Analysts: Veronica Burford, Jeremy Smith
Copper prices have increased rapidly to their highest point since 2011 over the past year. IHS Markit assesses the potential benefits of this development for the Peruvian economy, the world’s second leading producer and exporter of the “red metal”, as it digs its way out of an 11.1% GDP contraction in 2020. At the same time, Peruvian citizens will head to the polls for a presidential election on 11 April and mining looms as a divisive issue, generating significant uncertainty for the sector’s future.
The world price of copper climbed by 108% from late March 2020 to late February 2021, reaching its highest level since 2011, when prices were near their historic peak.
Peru is the world’s second leading producer of copper, and rising global demand has historically propelled growth in the Peruvian mining sector.
Copper is Peru’s most important export, a key determinant of the strength of the Peruvian sol, a significant source of government revenue, and a crucial element of the country’s overall macroeconomic success in the past two decades.
Peru endured the sharpest economic decline of any major Latin American economy in 2020, with a GDP contraction of 11.1%. A sustained period of high copper prices could be a boon for Peru as it begins its recovery in 2021, giving a lift to government revenues, the current-account balance, and GDP growth.
Our econometric analysis finds that, all else being equal, a 9% increase in the world price of copper after 12 months is associated with a 5% increase in merchandise exports, a 0.7% appreciation of the Peruvian sol against the US dollar, and a 2% increase in government revenues over the year following the shock.
Investor uncertainty remains high as Peru holds the first round of its general election to elect a new president and 130 members of Congress on 11 April. As there is no clear front-runner within the 5 main presidential candidates (18 in total), with none of them receiving more than 16.8% of voting intention, a second-round presidential run-off on 6 June is likely.
Radical proposals such as a constitutional reform potentially affecting the mining industry or reforming the existing mining law remain unlikely as the new Congress to be elected on 11 April is likely to be highly polarised, diminishing the capacity of the new president to garner enough support for more radical changes.
The focus by the candidates on mining ahead of the election is likely to increase the risk of regional authorities, political parties, and local communities unifying and mobilising against planned mining projects.
Peruvian copper in the 21st century
Early last year, as the coronavirus disease 2019 (COVID-19) virus spread throughout the world, the price of copper on the London Metal Exchange (LME) plunged by 27% within two months to a low point of USD4,617 per tonne on 23 March 2020, depths not seen since global commodity prices bottomed out in 2016. Remarkably, by early July copper prices had regained all ground lost from January to March (see Chart 1). However, far from stopping there, copper continued its steep ascent through the rest of the year, reaching USD9,615 per tonne by 25 February 2021 – 108% above the March low and a level not attained since 2011. This rebound is mostly explained by powerful demand for construction materials in mainland China, which accounts for about half of global copper consumption, as well as by supply disruption among the leading producers. In addition, copper is increasingly important as a key component of renewable energy technologies.
For Peru, the world’s second leading producer and exporter of the “red metal” behind Chile, this surge could be quite significant. Although Peru endured an 11.1% GDP decline in 2020 – the deepest contraction of all major Latin American economies – its recovery would be substantially aided by a sustained period of elevated copper prices. This is particularly the case given Peru’s second lockdown in February 2021, which has curtailed economic activity and placed further strain on government finances.
Copper mining is deeply intertwined with Peru’s macroeconomic success over the first two decades of the 21st century. Copper exports formed the basis of Peru’s trans-Pacific economic relationship with East Asian supply chains, most of all with mainland China. Following its 2001 accession to the World Trade Organization, mainland China’s role as an assembly hub for manufactured goods has expanded dramatically. Advanced electronic manufacturing and heavy industrial activities all needed copper either as a component or for wiring new manufacturing facilities. Around this time, particularly leading up to and following the 2008–09 global financial crisis, mainland China undertook an infrastructure buildout of unprecedented scale. This generated demand for raw construction materials that far outstripped what mainland China was able to produce domestically, buoying the world price of copper and other commodities.
