development in 2016, compared with our base case of 400kt China demand growth in 2016,” the firm states in its report.
Pressure on copper prices
Goldman Sachs has been holding to a rather bearish outlook for copper, setting its target price for the red metal at $5,200 per tonne. To be sure, there’s been plenty of pressure on the copper price lately. The red metal has fallen 11 percent since May 12, and recently hit a three-month low on the back of a strong US dollar. Spot copper closed at about $2.59 per pound on Wednesday.
Taking a look at other factors affecting the copper price, Ioannou pointed to concerns about how quickly China is moving ahead with its state power grid project. “Last year they only got through about 80 percent of what they hoped to, and if you look at the numbers this year … it sounds like they’re behind already again,” he said. “In terms of the physical consumption that we were anticipating this year from that project, it’s probably going to be less. That’s not to say they won’t consume all that copper to finish the project, it’s just going to take longer.”
On the inventory side of things, Ioannou noted that copper inventories in Shanghai have fallen 27 percent year-to-date and 40 percent in the past three months. However, he also noted that London Metal Exchange copper inventories have risen 78 percent so far this year, which could be a concern.
The upshot
The potential for China to use aluminum wiring is certainly interesting, but overall, Ioannou suggested that there are other, bigger considerations at play when looking at copper demand. To give one example, firms such as PricewaterhouseCoopers have focused on global copper supply rather than on Chinese demand, reiterating broader concerns that a lack of supply growth could lead to a supply deficit sooner rather than later.
Ioannou said that Haywood wouldn’t be surprised to see copper stay around its current level for now — around $2.50 to $2.75 — with the next possibility for an upward price move coming in the fall.
Securities Disclosure: I, Teresa Matich, hold no direct investment interest in any company mentioned in this article.
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