Copper – The Key to a Green Future

The Latvian version of this article is available in print in the May2021 issue of Forbes Latvia

Over the next seven years, the EU has budgeted 1.8 trillion euro – or 60 times Latvia’s current GDP – to help rebuild “a greener, more digital and more resilient” post-COVID-19 Europe. The largest share of this astounding amount of money, around 1 trillion euros, will go towards the fiscal embodiment of what the EU considers to be “cohesion, resilience and values.”

What does that mean? Well, according to the money pledged to the Recovery and Resilience Facility (RRF), in order for EU members to access the majority of this funding, a minimum of 37% must go towards climate investments and reforms, while a minimum of 20% must go towards fostering digitization.

If you were under the impression that combating climate change and encouraging digitization were commendable ‘policy initiatives,’ you would be wrong. It turns out they are ‘values.’ And if you spend any time following financial markets and reading central bank commentary, you understand just how important semantics can be – especially when it comes to committing central bank firepower. ‘Policy initiatives’ are what you would like to do, ‘values’ are what you have to do.

Europe is calling its shots and is committed to making them. Anything else, would evidently be un-European. As a citizen of the European Union, I appreciate the boldness of these initiatives, and am optimistic that they will be a very strong catalyst for positive change.

As a professional investor that spent the beginning of his career in Canada and profiting from the commodity boom that was created in the wake of China’s inclusion into the World Trade Organization, this is bringing back very fond memories.

How so? Global consulting firm McKinsey calculates that Europe will need to spend over 28 trillion euros over the next 30 years to reach carbon neutrality. Now we’re talking real money. As a comparison, according to Goldman Sachs, China invested around 15 trillion in today’s dollars into building its economy from 2001-2011. The impact on commodity prices was staggering:

Source: Bloomberg

By completely transitioning from a carbon based economy, Europe will be making no less great a historical leap than China’s economic boom during the start of this millennium. The thing is, Europe will not be the only one making this massive transition. The Biden government is trying to drive through legislation that will target US carbon neutrality by 2050 as well. China is targeting carbon neutrality by 2060.

Some of the world’s largest companies are taking an even more aggressive approach than their governments. For instance, Amazon’s founder and chairman Jeff Bezos just wrote in latest and final shareholder letter that Amazon is making progress toward their own goal of 100% renewable energy by 2025, five years ahead of their initial 2030 target. Moreover, they are the largest purchaser of renewable energy in the US.

All of these transformations and investment in green energy infrastructure will place massive demands one commodity more than any other: copper.

Recently, Goldman Sachs, which has been at the forefront of pushing the green economy as an engine for economic recovery came out with a compelling report titled “Copper is the new oil” (April 13, 2021). In this report they made several very bold assertions. First of all, they emphasized that there is no decarbonization without copper, and that the critical role copper will play in achieving the Paris climate goals cannot be understated.

Secondly, they made the case that the transition away from hydrocarbons to renewable energy, electric vehicles and batteries would result in the largest surge in volume growth of copper demand that world has ever seen.

Lastly, they calculated that the copper supply market is vastly underprepared for the boom in demand. As such, they forecast “a long-term supply gap of 8.2Mt by 2030, twice the size of the gap that triggered the bull market in copper in the early 2000s”.

As a result of these factors, Goldman Sachs expects that copper prices will have to reach $15,000/ton in order to incentivize miners to bring on new supply, which could take anywhere from 2-3 years for past-producing or ‘brownfield’ mines to be put into production. New or ‘greenfield’ mines can take more than 8 years to be developed.

Copper miners had only recently recovered from the bust of the past cycle peak in 2011, when Trump’s trade war with China sent prices into decline at the end of 2017. What looked to be a recovery was then unceremoniously disrupted by Covid-19. All of this volatility discouraged risk taking on the part of copper producers and delayed development timeliness, resulting in the current forecasted supply gap. 

Given the massive amount of initial capital needed to build mines and the time necessary to bring then into production, copper miners do not seem to be in too great a hurry to invest in new supply just as their cash flows from the current near-record copper prices ($9300/ton) are filling up their coffers, allowing them to deleverage and return capital to shareholders.

Planning new mines not only involves massive financial commitment, but a myriad of other complicating factors – especially political and environmental risk. You cannot just pick up whatever progress you have made in developing a mine and move it elsewhere if the political climate sours in the country in which you are operating. Also, a funny thing happens when miners start to make money – local governments tend to want to renegotiate the terms of engagement.

Moreover, receiving full environmental permitting has never been more difficult to obtain in developed markets. Today’s investors demand the highest ESG standards, and given their line of work, miners have to work harder than almost any other industry to show that they are responsibly engaged with all stakeholders.

The combination of these factors and inherent industry risks means that mining companies trade at a discount to companies in other industries. Moreover, building mines is hard, and people that dig rocks for a living do not tend to be the best marketers. But make no mistake, copper miners are poised to make a fortune for their shareholders, and could receive an additional tailwind from an industry re-rating.

Let’s take one of the world’s largest copper miners as an example. In their most recent quarterly report, Freeport McMoRan (FCX) stated that at $4/lb copper ($8800/ton), they would have a 2022/2023 EBITDA of $12 billion and operating cash flow of $8 billion. Its sensitivities to a +/- $0.10 move in the price per pound of copper would be $425 million and $325 million respectively.

Given these metrics, if copper were to rise to Goldman’s target price of $15,000/ton or $6.80/pound, then FCX’s EBITDA would be $12 billion + $425 million x 28 = $23.9 billion. Operating cash flow would be $17.1 billion.

These are massive numbers for a company that has a current Enterprise Value of $67.1 billion.

As a comparison, Goldman Sachs forecasts that Tesla will report just over $13 billion in EBITDA in 2023. That is just under half of what FCX could be making even though it trades at one tenth of Tesla’s Enterprise Value.

Source: Bloomberg

Now at this point you might be expecting me to comment on battery metals that will be in high demand by electric vehicles as such as lithium, nickel and cobalt. Surely, there are opportunities is this space, but you must be very careful, because EV adoption rates are all prefaced on lower battery costs. EV producers and battery makers will do everything possible to bring down battery costs to reduce the price difference between EVs and Internal Combustion Engine vehicles (ICEs). However, EV makers cannot avoid paying for copper by substituting it for another metal unless prices get absolutely nonsensical, which, in the meantime, would be phenomenal for copper producers.

Recently, legendary mining executive Mick Davis commented to the Financial Times:

 “I benefited from the large secular change in demand from China’s industrialization, but this is coming about because of government regulations — you don’t need to make an assumption about [economic] growth. There is structural growth and governments will ensure it will happen.”

The developed world’s commitment to transitioning to sustainable energy production and the electrification of their economies will create one of the most impactful changes in our lifetime. However, the politicians forgot to run things by the one industry upon which the most critical of inputs – copper – depends, thus creating a generational investment opportunity for copper investors. If you believe in a green, sustainable future, you have to believe in copper.