This was a major opportunity for Peru, whose Andean mountains contained vast untapped reserves of copper ore. Soaring copper prices substantially increased the profitability of Peruvian mining projects, allowing the country to attract more foreign investment. The 2001 opening of the Antamina mine in Áncash Department was a major landmark that launched the country’s 21st century copper boom (see Chart 2). The Antamina project became one of the largest copper and zinc mines in the world, and its capacity was subsequently increased by 31% in 2010. This was followed by the completed expansion of Cerro Verde and the opening of Las Bambas, Peru’s two largest copper mines, in 2015 and 2016, respectively. These three projects, among others, have attracted tens of billions of dollars of foreign investment and enabled Peru’s quarterly copper output to rise nearly sixfold from 2000 to 2016, giving a sizeable boost to GDP growth over the past two decades. In 2015 and 2016, the mining sector alone contributed more than 40% of Peru’s real GDP growth.
Copper plays an outsized role in the modern-day Peruvian economy
As output by volume expanded dramatically, Peru’s economy became more sensitive to price movements. Today, copper prices exercise an important influence on the Peruvian economy through three major channels.
First, copper is Peru’s largest export, making it an important source of foreign-exchange earnings. In 2019, Peru exported USD48 billion worth of merchandise; its mineral products accounted for 59%, of which copper alone accounted for half (see Chart 3). Outside of the mining sector, no single product has a share exceeding 5%. In terms of the nominal value of exports, a major price increase such as that observed over the past year, if sustained, can be similar in impact to opening a brand-new mining operation. For instance, in 2020 Peru exported USD12.7 billion worth of copper at an average price of USD5,821/mt; an average price increase of 25% in 2021 would have a greater impact on exports than adding the equivalent of Cerro Verde’s 473,000-tonne 2016 output, while keeping the price constant.
According to the Ministry of Energy and Mines of Peru (Ministerio de Energía y Minas del Perú: MINEM), mainland China received 63% of Peru’s copper exports from January to October 2020, followed by Japan and South Korea (see Chart 4). Peru signed a free-trade agreement with mainland China in 2009 and bilateral agreements with Japan and South Korea soon followed. Peru is now also a member of the Comprehensive and Progressive Agreement for Trans-Pacific Partnership. East Asian investors now directly fund Peruvian mining operations and support the development of the country’s shipping and other logistics infrastructure.
Second, the copper price is now a key determinant of the strength of the Peruvian sol. Historically, the sol has been notable for its stability, largely avoiding the volatility plaguing many other emerging market currencies. However, over the past couple of decades, copper price movements have stood out as a key factor driving the PEN:USD exchange rate (see Chart 5). Setting aside the period of the 2008–09 global financial crisis, copper prices experienced a steep rise from 2003 to 2011; during this time the sol followed a gradual path of appreciation against the US dollar. This process then reversed as the commodities supercycle came to an end, with several other inflection points occurring since 2016, each exhibiting the same basic pattern. The period since March 2020 represents the latest inflection point, suggesting a probable short-term appreciation. So far, however, domestic political instability and continued uncertainty surrounding the global COVID-19-virus pandemic have prevented the sol’s appreciation.
Third, the copper mining sector is an important source of government revenue, both national and local. The mining sector, of which copper mining is the largest portion, provides 11% of annual tax revenue in Peru, according to the Natural Resource Governance Institute. The Peruvian government exercises property rights over the country’s natural resources and it enters into contracts with private-sector entities, mostly foreign investors, to permit the extraction of those resources in exchange for tax and royalty payments. Corporate tax payments scale with project profitability, while royalties are a function of operating income; in each case, the price of copper is a crucial determinant. A portion of corporate tax payments to the national government is subsequently distributed to subnational governments. Local governments also collect fees according to the land area in use for mining operations.
During boom times for copper prices, mining revenues helped the Peruvian government achieve a fiscal surplus every year from 2006 to 2013 (other than 2009) and grow its Fiscal Stabilisation Fund (FSF). The value of the FSF peaked at over USD9 billion in 2014. These funds gave Peru the resources needed to pay down public debt, respond to natural disasters, and compensate for revenue declines amid lower copper prices in recent years. These gradual withdrawals lowered the balance to a still healthy USD5.5 billion by year-end 2019.
Quantifying the impact of copper price shocks
It is well established that when the price of copper rises, there is a tendency for Peru’s exports, currency, and government finances to strengthen. The question remains: by how much? Distinguishing the impact of copper from the myriad of other effects is challenging enough. Furthermore, copper prices are subject to constant swings, making the influence of any given rise or fall difficult to determine.
IHS Markit recently conducted a time-series econometric analysis to better quantify the effects of copper price movements on the Peruvian economy. The results offer a sense of the potential boost that Peru may receive from the ongoing copper price rally.
