The recent energy squeeze has shown us the unseen consequences of curtailed investment in fossil fuels, highlighting that the opportunities for investors to generate good returns from the required transition might not be the most obvious ones.
A similar phenomenon is occurring in the metals market, where investments have dwindled in the steel industry, one of the highest carbon-emitting sectors due to the use of coking coal both as fuel and support in the blast furnace.
Its history of poor returns and high volatility as well as being a commodity that the Chinese make in bulk have meant that the steel industry has never really been investor-friendly. But the lack of certainty on the pathway to decarbonisation has made it even more unattractive.
The lack of investment has come on top of consolidation and reduced production in the US and Europe, adding to an already tight supply situation. With the increasing focus on CO2 emissions, steelmaking companies have been reluctant to restart older, less efficient plants despite record margins. Crucially, China has been actively cutting production and reducing exports in order to meet tighter emission targets.
Against this backdrop, steel prices have surged as various governments, including the US, have boosted demand with green infrastructure plans. Just as everyone is clamouring for steel to build infrastructure, such as wind turbines, production is unable to meet demand.
The situation in the steel market is in stark contrast to copper, the metal required to generate and conduct electricity for everything from electric vehicles to wind and solar farms. Everywhere you turn, there is someone giving you the bull case for copper.
With western governments committing to spend money on renewable energy and infrastructure, we appear to be entering a cycle where demand for metals such as copper will be strong not just in the emerging east but once again in the developed west. No surprise that copper prices have hit record highs, recovered from the depths of the downturn in 2020.
While all the large mining companies slashed their capex budgets from 2015 under pressure from high debt burdens and low prices, they all kept their copper projects going. Over the next three to four years there is production capacity equal to over 10 per cent of demand from large projects and increased supplies from scrap metals.
With investors keen to support decarbonisation and the transition away from fossil fuels, copper projects have been the first to get the capital they need to develop. The trend is real, but it will still be cyclical and volatile.
As we change the basis of our energy supply from fossil fuels to mainly metal-based technologies, we face real upheaval in many commodity markets, the start of which we have seen in the past 12 months. Covid-19 and its aftermath must take some of the blame but years of changing patterns in capital investment are also having a big impact.
For policymakers and society, there is a broader lesson. To decarbonise the world and make the transition to net zero, just abandoning “old” industries and penalising them with carbon taxes will not work. We will have to work with these sectors and invest in new technologies that will help them decarbonise. Otherwise, the unseen consequences will lead to the “shock of the old” upending the birth of the new, modern economy we all want.
George Cheveley is portfolio manager at asset management group Ninety One
The Commodities Note is an online commentary on the industry from the Financial Times