February 10, 2021
The bridge to a cleaner world can’t occur without the same building blocks used in the industrial revolution. In essence, the massive renewable energy and electric vehicle buildout that many expect will require substantial new investment in the old economy, including certain commodities.
To justify the required investment, prices for a number of mined commodities, in our view, will have to trade higher to overcome higher costs of capital and to incentivize managements to focus again on growth. We expect significant commodity price appreciation, and the valuation gap we see in natural resources equities may close as these issues become more demanding in many investors’ minds.
Lessons from the commodity boom
During the previous commodity boom in the early 2000s, many miners entered a growth mode to meet the incremental demand that was largely driven by China. Unfortunately, many of these investments proved disastrous, with significant capital destruction occurring across the sector. The subsequent C-level purge saw new management teams with a new focus on capital discipline. To wit, according to S&P Global Market Intelligence, total mining sector capital expenditures fell from a peak of approximately $150 billion in 2012 to approximately $60 billion today.
ESG concerns in mining
Further exacerbating the conundrum for miners is a rise in environmental, social, and governance (ESG) concerns relating to the mining sector. These concerns center on the carbon intensity associated with mining, various high-profile mining failures such as the Vale Brumadinho tailings dam, the high fatality rates associated with mining, and the shareholder and governance misalignment mentioned above. The net effect of these ESG concerns is a higher cost of capital in the sector. This is acutely felt by junior miners where lack of funding is leading to a dearth of exploration spending. The lack of exploration spend today subsequently leads to a lack of development opportunities in the future.
The net effect of the higher cost of capital and lower capital spend is a general lack of investment in growth, which is severely impairing the supply growth outlook for a number of mined commodities, notably copper.
The muted supply outlook for copper comes at a time of rapidly rising demand, bolstered by the robust adoption of renewable energy and electric vehicles. Renewable power systems are at least five times as copper-intensive as conventional power technologies, and electric vehicles contain more than four times the copper of an internal combustion engine vehicle. A recent report by an industry analyst estimates an incremental 7 million metric tons of copper will need to be produced between now and 2030 (source: Jefferies). To put that into context, today’s production amounts to approximately 23 million metric tons. To stimulate the investment required to meet this demand, higher copper prices are necessary.
One future positive on the supply outlook will be an increase in copper recycling. Recoveries from electric vehicles and renewable energy recycling have shown to be as high as 100%. However, in order for this to become a meaningful addition to the supply outlook, electric vehicle and renewable adoption will need to greatly increase in the short term for those assets to reach the end of their useful life in the long term. Based on current trends, we believe this recycled supply may become a truly meaningful contributor to the supply outlook, reaching approximately 30% of total supply by 2035.
Ultimately, we see companies working to meet the needs of a cleaner world while also striving to operate at the highest standards. We anticipate this should lead to renewed appreciation and acceptance in the market.