Taking our three variables (merchandise exports, the PEN:USD exchange rate, and general government revenue) in turn, we seek to determine the response of each over time to a change in copper prices. To do so, we assume that Peru is a price-taker in world markets and that there is a one-time unanticipated shock in the world copper price. This shock could be a supply disruption, a rush of speculative investing, a sudden increase in demand, or any other unexpected force that moves prices in the manner modelled in Chart 6.
The immediate impact of the experimental shock produces a 5–6% increase in copper prices within the first month. Prices continue to rise for another few months, although at a sharply decelerating rate, after which the effect dissipates altogether. After a year, prices settle at 8.8% above the initial level. We applied this methodology to a sample of seasonally adjusted monthly data from January 2002 through to November 2020; starting in 2002 excludes the period prior to the opening of the Antamina mine, which precipitated a structural shift in copper’s role in the Peruvian economy (see the first section above for historical context). This methodology allows us to trace the effect of one particular copper shock in a quasi-experimental setting over a 12-month period.
Turning to the results of this exercise, we estimate that a one-time shock causing copper prices to rise as described above is, all else being equal, associated with:
A cumulative 5.0% increase in the nominal US dollar value of Peru’s merchandise exports;
A 0.7% appreciation of the Peruvian sol; and
A cumulative 2.0% increase in general government revenues over the following 12 months.
Higher copper prices could give Peru a boost in 2021
Returning to the real world, our analysis suggests that the recent copper price surge, if sustained, could give a significant lift to the Peruvian economy, particularly in the first half of 2021, precisely when it will be needed the most.
Amid the recession in 2020, the Peruvian government noted that its revenues fell by 17.9% even as it implemented an economic stimulus package worth 20% of GDP. As a result, the fiscal deficit ballooned to almost 9% of GDP. The government financed this deficit mainly through bond sales and the withdrawal of nearly all reserves from the FSF, which had held approximately USD5.5 billion at the beginning of the year.
Moreover, Peru entered its second lockdown on 1 February this year, imposing mandatory quarantine requirements on large portions of the country in an effort to stem the tide of second-wave COVID-19 infections. The government announced new stimulus payments of PEN600 to 4.2 million affected households as well as tax relief to businesses and all but the highest earning individuals in areas under strict lockdown. These measures will help to soften the blow, but will further postpone an already challenging road to fiscal consolidation. The lockdown was replaced with a 9 pm curfew in high-risk areas on 1 March.
In this context, a revenue windfall from improved performance of the copper mining sector, which has been unaffected by this lockdown to the extent of the first, would prove to be timely. As noted earlier, the ongoing copper rally is much larger than our experimental shock: as of late February 2021, prices were 108% above the March 2020 low and 56% above the pre-pandemic level at the beginning of 2020. Overall, IHS Markit expects that copper prices will be 42% higher in 2021 than in 2020 on average, nearly five times the impact of the shock modelled in our analysis, in which government revenues grew by 2% over the course of a year. Although the revenue boost should not necessarily be expected to scale proportionally, the benefits will be significant nonetheless; for reference, a 2% increase in revenue above the 2020 level more than covers the cost of the newly implemented cash transfers.
At the time of writing, the Peruvian sol is at its weakest historical point against the US dollar. At the present exchange rate of PEN3.75:USD1.00, the estimated 0.7% appreciation associated with the copper price shock in our analysis would imply an appreciation to PEN3.72:USD1.00. We forecast that the sol will strengthen to PEN3.58:USD1.00 by the end of the year, reflecting the expectation of noise and uncertainty surrounding the general election in April as well as the downward pressure applied by copper prices. Finally, we anticipate that the effect of higher copper prices will be enough to keep the current account essentially in balance in 2021 (0.1% of GDP surplus) as merchandise exports recover more swiftly than imports. However, these benefits can easily be reversed if prices fall, which is possible if supply recovers as demand remains weak in the first half of this year.
Regardless of what happens to prices, expected increases in volume output suggest that copper production will continue to drive Peru’s growth in the years ahead. According to the MINEM, a large number of copper mining projects are either currently under construction or scheduled to begin construction within the next few years.
