London, 3 November 2011: Reuters

The strike at the Grasberg copper mine in Indonesia is now in its seventh week. Production in any meaningful sense of the word has ground to a halt, and Freeport McMoRan , the majority owner and operator, declared partial force majeure last week. Talks between management and union, which is seeking pay parity with Freeport operations in other parts of the world, are deadlocked.

Barricades, roadblocks and sabotage of key infrastructure provide multiple flashpoints for a worsening of the violence, which has already claimed six lives as the stand-off inflames long-simmering separatist tensions in the province of Papua.

At any other time, the unfolding drama at Grasberg would be the focal point for copper traders the world over. These, however, are far from normal times, and supply side news, even in a market bedevilled by a shortfall such as copper, has been subsumed by the greater macro fears surrounding the future of the eurozone. Moreover, there is a degree of disruption fatigue in the current copper market.

Strikes have proliferated this year as unions seek a bigger slice of the profits accruing from what are still, even after the September sell-off, historically very high prices. It's not even as if Grasberg is the only mine currently being affected by strike action. A walk-out at Cerro Verde in Peru, also majority-owned by Freeport, has lasted over a month.

But Grasberg happens to be the world's second-largest copper mine. Production last year was just over 600,000 tonnes of copper in concentrates, accounting for around 3.75 percent of global mine output.

The length of the strike and the severity of the impact on production will affect the market. It's just a case of how hard and for how long.

PRODUCTION HIT

On Tuesday Freeport issued an update on the strike's impact on production. It was as clear as the mud at the bottom of the mine's giant open pit. According to Freeport, milling operations, which is where the ore gets converted to concentrate, were running at an average rate of 120,000 tonnes per day in October, rather than the targeted 175,000 tonnes per day. That's a drop of just over 30 percent.

The company had intended to produce around 2 million pounds of contained copper per day in the fourth quarter. The implied loss for October was around 19.0 million pounds, which is the equivalent of around 8,600 tonnes of contained metal.

Doesn't seem too bad, does it, considering that the mine is experiencing its worst industrial action since starting production in 1990?

There are three important caveats to that calculation, though. First, the strike pre-dates the October start of the fourth quarter. It began on Sept. 15 and together with an earlier "warning" strike hit third-quarter production to the tune of 70 million pounds (31,750 tonnes) of contained metal.

Second, the company's Q4 targets were already lowered to take account of the continuing industrial action. That 175,000 tonne-per-day milling rate, for example, is only around 75 percent of "normal" levels. At "normal" levels, metal production could have been expected to be in excess of 2.6 million pounds per day, assuming no change in targeted ore grade.

Reworking the calculations accordingly suggests that production in October was around 18,000 tonnes less contained metal than would have been the case had there been no strike at all.

Third and most important, the daily milling rate at Grasberg is currently zero, and that has been the case since Oct. 22.

That's because of sabotage to the pipeline transporting the concentrates from the mine to the port. Freeport has said it expects repairs to take around a month, assuming it can access the key parts of the affected line, which it currently can't because of road-blocks.

With no pipeline to carry the concentrates, there's no point producing more. And with no milling operations, it's a moot point as to whether it's worth mining more ore, even at what Freeport terms the current "reduced" rates.

Put simply, right now Grasberg is costing the copper market around 1,200 tonnes per day in contained metal, and it will continue doing so until the flow of concentrates from mine to port resumes.

MARKET HIT

This lost production is hitting the copper supply-chain at its most vulnerable point. The world's copper mines produced just 0.l percent more metal, or 27,000 tonnes, in the January-July period relative to the same seven months of 2010, according to the International Copper Study Group.

Global supply was supposed to have risen by around 1 million tonnes this year. Of course, no-one who understands anything about copper mine supply took that figure at face value. All analysts now put an allowance for unforeseen disruptions, such as the strike at Grasberg, into their forecast calculations.

Researchers at Macquarie Bank, for example, deducted 700,000 tonnes, a highly conservative view of the likely hits on output from strikes, ore grade changes and technical problems.

Last month, based on the Q3 operating data now coming through, Macquarie slashed its mine growth forecast to just 100,000 tonnes. And counting ... with every day the Grasberg strike rumbles on. The copper concentrates market is tightening accordingly. Spot business is currently being transacted at treatment and refining charges of just over $40 per tonne and 4.0 cents per pound.

That compares with $56 and 5.6 cents for term 2011 shipments and with $85 and 8.5 cents for second-half 2011 shipments. The loss of supply from Grasberg will be a major talking point between smelters and miners as they argue over 2012 terms. Smelters' stated ambition to improve on the 2011 calendar terms looks decidedly optimistic.

And it is only a matter of time before the raw materials impact becomes refined metal impact. Indeed, the loss of output at Grasberg could feed rapidly into the supplychain, because part of its production travels only as far as the 300,000 tonne per year capacity PT Smelting unit, which to all intents and purposes is fully integrated with Grasberg.

This loss of production, remember, is occurring at the same time that scrap supplies are dwindling, top global buyer China is stepping back into the international market and visible inventory is falling.

LONG-TERM HIT?

Even if the strike were settled tomorrow, it would still cast a long shadow for months and quite possibly years to come. Grasberg sits on the largest copper reserves of any operating mine, meaning it will be a core part of global supply for a long, long time.

The violent nature of this strike, and its intertwining with the separatist movement in the province of Papua, suggests that relations on the ground will never again be quite the same.

Across the border in Papua New Guinea is a reminder of what can happen when a mine dispute becomes part and parcel of a violent separatist struggle. Somewhere on the island of Bougainville in the North Solomons lie the rusting remains of what was once one of the world's biggest copper mines.

A series of apparently minor incidents in the late 1980s led to a full-scale war of independence in the 1990s. That war is over. The Bougainville copper mine has never come back. Grasberg is no Bougainville, although the fact that even the local police don't seem sure whether the sabotage and shootings are perpetrated by strikers or separatists is an ominous sign of the meshing of industrial and political agendas.

But at the very least, the copper market is learning that the world's second-biggest mine is sitting in a highly charged political environment and that two decades of stable worker-management relations are now over.

Ends --

By Andy Home, Reuters market analyst – for Commodities Now with permission.

The views expressed here are his own.