Global commitments to net zero are changing the landscape for commodities, says Olivia Markham, Co-Manager of the BlackRock World Mining Trust plc. This creates a strong backdrop for the year ahead.
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2021 was a good year for the mining sector, with high earnings and rising dividends driving improving share price performance for many companies. Many investors are asking whether the cycle may be drawing to a close. Far from it, at BlackRock we believe we are only partially through a material multi-decade investment cycle linked to net zero.
The drive by global governments to move to net zero is changing the landscape in the mining sector. Around 80% of the world’s GDP (Gross domestic product) is now under a net zero commitment1.To achieve these ambitious goals, countries will need to significantly change their energy infrastructure. This forms an important part of President Joe Biden’s US $1.2 trillion infrastructure bill and the European ‘Green Deal’, which, in turn, drives demand for commodities in particular.
The commodity market is supplying the necessary ingredients for society to achieve net zero. This is largely focused on the key metals needed for the electrification of the economy – copper, cobalt, lithium, nickel and rare earths. These are going to be vitally important in building the necessary solar, wind, grid improvements and electric vehicles required for society to move towards a lower carbon future.
Supply constraints
Supply in many of these areas is constrained. This is partly due to short-term considerations such as bottle necks and supply chain problems caused by Covid. Russia’s invasion of Ukraine is also leading to supply disruption, pushing commodity prices higher. here are also more fundamental and longer lasting problems at work – the increasing maturity of certain mines, declining grades, plus environmental, social and governance considerations affecting the way mines operate. Water availability is also becoming increasingly problematic. This makes it increasingly challenging for the mining sector to bring on supply at a sufficient pace to meet demand.
Also, these supply problems come after a period of considerable discipline on the part of many mining companies. Capital has been withheld, which has also constrained supply over the last decade.
The recent trend in copper illustrates this supply dynamic. Copper supply has regularly underdelivered on expectations, often by as much as 5% of the global copper industry annually. Compounded over time, this creates a significant deficit. The world’s largest copper producer, Chile, has dedicated billions of dollars of investment, but has not been able to increase supply since 20162.
In our view, this means commodity prices need to stay sufficiently high to incentivise more supply. As demand for green infrastructure picks up, copper demand, related to solar, wind and electric vehicles, is set to double by the end of this decade. This is replicated across other commodities as well. Against this backdrop, the move to net zero is likely to create a significant investment cycle.
Carbon-heavy industries
There are other elements to the net zero progression that need to be considered. For example, it has changed the way we think about energy-intensive commodities such as steel and aluminium. Historically, the carbon impact of mining these commodities has not been incorporated into their pricing. As countries around the world start to impose carbon pricing, it could prompt a significant change. In the case of aluminium, an energy intensive commodity, we expect low carbon producers with access to renewable power to benefit as carbon prices increase the cost of production for thermal coal powered smelters and customers increasingly look to pay a premium for low carbon produced aluminium. In the BlackRock World Mining Trust, we have exposure to low carbon producers of aluminium and steel that we believe will benefit from this trend.
Valuations for mining companies still look attractive, even after a strong year for the sector. The shares trade at attractive valuations relative to global equity markets and relative to their own history. Dividends are strong, as are balance sheets. The changes brought about by net zero are not implied within valuations. As inflation expectations increase, commodity prices tend to move higher.
China is another consideration for the mining sector today. It has been a strong source of demand for commodities for the past two decades. It slowed significantly in the second half of 2021 and there was a pullback in some commodity prices as a result, notably iron ore. However, China appears to be moving towards stabilising the economy, increasing credit availability, and has resumed a number of infrastructure projects which should be supportive for demand in 2022.
The war in Ukraine has introduced a new dynamic into the commodities complex. Should we see a significant de-escalation in the present situation then prices for commodities are likely to ease in the short term. However, over the medium to long term we see countries reliant on Russian commodities, most notably energy, look to accelerate their renewable plans to secure and diversify their energy needs which in turn increases demand for the commodities that enable the transition.
We remain optimistic on the outlook for the sector in 2022. Commodity markets are tight today with very low levels of inventories and limited new supply growth on the horizon. Demand is set to benefit as the economy continues to recover post Covid and global infrastructure spending commences this year. The move towards net zero is a multi-decade investment cycle that will require a significant amount of commodities to enable it. When combined with the constraints on supply, we expect many of the commodity markets to remain tight for a number of years to come, which is supportive of prices.
This material is not intended to be relied upon as a forecast, research or investment advice and is not a recommendation, offer or solicitation to buy or sell any securities or financial product or to adopt any investment strategy. The opinions expressed are from BlackRock as of March 2022 and may change as subsequent conditions vary.
1University of Oxford, November 2021
2Trading Economics, November 2021
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