Merryn Somerset Webb: a commodities supercycle like never before

If you want to have even the faintest hope of being green and clean, you are going to have to get very dirty first. That’s the core message from Ed Conway’s new book, Material World.

One of the odd things about the modern world, he says, is how disconnected we have become from what it is that makes that modern world work. We forget that the building blocks of our civilisation depend on vast gas-guzzling machines digging holes to extract grubby metals and minerals. Every fibre-optic cable requires copper, all glass needs sand, every semiconductor requires silicon (the main element in sand and quartz), every battery requires lithium and every major structure steel.

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All this involves massive amounts of energy – any conversion of a raw material into a product is really about energy use and is shot through with emissions. Take silicon – the thing we need to make the metal we make solar panels out of and to make the chips that make everything work. To make that you need to smelt. And smelting needs coal: you can’t (as things stand) have clean solar without dirty coal.

Even in normal times, getting the materials we need out is something of a challenge. Today it is an almost insurmountable one. Why? The energy transition. The scale of what we have to do to extract everything we need to fulfil the carbon-reduction promises our governments have made is “extraordinary”, says Conway. Think of the steel, copper, iron and aluminium required to completely revamp our national grid – and the metals needed to build the turbines, solar panels and nuclear power plants to fuel it.

The upgrade of the global electricity grid to cope with electrification is estimated to need some 427 million tonnes of copper alone – that is more than eight times the amount to be used in turbines, panels and energy storage combined. The copper required to produce an electric vehicle (EV) is four times that of a conventional petrol car, and the copper required to produce a megawatt of onshore wind energy over twice that of the gas-powered plant. The result?

The International Energy Agency (IEA) expects renewables’ demand for copper to double by 2030 – to 36% of global demand. You will see the problem. There is a period of extreme resource exploitation and extreme energy use ahead, one we need to get over the hump of to a world of greener energy, but also one that (inconvenient truth alert) will be more “dirty and brutish” than most of us (politicians in particular) have even begun to imagine. 

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The good news, such as it is, is that in this brutish hump there could be some excitement for investors – in the form of a commodity supercycle. We know that demand for almost everything commodity related will rise from here – even oil. As Jonathan Waghorn of Guinness Global Investors points out, demand for oil is unlikely to peak before 2030 and even by 2050 it is reasonable to assume that we will still be using something “in the order of 70 to 80 million barrels a day” - only 20% less than we use now.

It’s also worth remembering just how ubiquitous and irreplaceable fossil fuels are in life. Most fertilisers depend on natural gas – and our survival for now at least depends on fertilisers. At the more minor end of things, something that will be more important to some than to others: salt and vinegar crisps. The flavouring on them says Conway is acetic acid – the source of which is usually petrochemical. Fossil fuels aren’t going away in a hurry.

We also know that demand for a lot of commodities will be less elastic in the past. Previous commodity supercycles have been more country-specific notes Wisdom Tree’s Nitesh Shah. Think the urbanisations of Europe, the US and then China – these all came at different times and some distance apart. Today we are seeing an attempt at transformation at a global level: all countries want the same metals, and lots of them, at the same time regardless of price. “It’s going to be tough...and most countries are realising this quite late.”

We also know that supply is a bit more inelastic than usual. In past supercycles the cure for high prices has usually been high prices. The higher they go, the more companies invest in raising production. And then the more prices fall. However, this time might actually be different.

The rise of environmental, social, and governance (ESG) investment policies across the financial sector has made investors reluctant to support mining and had the effect of pushing up the cost of capital across the commodity spectrum. The result has been a fall in discoveries: a mere four copper deposits have been discovered since 2015[1](there were 31 between 2008 and 2015) and the grades coming out of existing mines are deteriorating. At the same time it has become increasingly difficult to get permits to either explore or to dig and drill (note the furore in the UK around the granting of exploration licences for the Rosebank oilfield in the North Sea).

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One of the big obstacles to net zero, says Conway, is the difficulty of getting permissions to mine (the lead time gets longer and longer) and once you have done that, getting hold of employees. The idea that mining is a dying industry (tell your teenagers that it isn’t and that the Camborne School of Mines would welcome their application) has led to a shortage of mining engineers and geologists.

There is also a geopolitical element here: China has something of a stranglehold over the supply of many of the metals – both the original supply and the processing – that we need. Add the decreased elasticity of supply (the rising costs of capital and the permit problem) and the decreased elasticity of demand (thanks to net zero being an imperative for most governments) and this supercycle might be more dramatic than those of the past. Think higher price troughs and, say the analysts at Stifel, “a structurally upward bias”.

It is easy then to think that we might be knocking around the beginning of a huge structural supercycle in commodities, particularly given the years of underperformance in the sector and its equities. One illustration of that doing the rounds of commodity bulls: you could, right now, for the current market value of Apple Inc (NASDAQ:AAPL) alone, buy all the top 100 mining companies in the world – plus a bit. I know which I’d rather have.

There are short-term risks: commodities mostly go down in recessionary times – and oil could become its own worst enemy (rising oil prices are good at creating recessions!). But in the medium term the opportunities are pretty interesting. Look to some of the big oil companies, says Jonathan. They might not be popular, but in the Guinness Global Energy Fund holds oil companies that are generating 11% free cash yields every year – largely because their capital expenditures are now so low (back to the cost of capital and ESG).

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If it is dividends you want, this is the place to be. Right now dividends average around 4%. But with free cash flow at 11% you should expect them to rise – or at the very least to be very secure. It is also the place to be if you want cheap stocks: the likes of Shell (LSE:SHEL) and BP (LSE:BP.) in the UK and Repsol SA (XMAD:REP) and TotalEnergies SE (EURONEXT:TTE) in Europe all trade on price/earnings (PE) ratios of 6-7 times. If oil stays around $80 a barrel, says Jonathan, you’ll have your money back in 10 years.

That said, there are obvious risks to fossil fuels – a much faster transition than currently factored in or a technological leap of some kind that moves things forward in an unexpected way. A battery breakthrough could, for example, totally disrupt the idea that we will be needing 80 million barrels of oil a day in 2050, says Shah. If you want to make a wider play on commodities; on renewables; or on battery technology, there are thematic exchange-traded funds (ETFs) available to meet most themes.  

Finally, no conversation on commodities is complete without a word on gold. It isn’t like other metals says Jonathan – you have to think of it as more like a currency. With that in mind, look at inflation, bond yields and historical price movements, and it makes sense to think that gold should head over $2,000 an ounce next year. He isn’t the only one that thinks this. In the US, consumers are so keen on gold that Costco has started selling 1oz gold bars. They are limited to two a customer – and selling out fast. If the transition goes as expected maybe look out for them selling out of bars of copper within the decade.  

Merryn Somerset Webb is a senior columnist for Bloomberg. Previously, she was editor-in-chief of MoneyWeek and a contributing editor at the Financial Times. She is also a non-executive director of several UK-listed investment trusts.

[1]https://www.spglobal.com/marketintelligence/en/news-insights/research/copper-discoveries-declining-trend-continues