The Energy Transition: Navigating Thematic Investing & Geopolitics - Part III

This is part III of III in a limited series on the intersection of geopolitics with thematic investing in sectors with geo-strategic significance.

As security takes precedence, governments are playing a bigger role in industries with geo-strategic importance by providing accommodative financing conditions. Whether in the form of interest-free loans or tax incentives, global leaders are looking to wield a number of policy levers to accelerate their position in this multi-dimensional race.

In industries with high costs and long time horizons for returns in an environment of high interest rates, the private sector will need a push - or a pull. Legislative measures like the US Inflation Reduction Act and European Chips Act are just two of many examples of targeted industrial policies.

The sharp rise in demand for these resources, combined with an inelastic response amid shifting supply chains creates notable upside risks to inflation. Or specifically, “greenflation”. And that leaves markets, economies, and states vulnerable to the disruptions caused by a rapid energy shift transition. 

What we are seeing now suggests that what started off as a moral cause of tackling climate change has rapidly evolved into another thematic pawn on the geopolitical chessboard.

And these changes are coming at a particularly delicate time in international relations which in turn makes economies, markets, and states more prone to policy-induced volatility. 

Mine Baby Mine

The green energy transition is driving up demand for metals, but regulations and the need to consider environmental and social factors have caused the time to open new mines to increase from 5 to 10 years.

As The Economist wrote: “Unfortunately, miners are also investing a lot less than they once did, as their latest set of earnings, released this week, confirm. The world’s biggest miner, bhp, last year spent less than half of what it did a decade ago.

In part that is for sensible reasons: miners are rightly conscious that theirs is a boom-and-bust industry. The last time they splashed out, during the China-led bonanza of 20 years ago, a spectacular crash followed”.

This lack of flexibility in the supply chain, coupled with pressure on publicly traded mining companies to adhere to ESG metrics, is likely to result in higher metal prices as demand outpaces slow-moving supply.

In essence, the green push is creating a multi-faceted supply problem that will likely translate to higher commodity prices for mining companies. And the geography and geopolitical topography will complicate the process and potentially push commodity prices - and shares of companies specializing in their extraction - higher.

Concentrated Deposits

The narrow clusters of key minerals and metals necessary for the energy transition is poised to be a flashpoint for supply chains. For example, 70% of cobalt supply is from the DRC, and 70% of rare earths are mined in China.

The top six producing countries for copper made up around 60% of production in 2022, and this has major implications for modern geopolitics. Here is an additional breakdown for each key commodity.

Lithium
In 2022, Australia produced approximately 61,000 metric tons, accounting for 49.91% of global production, with Chile at 39,000 metric tons or 31.81% of the global total.

Nickel
In 2022, Indonesia produces 1.6 million metric tons a year, accounting for 61.07% of global mine production, with the Philippines far behind at 330,000 metric tons, representing 12.60% of the global total.

Cobalt
In 2022, the Democratic Republic of the Congo (DRC) produced approximately 175,000 metric tons, accounting for 78.83% of global production. In second place is the Philippines at 30,000 metric tons, or 13.51% of the global total.

Copper
In 2022, Chile produced 5.9 million metric counts, accounting for 27.45% of the global production, with Peru at 2.7 million metric tons or 12.59% of global production.

Apart from Australia, Indonesia, DRC, and Chile have a history of political instability. The prevailing risk here is of it spilling over into their mining activities and disrupting global supply amid a period of heightened demand. But that’s mostly just extraction.

Concentration is even stronger at the refining and processing stages, and the country with a near-monopoly of it is in a tug-of-war with the US.

A Deeper Look Into Lithium

Demand for lithium ion batteries is being driven - so to speak - largely by the growing number of EVs being purchased. EVs are typically 15 to 20 percent heavier than comparable internal-combustion engine (ICE) vehicles.

Argentina, Bolivia, and Chile hold around 58 percent of global lithium reserves, making these countries key players in this expanding market. Lithium’s high coefficient of variance seems to reflect the immature and dynamic nature of the lithium market, driven by factors like increasing demand for electric vehicles and limited supply. 

Despite a favorable outlook for lithium from a perspective of supply and demand, the high threshold of risk necessary to tolerate in an environment of low interest rates could extend the comparative illiquidity of the lithium market relative to the oil market.

This is where in my view, government support/industrial policy will likely come in to fill the gap and temper what will be a volatile commodity. One of the driving causes of price fluctuations is China’s involvement in the lithium sector

However, obviously this has to be done carefully because as is the case with Bolivia, heavy government involvement and restrictive conditions for outside investment hampers FDI.

As a consequence, their goals for becoming an even bigger player in the lithium market by 2030 may be stretched further unless outside investment is allowed in. Research firm Wood Mackenzie predicts that lithium project investment will reach $14 billion in 2024, more than double the amount in 2023.

Despite all the legal provisions and stipulations, investors have no real guarantee for their activities, especially when the guarantor has defaulted on its national debt three times in the last two decades.

As the United States seeks to increase its stake in the lithium market by securing supply chains, Argentina's ethical issues in mining and ties to China could cause it to be classified as a foreign entity of concern, precluding access to the US Inflation Reduction Act. 

As far as competing geopolitics go, the US may opt to increase capital contributions to the IDB, or by investing in energy security with provisions excluding foreign adversaries, namely China.

China is South America’s top trading partner and a major source of both foreign direct investment and lending in energy and infrastructure, including through its massive Belt and Road Initiative.

China has signed comprehensive strategic partnerships with several Latin American economies, one of which is Chile, a key point in the lithium triangle. 

As far as US policy goes, this is right in Washington’s backyard, and to have a foreign adversary be the largest trading partner in a key region peppered with strategic resources is obviously a national security\ concern by itself, but that vulnerability is pronounced during an energy transition where there is an asymmetric prize awarded to those who maximize those supply chains first. 

For more on the energy transition, be sure to see my previous reports:

Why Geopolitics Will Matter for the Energy Transition

Riyadh's Energy Shift to Boost Saudi Regional Influence

Mining Stocks May Surge on Global Energy Transition. But There's a Catch

*Not financial advice.