Metals & the Clean Energy Transition

If the renewable energy transition is a mega trend, why have we've seen weakening in metal prices?




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Transcript

Metals & The Clean Energy Transition

Katz: Welcome back to The Real Spiel with Ryan and Kurt. Let's talk a little bit about metals, Kurt, and this ongoing clean energy transition. A lot of you get the word “megatrend” occasionally thrown around, but many are aware of kind of the renewable energy transition and obviously the growth of electric vehicles over the past decade. But even with this growth, we've seen somewhat weakening in metal prices, especially over the past, say, six to twelve months with ongoing diminishing supply to meet this increasing projected demand with copper, lithium, cobalt, iron, or aluminum, among others. How do you see the recent weakness in pricing fitting into the longer story? 

Nelson: Sure. Hey, Ryan, I think this is natural in this cycle. If we are in a long-term, let's call it a sector-driven super cycle in metals prices, it's not going to be a straight line. So, there is going to be volatility. And one of the things probably impacting metals overall right now is that they often are tied directly to industrial demand associated not necessarily with electric vehicles and renewable energy, but more traditionally with construction, economic development, GDP growth, and their critical components in general industry and manufacturing. There are some concerns about global GDP, there's been weakening numbers projected from the World Bank or from the IMF on a global basis, although US economy has done well and seems to still be robust. There are concerns about China slowing down and we're seeing interest rates at an elevated level right now. They're projected to remain higher for longer and so that can continue higher interest rates higher cost of borrowing can be a negative factor for expanding economy. So, I think there's some short-term headwinds and metals are taking the brunt of some of that outlook or sentiment, but this longer-term story is still very strong and intact. The projected demand growth and things like aluminum and copper and battery metals such as cobalt and lithium is extraordinary in its scale and its persistence. Lasting multiple years into a decade, and I think that the medium-term to long-term story is still intact and maybe that spring has coiled a little bit more as prices have remained soft and the industry has been under invested over the prior decade. 

Katz: Absolutely. And as we discussed earlier, Kurt, it's hard for these inventories to bounce back, right? Can you talk a little bit about just the amount of time that it takes to get these inventories back up. They’re already extremely tight markets. The projected demand for all of these different battery input metals, is significant over the next decade and the supply just isn't there right now. Can you talk a little bit about what needs to happen for this supply to meet the ongoing demand? 

 Nelson: Sure, Ryan. One of the things that we care a lot about as a fundamental to commodity markets is the relative state of inventories of any particular commodity. The challenge for commodities is that they're sometimes hard to observe. There is actually decent data on metals. There are inventories from exchange warehouses for the COMEX Exchange, which is part of the CME Group. The London Metals Exchange is one of the large clearinghouses of industrial metals prices. And then the Shanghai Exchange also has begun to produce some data on observed inventories. Now, it doesn't include private and warehouse stocks and other sources of potential inventory, but it certainly gives you a sense of at least reported inventories and regulated inventories. We're seeing, for example, copper and aluminum at 20-to-30-year lows for the London Metals Exchange. So, while prices have softened and weakened, we've seen inventories go from very low levels to really low levels that we haven't witnessed before in our financial careers. 

 The problem there is that when you have a lot of commodities, let's just say, for example, corn. If you have a ton of corn in silos and there's an increase in demand for ethanol, for something else, or there's a decrease in supply because of a weather shock, drought or flooding in the plain states of the US that creates a shock to supply, demand goes up, supply goes down, or both. If you have a ton in inventory, it's no big deal. You can just deliver from inventory, from USDA reported warehouses and silos, and you deplete inventories, but you have it there. So, you'll have a price impact, but it would be muted. Things get really interesting when inventories are very low because now any shock to supplier demand has an outsized effect because you don't have this buffer stock to deliver from. I highlight that as just an example because the buffer stocks, the above ground inventories in these metals across the board are at multi-decade lows. So why don't we increase supply? Well, I think we're going to try to, but there's an incredible headwind that's specific to the metal sector that's different from energy or agriculture. 

