The energy transition is a metal transition. Instead of burning fossil fuels, a lot of metal is needed to generate, store and transport energy. The most essential metal is copper. An electric car uses four times more copper than a fossil-fuelled car. For example, copper is also required to transport electricity to the many charging stations. Generating electricity from wind also requires five times more copper than the fossil-fueled alternative. By the middle of this decade, therefore, there is likely to be a global shortage of copper. This means that more copper mines will have to be added and we will also have to tap into lower-grade copper ore. It can take up to 16 years between the start of a copper mine and its eventual production and, for the time being, investors are reluctant to do so. An additional advantage of the energy transition is that metal consumption can eventually become completely circular, but we are still a long way from that. First, much more metal will have to be extracted from the ground than ever.
Now copper is also seen as a good indicator of economic development, hence the nickname Dr Copper. The demand for copper from renewable energy is still many times smaller than the demand from construction and industry. Moreover, more than half of all that copper goes to China. At the moment, the Chinese housing market is in a bad situation (due to Evergrande and, more recently, the mortgage strike started in Henan province) and the US housing market is also experiencing a marked slowdown as a result of a doubling of mortgage rates (although after that doubling, mortgage rates are still lower than during the housing bubble earlier this century).
Furthermore, speculative positions in copper were also reduced due to the threat of recession (the most predicted recession ever). The result was a surprisingly rapid fall in the price of copper (and other metals), which incidentally is still at such a high level that it leaves sufficient margin for listed mining companies. In this respect, an investment in commodity shares is a better alternative than an investment in raw materials. Not only are these companies almost all still profitable when commodity prices are halved, but they are also spectacularly cheap from a historical perspective with discounts of 60 to 80 per cent compared to the broader stock market.
The costs of a copper mine include energy costs and labour costs. Because the copper percentage in the ore of existing mines gradually decreases, the cost per ton of copper increases more. Furthermore, the cost price depends on the yield of by-products such as gold, silver and molybdenum. The cost of royalties (payments to governments) is also rising steadily. Historically, copper prices had to fall below cost to reduce supply, but in recent decades capital discipline in the industry has increased due to greater concentration. In response to the lower copper price, mining companies are already taking steps to reduce costs. The ultimate consequence will be that less capacity will be added, resulting in structurally higher copper prices.
There are metal segments where energy costs determine a much larger part of the cost price. Think, for example, of aluminium and iron. Aluminium is produced where the electricity costs are the lowest, and that is no longer in Europe. The smelters in Europe are closed and will not be opened again for some time. With the current European electricity prices, even driving an electric car is more expensive than the fossil alternative, helped by the extra subsidy for fossil fuels. Due to the high electricity prices, coal prices have quadrupled in a short period of time and this causes less steel to be produced, which in turn drives down the price of iron ore. Here too, extraction and production have become increasingly concentrated, leading to greater capital discipline and higher average prices. In iron ore, four producers account for 70 per cent of the total market.
Besides copper, the energy transition also requires platinum, aluminium, cobalt, nickel and, of course, lithium. Platinum is used in fuel cells (for hydrogen), up to ten times more than in a catalyst of a fossil-fuelled vehicle. Fuel cells are likely to be used mainly in larger vehicles (trucks, ships, trains), also because of their superior range. Aluminium is mainly used in solar panels and in making electric cars lighter. Even more than copper, the demand for cobalt and nickel is highly sensitive to the energy transition. The demand for cobalt will increase twenty-fivefold by 2040. For lithium, the demand will triple by 2025 compared to today. Many producers of these metals are attractively valued due to the fact that they are pricing in a recession, with dividend yields in excess of 10 per cent and free cash flow in excess of 15 per cent. With an EV/Ebitda between 1 and 4, these stocks are historically so cheap that it is a good time to enter. Mining shares are further oversold and speculative positions have been reduced. Even in a stress test (copper price -55 per cent, aluminium -45 per cent and iron ore -75 per cent), a free cash flow return of 5 per cent remains.
Mining companies today are virtually debt-free, and the industry is more concentrated (oligopoly), which means that there is greater capital disintegration. In the energy transition, the management of mining companies does not have to reinvent the company, in contrast to the oil industry, for example. Furthermore, mining companies are much more sensitive to an acceleration in the Chinese economy than to a slowdown in the American and European economies.
Normally, investors can ignore the mining sector ahead of a recession. Oddly enough, fear of a recession is priced into the commodity market but not into large parts of the equity market. A recession can be used for takeovers (especially now that the major parties are debt free). For example, several parties are interested in expanding in the field of futures minerals.
Comments