The Biggest Threat to the ‘Green Energy’ Transition, as featured in The Assay, May 2021

By August 16, 2021 No Comments

The biggest threat to the rapid decarbonization of the power generation sector, and the electrification of the transport sector, is the supply of key commodities such as copper, nickel, and lithium failing to keep up with the long-term growth in demand.

Particularly with copper and nickel, the weak prices for much of the last decade have translated into lower levels of exploration and thus falling new discovery rates. This has exacerbated the reserve depletion and grade deterioration from existing operations. Further, the necessary increased focus on environmental, social and governance (ESG) issues around mining has curtailed some projects and added to development timeframes for many others.

However, arguably the biggest issue is the fact that many of the regions with the best resource endowments of copper, nickel, and lithium lack the political and social stability to inspire investment confidence and certainty. COVID-19 is battering countries’ health systems and balance sheets, and the growing inequality between the rich and poor is driving a distrust of political leaders and established political systems.

Firstly, let’s examine what’s going on in Chile. Chile is the world’s largest copper producer generating about 25% of global copper supplies. It is also the second largest producer of lithium.

The Chilean government currently has a 40.3% tax on commodities, in line with other major mining countries. Under the new bill that has passed the lower house and is now being considered by the upper house, the tax regime will shift from a share of profit to a share of revenue with the implication that the tax rate could double in high commodity price scenarios. While the president is required to provide final sign-off on any changes, it’s hard to see how tax rates in Chile could not increase by a meaningful amount. This will slash the return on new capital investments and make future investments in Chile less appealing.

Peru is the second largest copper producer at about 10% of global supply. They are in the midst of an election campaign with the first round of voting not delivering a candidate with over 50% of the votes, thus forcing a run-off vote between the two highest vote getters – far-left candidate Pedro Castillo (19% of vote) and Keiko Fujimori (13%) – on 6 June 2021. Castillo has pledged to redraft the constitution aimed at giving the government a more dominant role in the resources sector, and has talked publicly about lifting resource sector tax rates and potentially nationalizing mining projects to fund health care and education. Fujimori, making her third run at president, is the daughter of Alberto Fujimori, who was president from 1990 to 2000. She has been plagued by corruption allegations and is seen as supporting free markets and the current constitution.

Among other resource-rich South American countries, we have Argentina, which is the fourth largest producer of lithium but has an unsustainable level of debt with little ability to repay. It was ranked as one of the 10 least attractive jurisdictions for investment in the 2020 Fraser Institute investment attractiveness ratings.

The global nickel market is dominated by Indonesia, which has sought to build a nickel processing industry based around its nickel laterite deposits. This has seen the country emerge as a major exporter of nickel pig iron (NPI), primarily used to produce steel. Recently, the largest steel producer in the world, Tsingshan, has announced plans to convert NPI into a nickel matte as a means of accessing the expanding battery market. There are, however, emerging concerns over the environmental credentials of the Indonesian processing sector, and we note that Indonesia ranked in the bottom 10 countries for investment attractiveness in the Fraser 2020 study. Indonesia is also home to the Grasberg gold/copper mine which is a cornerstone asset of one of the largest copper producers, Freeport McMoran.

Shifting across to Africa, Robert Friedland’s Ivanhoe Mines is looking to develop the massive Kamoa Kakula copper project in the Democratic Republic of Congo (DRC). At peak production, this project has the potential to produce over 800,000 tonnes per annum. The DRC is currently the fourth largest copper producer globally but ranked in the 10 least attractive jurisdictions on the attractiveness of their mining policies.

The lithium sector has been dominated by Australia in the hard rock spodumene market and by Chile in the brine salts, which typically produces a lithium carbonate. Processing has been centred in China. Low prices over recent years has curtailed development, although recent price spikes have driven renewed investor activity as the electric vehicle market transitions into the mainstream. The race is now on to lift production and to develop processing facilities outside of China. As detailed earlier, Chile’s proposed new tax regime delivers a possible headwind to capitalize on this opportunity.

Australia – no place like home
There remains some doubt as to the world’s ability to deliver the required supply of key commodities such as copper, nickel, and lithium in a world seeking rapid decarbonization and electrification.

What is clear though is that Australia is ideally placed to capitalize on this increasing demand and to benefit from higher commodity prices that may well result from supply shortages.

Australia is the largest producer of lithium in the world, the sixth largest producer of copper, and the fifth largest producer of nickel. It has a stable legal and political system, a relatively strong financial position and world-leading mining sector expertise. It also has large, highly prospective regions that remain relatively unexplored.

Australia is ideally placed to be a cornerstone supplier of green energy metals to the world. With the right amount of government vision and support, it is well placed to add value to these commodities prior to shipping them out to the world.

From an investment perspective, while Australia may lack many of the “mega projects” on offer in less attractive destinations, it provides a potentially lower risk investment opportunity for those looking to build exposure to the green energy commodities.

The Biggest Threat to the ‘Green Energy’ Transition