Table 1: Upcoming copper mining projects
Of all mining projects in Peru with an expected completion date of 2023 or earlier, USD9.6 billion (92%) out of a projected USD10.4 billion in investment will go towards copper projects, with the remainder assigned to gold, iron, and silver operations. MINEM projects that copper production in 2025 will exceed the 2019 level by 29% in volume terms. If realised, these additions would make a direct contribution worth approximately 1.5% of 2019 real GDP over the next five years, notwithstanding any potential spillover effects for the rest of the economy.
Political impact – investor uncertainty amid the election
Investor uncertainty remains high as Peru holds the first round of its general election to elect a new president and 130 members of Congress on 11 April. As there is no clear front-runner within the 5 main presidential candidates (18 in total), with none of them receiving more than 16.8% of voting intention, a second-round presidential run-off on 6 June is likely. Also, a high number of undecided voters, more than 30%, makes forecasts about the election complicated.
As the electoral campaign has advanced, candidates have polarised the electoral debate around mining. Discussions about increasing taxes for mining companies in Peru have recently gained traction after the rapid rise in the price of copper. The left-wing vote is divided between centre-left candidate Yonhy Lescano from Popular Action (Acción Popular: AP) and leftist Verónika Mendoza from Together for Peru (Juntos por el Perú: JPP), who has traditionally held an anti-mining stance and proposes a revision of the business-friendly 1993 Constitution, an increase in royalties, and an overhaul of the national system of mining concessions. The conservative and right-of-centre vote (supportive of mining investments) is divided between Keiko Fujimori, a former presidential candidate who made it to the second-round run-off in 2011 and 2016, from the Popular Force (Fuerza Popular: FP) party; businessman Rafael López Aliaga; and George Forsyth, a 38-year-old former mayor of Lima’s La Victoria district.
IHS Markit assesses that more radical proposals, such as a constitutional reform potentially affecting the mining industry or reforming the existing mining law, remain unlikely as the new Congress to be elected on 11 April is likely to be highly polarised, diminishing the new president’s capacity to garner enough support for more radical changes. It remains likely that on 11 April no single party will secure a majority; representation will remain atomised among many small parties with little internal discipline. However, whoever wins the presidency is likely to seek smaller changes to strengthen environmental protection. Candidates who have usually had a pro-mining stance, such as Fujimori or Forsyth, have emphasised on their campaign trails the need to ensure that there is a greater focus on social and environmental factors for projects. Such changes would be likely to increase pressure by local communities and potentially delay new extractive projects during the consultation process; however, they are unlikely to cause project cancellations.
Protest risks against mining projects will continue to remain high during 2021
Successive governments have struggled to find ways that avert costly conflicts by enabling communities to benefit from mining development. A recent initiative has been the relaunch of a programme first announced in 2017, the Fondo de Adelanto Social (FAS), a fund designed to finance infrastructure in communities that agree to enter into dialogue with mining companies. Minister of Energy and Mines Jaime Gálvez has promised to push ahead with the scheme, but much will depend on who succeeds him when the new government takes office in July.
The candidates’ focus on mining ahead of the election is likely to increase the risk of regional authorities, political parties, and local communities unifying and mobilising against planned mining projects. Mining projects will be likely to face violent protest and minor property damage risks in the one-year outlook. Social conflicts over access to natural resources are concentrated in the regions of Áncash, Apurímac, Arequipa, Ayacucho, Cajamarca, Cusco, Junín, Piura, Puno, and Tacna. According to the Peruvian Ombudsman's Office, around 88% of social conflicts relate to concerns about mining (66.7%) and hydrocarbon (21.9%) projects. Grievances over the perceived environmental impact or lack of compensation are a central component of protests. One of the main causes of conflict between the national government and local communities is the supply of water.
Hotspots for social protests against mining are likely to include Newmont's Minas Conga in Cajamarca; Southern Copper's Tía María mine in Arequipa; Glencore Xstrata's Antapaccay mine in Espinar Province, Cusco; and MMG's mine at Las Bambas in Apurímac. Elevated risks of ground cargo disruption are likely to continue affecting copper transported through the Apurímac-Cusco-Arequipa highway (also known as the Mining Corridor) from MMG's Las Bambas mine towards the Port of Matarani in Arequipa in the one-year outlook, as was the case in December 2020–January 2021 when a 26-day blockade disrupted the transportation of 139 tonnes of copper from the Las Bambas mine, leading to losses of USD530 million.