Although some commodities will play a distinct role in the world’s move towards a lower carbon future, assets worth billions are likely to become unpalatable and therefore stranded over the next 10 years – a very real threat investors must be alive to.
Commodity prices have been steadily rising since the start of the year (as of 14 April), with the Bloomberg Commodity Index increasing 9%, and brent crude oil a record 26% over the same period. The story told by many market commentators is that expectations of a strong economic rebound and large infrastructure spending plans are driving demand.
But hailing the start of a supercycle is an oversimplification and exaggeration that ignores improvements in both efficacy and access to cleaner forms of energy over the past few years.
This time is different
Crucially, in this recovery, governments are looking to ‘build back better’ from the pandemic. Low carbon infrastructure such as solar panels, wind turbines, electric vehicles and charging stations are going to attract a significant portion of government investment over the next 10 years.
In the US, following the successful passing of a $1.9trn stimulus package, President Biden’s government is now turning its attention towards a $3trn spending commitment to green energy and infrastructure. Meanwhile, in the UK last November, prime minister Boris Johnson announced a £12bn 10-point plan for a ‘Green Industrial Revolution’, hoping to create and support 250,000 jobs.
Some commodities are fundamental constituents of these technologies. Copper, for instance, is needed in large quantities for electric cars and charging grids, while lithium, graphite, nickel, manganese and cobalt are used in lithium-ion batteries.
Palladium and platinum are key in catalytic converters – used to reduce harmful emissions – and wind turbines use steel, which is produced from iron ore. Solar panels, on the other hand, require silver.
What about oil?
Noticeably absent from this list is oil. The oil price has been supported since the start of this year by the expectation of a pick-up in the economy, alongside cuts to current production and a reluctance from energy companies to invest in new production.
But BP’s CEO recently announced oil demand has already peaked. This contrasts starkly with pre-Covid estimates, which predicted 2030 would be the year of “peak oil”.
In reality, the writing has been on the wall for oil investments for some time. This is well illustrated by stock returns over the past 100 years –$100 invested in the S&P 500 a decade ago was worth over $350 in November last year; the same investment in the S&P Global Oil Index lost the investor $30 over that timeframe.
But not all hope is lost for oil companies. Leading oil companies have an historical opportunity to transform their core business towards greener energies and the current trend higher for oil prices provides them with some breathing space and cash to do so.
Forward-looking execs
For those oil companies looking to position themselves for commercial success, this provides an opportunity to invest more decisively in renewables to finance their energy transition. This will require a marked change in approach since currently only 1% of capex by the largest oil and gas companies is going towards low-carbon business, according to the International Energy Agency.
Ultimately, the decision is up to management, but it is likely to be crucial in defining the company’s future, one way or the other.
The reality is that a company choosing to develop high-cost projects that contradict the intentions of the Paris Agreement is taking on significant risk, because it is investing in assets that have a high probability of becoming ‘stranded’ (e.g. lose all their value) as the world decarbonises.
Carbon Tracker Initiative, an NGO that carries out in-depth analysis on the impact of the energy transition on capital markets, has highlighted 15 of the largest projects proposed in 2019 that are not commensurate with the International Energy Agency’s scenarios to limit the rise in the average global temperature to between 1.65˚C and 1.8˚C. These projects account for $60bn in capex and are expected to become stranded over the next decade.
Be wary of ‘FOMO’
In the view of many markets’ participants, the ‘reflation trade’ being talked up since the start of the year will be supportive of higher prices for commodities that have a place in a low carbon future. The obvious odd one out here is oil.
Declarations of a supercycle can be enticing, eliciting fear of missing out (Fomo). Savvy investors will pay particular attention to the capex intentions of big oil and energy firms and if they refuse to take the opportunity to pivot towards cleaner energy projects, it may be time to revisit the allocation – before their assets get stranded, and yours stagnate, or worse, plummet.