 Energy is probably the easiest to resolve because of this invention that we've all heard of over the last 10, 15 years, which is hydraulic fracturing, horizontal drilling. We're able to do that very well in the U.S. There's other parts of the world where it may not be as a technology that's as easily exportable or implementable because you need to have access to water, you need to have access to infrastructure and labor. But in the US it works great, and we've gone from being an energy importer to an energy exporter of gas and through LNG or through oil. Agriculture is a little bit slower, but you can within one harvest cycle, typically one year, you can rotate into a crop that's under supply. I do see farmers doing this every year, switching from soybeans to wheat to corn and where's the opportunity set. But you can also create more arable land, improve agriculture, add more fertilizer, maybe have some innovations in genetic modifications that increase yield. So, you can deal with an agricultural shortage typically in a one-to-two-year time frame if it's a focus of a government or an economy to expand. Metals, there's just no shortcuts, and this technology that we use to extract metals from the earth is the same thing that we largely have used for the last 50 years or more. It takes roughly 10 years, Ryan, to explore, identify an underground reserve of copper or aluminum or even precious metals like gold or silver, and the technology is largely the same. You have to get local permitting. That can be a multi -year process, dealing with local populations and governments, dealing with what is an environmentally hazardous process sometimes in the extraction of metals from the Earth. Then you have to spend billions of dollars to create a mine of reasonable scale. You have to bring in hundreds or more than 1,000 workers to extract that, and then you have to get it from the mine to a refinery or a place to purify that metal. 

 We know that this process, even ten years can be sometimes short for some of these mines. It's often 15 years or longer and sometimes these mines don't get approved. I've seen that happen in the U.S. because of environmental concerns. We found one of the largest deposits of copper in northern Minnesota in the last decade. I think it's the largest deposit in North America ever found, problem is it's close to the boundary waters in these protected nature areas and after a multi-year effort the development of that mine was stopped.  I think that sets us up really strongly, when I mentioned a coiled spring before, I think the attention is really building here. Because I don't see anything interrupting this growing demand, it's not just a government effort to try to move us away into these greener energy sources like solar or wind or greener transportation processes like electrified vehicles or hybrid vehicles, including electric trucks, electric buses, public transportation. They are all going to grow steadily over the next decade because consumers want it and governments want it. So, there's two tailwinds to demand there. And it will be persistent, and it will be a multi-year evolution. We are not seeing a supply response. We're seeing an underinvested sector of the world economy and of commodities in particular. Weak prices in the 2010s led to an entrenching and survival mentality among the main metal producers. 

 Then we hit Covid, and now we've got this new demand, but we're not seeing it really factor and flow through into higher prices over the last six to twelve months. They're still not playing offense, which means we're continuing to kick the can down the road for a potential supply response to what I think is sort of baked in as a long-term growing demand. 

Katz: So already tight markets in terms of supply. You've got under investment and new mines and what is expected to be brought into the supply. But also, you just mentioned the mining and the hundreds of workers and how much of an extremely energy intensive process it is to not only mine, but also transport and refine these metals. Can you talk a little bit about the effects of the costs of energy and the increasing cost of labor to expand production and refine these metals? 

Nelson: I mean, one of the things that's kind of interesting about metals is that they tend to be geographically concentrated. So, we know that a huge amount of the world's copper comes out of Peru and Chile. And they've had interesting political events over the last, say, three to five years where you have more progressive government leaders, more focused on the workers as opposed to industry. There's even been discussion of potentially nationalizing mines and centralizing the revenues generated from these mines directly to the government. 

And there's a lot of concern about environmental impact. We're not going to run out of copper. We're not going to run out of aluminum on the planet. We have hundreds of years in the Earth's crust. The problem is getting it out and then getting it refined. Aluminum is a great example. I think 10% of the Earth's crust is composed of aluminum in some compound form. To take it from aluminum in the Earth to pure aluminum that you would use in manufacturing, or an industry is really, because of a process we've developed over many decades ago, it's really a pure power cost, energy cost. So higher energy prices are gonna mean, even with abundant supplies of aluminum, the cost of aluminum is gonna go up. Also, we have geographic concentration of refining.

 So a lot of raw copper comes out of Peru and Chile, but a lot of the refining into copper rolls that can be used in industry happens in China because they've had abundance copper, they've had low labor unit cost, and really not that much concern about the environment compared to other developed countries. So, you've got a geographic concentration of finished product copper coming out of China. To the extent there's trade disputes or tensions with China that could disrupt global supply of copper. All of those things like we've talked about on prior podcasts, they tend to be things that interrupt supply while demand is going up and that comes through into higher prices. 

Katz: Definitely seems like a ton of tailwinds for the for the metal space over the next decade or so. This has been The Real Spiel with Ryan and Kurt. Love to get your feedback any questions topics you like covered at therealspiel@USCFInvestments.com and we will talk to you next week!