Chile's copper industry

Chile's copper industry is approaching a turning point. For nearly 10 years, increased foreign demand for copper spurred rapid economic growth in Chile, providing a steady flow of revenue for the government. This boom appears to be slowing, however, a development that puts Santiago in a potentially problematic situation. As Chile copes with reduced revenue and continues with plans to introduce important reforms, mining exploration and production will be key to securing Chile's long-term future as a top copper producer.

Analysis

Chile's relationship with copper is a notable example of Latin America's commodity-driven economies. For several decades, Chile's copper mines have been the primary drivers of economic growth. The metal makes up 20 percent of the government's revenue, and copper and copper products made up 52 percent of the country's exports in 2013. Chile is the top producer of copper in the world, yielding more than 30 percent of global output with 5.7 million metric tons per year.

Chile's Dependence on Copper

The country's copper boom came about during the wider Latin American commodities boom of the mid-2000s. Increased East Asian demand for commodities such as oil, iron ore, copper and soybeans spurred significant growth across Latin America's economies. Steady Chinese demand also enabled countries that would otherwise be vulnerable to global slowdowns in economic growth to ride out the economic recession in 2008 and 2009.

As Chinese demand for commodities increased, the average price of copper skyrocketed. It grew from $1.87 per pound in 2005 to $4.05 per pound in 2011, but dipped to $3.32 a pound by 2013. Consequently, the Chilean national government's direct revenue from state-owned copper firm Codelco, which produces almost 30 percent of Chile's copper, dipped from a high of $6.9 billion in 2011 to only $1.9 billion in 2013. The slowdown in global demand observed during the past two years has taken its toll on Chile's economic growth and public finances, precisely because of the country's extreme dependence on a single metal.

While Chile's position as the world's largest copper producer will not be threatened over the next several years, low prices abroad have resulted in short-term financial constraints for the country. In addition, high electricity prices and diminishing mineral deposits also inhibit Chile's ability to quickly increase production levels. As a result, Chile's economy will grow more slowly over the next few years, and Chilean President Michelle Bachelet will have difficulty implementing desired reforms.

Impending Reforms

In January, the Chilean legislature will discuss education reform, a cornerstone policy of Bachelet's second term in office. To fulfill a campaign promise, Bachelet passed a tax hike in September 2014 to fund the education initiative, a move that is expected to garner $8.2 billion over the next three years. The move predated the fall of copper prices, and it appears the taxes will be able to fund the program.

Other reforms will be harder to deliver while copper prices remain low, however. In addition to her education initiative, Bachelet is also seeking labor reform and changes to the country's constitution before her term ends in 2018. The labor reform, which was submitted to congress on Dec. 29, contains clauses that would prevent firms from hiring additional labor during strikes and would expand workers' ability to bargain collectively. The labor reform could be subject to significant congressional debate in the coming year largely because, in a period of lessened economic growth, private businesses and opposition politicians are less likely to agree to measures that could threaten future investments.

While the low price of copper remains a problem for Chile, the country must also take measures to maintain its production rates. Several of the nation's mines are scheduled to close between 2014 and 2025, cutting copper production by about 1.2 million metric tons per year. To compensate, Codelco and private mining firms are expected to undertake significant exploration and expansion activities in coming years. The investments, which have already been approved or are under construction, are expected to provide more than a million tons of additional copper output yearly to offset this decline and, according to optimistic estimates, will push yearly production to over 8 million metric tons.

Meeting this target, however, will not be easy. Chile's high cost of electricity — around $250 per megawatt hour, nearly $50 more than the average cost in neighboring Peru — will hamper future mining projects. Hydroelectric dams supply around half of Chile's energy needs, but most additional capacity is powered by costly imported fossil fuels such as coal and liquefied natural gas. To offset some of the electricity costs, some individual copper projects have begun tapping renewable energy sources such as wind power. The government is also considering implementing energy reforms in 2015 that would lower electricity costs. Although these developments could eventually help Chile overcome some of the inherent limitations of its national electric grid, the country's existing energy problems will persist in the short and medium term, making it difficult for mining companies to produce.

Despite the downturn in global copper prices and the impending mine closures, Chile's position as a major copper producer is likely secure. While there have been delays in awarding environmental permits and concessions for recent mining projects, red tape has not forced the cancellation of any projects. Santiago will have to cope with reduced revenue while copper prices remain low, but the country's finances are not at a critical point. For the moment, a downturn in the Chilean economy is likely to keep Bachelet's approval ratings from recovering and complicate the passage of promised reforms, but it will not fundamentally affect the well-being of Chile's economy.