In this case some mines or companies are more efficient at getting the copper out. That might be due to the mine and/or the company. The lowest cost mine is the first bar on the left. The height of the bar is the cash cost per unit of getting that copper out. The next bar is the next most efficient mine and so on. As you move to the far right you can see a big jump in the cost to get copper out. Either that's a company with old technology or some other burden like high labor costs in that region or it's a crappy mine and it is hard to get copper out.
Of all the cost curves I've seen almost all of them have this spike at the right side. Our firm has our own cost curve for oil and it has this spike. It compares well to this chart except it is much flatter through the mid section. This is an important aspect of the oil cost curve that will be meaningful.
Now in the case of commodities like oil and copper there is no pricing power. I know people like to think oil companies gouge consumers but in the case of commodities that is very difficult. You need a cartel - an agreement among producers to cut supply when needed - to pull it off. And while OPEC is a cartel, the rest of the world's producers aren't. And besides, history has shown that OPEC has had very little restraint as a cartel.
So if we assume no pricing power, then we can use this chart to predict the price of copper. If the demand for copper is 6,000 kTonnes then the copper market will set the price at the cash cost of the mine that is at the spot on the graph where it reads 6,000 kTonnes. Why? Because if all those mines produced copper - some 11,500 kTonnes worth - then not all of it will be sold. So each mine will drop the price until they can get a sale. They don't want to sit on the copper. They want to sell it. At some point the price will drop to a point where it is unprofitable for a mine to produce anymore. The cash cost. Those mines are to the right of 6,000 kTonnes mark. It makes sense for them to shut down rather than paying their workers and buying the electricity to run the mining equipment because they are losing money. At some point enough mines shut down that only 6,000 kTonnes are produced and supply meets demand and we have a market price. What's most important here is that the price is set at the marginal producers cash cost.
As demand increases those mines that shut down will reopen. And if no new copper mining capacity comes online and our cash cost curve remains the same then the price will go up. That's because the mark has moved to, say, 7,000 kTonnes and the producer who can meet that added demand has a higher cash cost. He won't operate at a loss so he will demand a higher price or shut down again.
Now the oil cash curve is flat in the middle. So as demand has increased we have gone years without seeing a significant increase in price. But what happens when demand is 11,300 kTonnes of copper? The price again is set at the marginal producer and the marginal producer's cost is high compared to everyone else. Much higher. In fact in the graph above going from demand of around 9,700 to 11,300 kTonnes doubles the price. This is what is going on with oil. And this is what happened in 1970.
Just as the price of oil can rise very dramatically with small increases in demand it can also drop dramatically. The question on oil right now is can the decrease in oil usage we're seeing in the US offset the still increasing demand from places like China and India. Or can new high cost entrants (e.g., Canadian oil sands) enter and significantly change the cost curve. Those new entrants are working on it but it will also take quite a while. I'm betting on a big enough drop in demand. When, I don't know. But the drop in oil usage in the US in the late 1970s was quite significant (10%) and I see no reason why that won't happen over time now. That 10% drop in demand crushed the oil companies. The Middle East reeled after that event and many oil fields shut down.
The other thing keeping Chinese and Indian oil demand high is heavy subsidies in those countries. Most people talk about the US oil business being subsidized but in reality there aren't any. Europe has much higher gas and diesel prices because they tax the crap out of it. We tax too, but at a lower rate. China and India and others actually have real subsidies and their gas prices are lower than ours. This last month we've seen some easing of those subsidies a little sooner than expected. They are ultimately unsustainable and will disappear at some point. Then you would see some decrease in the growth rate of their oil demand. Whether it can actually drop or not is unknown.
From a personal standpoint I'd rather see even higher gas prices and for a long time. Then it might give our country enough incentive to get a real energy policy in place. The other benefit is that it gives capital going into alternative energy ideas a better chance of getting a return. That means more investment and that means those ideas turn into real products sooner. In fact I would love for someone in government to have the guts to put a permanent floating tax on all oil products. In other words, if gas ever does drop below $4 then increase taxes to make it stay at $4 or $5 or $6. The reason for this is that all alternative energy projects would know what they were up against - $4 gas is their bogey. That's their marker to beat. If it comes down too quickly and too far many of these projects will terminate.
If OPEC was smart and could do it they should cut production way back and jack up prices. Then at random points open up their oil fields and flood the market. This kind of uncertainty would effectively keep all alternative energy projects tabled.
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