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KEY THEMES SHAPING
THE FUTURE OF MINING
Aug 26, 2022
The first two themes mentioned below are more structural in nature and will impact the longer-term investment case for most businesses in the mining sector. The last four themes are likely to impact the industry over the shorter term – some positively and some negatively – but may also have longer-term ramifications.
The energy transition away from fossil fuels will benefit certain metals disproportionately.
To combat climate change, the world needs to move away from fossil fuels over time. This won’t be an easy shift and will be highly metals-intensive. Renewable sources such as wind and solar use large amounts of copper, zinc and steel. Electric vehicles will require much more lithium, nickel, cobalt, copper, and various other battery metals.
For example, Glencore has estimated that if the world wants to keep global temperature rises below 1.5 degrees Celsius, we’ll need to double the amount of copper per annum by 2050 compared to what we’re using today. This will create a structural demand tailwind for these metals less dependent on the economic cycle – much like the rise of the automobile a century ago did for gasoline demand.
Building new mines is a lot harder today than it was even a decade ago.
Meeting this extra demand will, however, not be easy. Let’s again take copper as an example. Exploration success has declined dramatically over the past decade. S&P Global Market Intelligence has estimated that we’ve discovered only about eight million tons of new copper per annum over the past decade. However, the world needs annual mine production of more than 20 million tons per annum, which implies that global reserves are declining year after year. In addition, Anglo American believes that it now takes longer than 10 years to build a new mine from scratch due to all the regulatory hurdles that need to be crossed.
This is of course highly beneficial to miners who own long-life assets. The diversified miners in our portfolios – Anglo American, BHP and Glencore – all have copper mines with more than 30 years of life on average.
The invasion of Ukraine and corresponding sanctions against Russia will likely result in a more prolonged energy shortage.
We were positive on fossil fuels for the medium term even before the Russian invasion of Ukraine – we argued that the lack of investment in new oil fields must lead to higher prices. This was a key reason for our investment in Sasol.
Sanctions against Russia are not helping in this regard and Europe will increasingly be seeking to substitute Russian energy sources. Germany is even restarting old coal-fired power stations – it has been estimated that their coal usage will now actually grow until 2025! Coal prices are currently at record levels – above US$300 per ton. Glencore is a key beneficiary of this, having invested in coal mines countercyclically when others wanted to get rid of them. Read more here about the impact of Russian sanctions and our investment case for Glencore.
Over the longer term, this crisis is likely to accelerate the use of renewables, but we think it likely that over the medium term, fossil fuel energy prices will be higher than normal incentive levels. In addition, energy-exposed equities don’t appear to be factoring this into their share prices, which is why we continue to favour a tilt towards these counters (Sasol and Glencore) within our portfolios for the time being.
Chinese stimulus measures should aid a struggling economy.
The Chinese market was arguably already in recession in the first half of this year, with this country’s no-tolerance Covid-19 policy having a negative impact on growth. This has weighed on metal prices over the past few months as China is by far the biggest user – consuming more than 50% of most industrial metals.
The Chinese have, however, announced quite meaningful stimulus measures to aid their struggling economy (~US$220 billion of special local government bonds, which are typically used for infrastructure projects), and this should provide at least some support to metal prices (particularly early-stage commodities like steel and therefore iron ore) towards the latter part of this year and into next year.
Governments want a bigger slice of the pie.
With many commodity prices reaching decade highs over the past few years, more governments are pushing for higher taxes and royalties to be levied on these businesses. Recent examples include the metallurgical coal royalty increase in Queensland, Australia, talks of an oil supertax in the UK and – importantly for copper markets – the prospect of higher taxes and royalties in Chile and Peru.
The reason the Chilean tax talks are of particular relevance is that around a quarter of global mined copper production and potential projects is located within that country. New tax proposals could see taxes as high as 60% when copper prices reach the levels seen earlier this year, up about 15% compared to current tax rates. The diversified miners in our portfolios have a fair exposure to South America, with around 30% of their profits coming from either Chile or Peru, so this will have negative consequences if implemented.
However, if higher taxes are implemented in Chile, it will also impact new project decisions and raise the incentive price needed to justify new mine investments in this country. This raises the attractiveness of existing long-life, low-cost copper mines – especially those outside Chile.
Inflation is starting to bite.
Inflation has also started to impact the miners negatively, with prices of steel, diesel, explosives and other consumables rising dramatically over the past year. This is not unusual – we’ve seen this happen over many past cycles, and some price increases are likely to reverse again when the cycle turns.
Here it really helps to own good, low-cost assets. To illustrate this: if prices rise by 15% and you make a 70% margin, your profits will fall by only 6%, but if you make a 40% margin, your profits will fall by 23%. Again, the big diversified miners in our portfolios all have mining assets on average in the lower half of the industry cost curve, which enables them to better deal with inflationary pressures than those higher up on the cost curve.
Overall, diversified miners Anglo American, BHP and Glencore are expected to be net beneficiaries of these themes. Sasol is also likely to continue to benefit from the short- to medium-term tightness in energy markets. We’re therefore comfortable to continue to maintain a meaningful exposure to the sector in our portfolios, but still with a tilt towards more energy-exposed counters, as we’ve argued above.
However, these investments are and will continue to be cyclical in nature, making it important to practise valuation discipline. We’ll continue to assess the market prices against our best estimate of fair value and act if we see any discrepancies.
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