Material Matters: Fossil Fuels, Future Metals

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A glance through the latest expert views and predictions about commodities: fossil fuels; future-facing commodities and lithium equities

-Demand for fossil fuels is expected to outstrip supply
-Australia lacks a major presence in refining/manufacturing of future-facing commodities
-Industrial metals a key part of the decarbonisation process
-Heightened takeover activity puts the spotlight on the lithium sector
 

By Eva Brocklehurst

Fossil Fuels

Fear that demand will fall away is leading to lack of investment in the supply of fossil fuels and, Shaw and Partners notes global oil demand is expected to return to pre-pandemic levels in 2022. This could, in turn, lead to all-time high fossil fuel prices in the years ahead as the world confronts an energy crisis.

In a nutshell, a push towards zero emissions may be gaining momentum yet the International Energy Agency has indicated that even after 2030, at least US$400m per year of investment will be required to develop new oil and gas supplies to offset the declines and ageing fields. In BP's 2020 annual energy outlook this is estimated at US$300-800m/year.

Shaw has reiterated an Overweight view on the energy sector because oil demand is rising, US shale production has been flat and spare capacity at OPEC has reduced.

The US active oil rig count is up 150% since August 2020 yet crude production has been flat for the past 12 months. This stems from a recovery off a low base, as the rig count is currently -55% below the highs of 900 in late 2018.

There is also the issue of drilled but uncompleted (DUC) shale inventory which is a source of low-cost supply and has been drawn down -40% since mid 2020. OPEC alliance production has made a 80% recovery to pre-pandemic levels yet Shaw believes forecasts for spare capacity could be generous, suspecting members are finding it difficult to ramp up.

Saxo Group analyst Ole Hansen expects the long term forecast Brent crude oil price range will shift up by around US$10, to the mid US$70s/bbl. The analyst also cites the IEA, which expects global oil demand to rebound by 1.6mb/d in October and continue to grow into the end of the year.

Around -30m barrels of production was lost during the US hurricane season and failure to reach a nuclear deal with Iran will add pressure.

Future-Facing Commodities

Currently, Australia has relatively minor presence in the refining or battery manufacturing processes that use future-facing commodities, despite being a producer.

Commodities described as future facing a those exposed to the megatrends of electrification, batteries, food security, decarbonisation and energy transition, Shaw and Partners explains, and these opportunities are relatively unfamiliar to Australian investors.

The broker cites an example from the CSIRO which shows that while Australia's lithium exports in 2017 totalled $1.1bn this represented less than 1% of the global battery value chain. In terms of stocks, as the broker points out, a chemicals business typically trades on a much higher multiple than a mining business, as it is less cyclical and does not have a depleting resource.

Hence, the Australian investment market will need to review the way these projects are valued as companies bring them to market. There are several emerging players in this sphere including Australian Potash ((APC)), which is preparing to start its Lake Wells sulphate of potash project in Western Australia. A full production ramp up is expected by 2024.

Silex Systems ((SLX)) is also a technology company focused on commercialising laser enrichment technology that applies to uranium production and enrichment as well as silicon enrichment. The company has an interest in a unique semiconductor technology as well, known as cREO, for 5G mobile handset applications.

Saxo Group acknowledges decarbonisation is a necessity but believes the current technologies of wind and solar do not perform well enough. The analyst, Steen Jakobsen, asserts the more decarbonisation occurs under the present model the more the economy is "metallised".

Supply chains are inelastic resulting from a lack of support for mine expansion and lack of capital flowing into the "dirty" production side because of ESG priorities. Inflation is expected to rise, a function of the inability to deliver supply relative to the quantity of demand, and negative real rates will mean the future is about low growth through low productivity.

In this situation there are two major asset classes, the analyst suggests, which will do well and these are government-sanctioned assets and those assets with price discovery. Saxo Group believes investors need to understand and act on commodities which have the best odds of producing long-term excess returns.

Rising costs across the board will mean inflation remains elevated for longer. Adding to this is the prospect of less aggressive central banks and a another period of safe haven and diversification demand. This has created a major incentive for investors to diversify towards commodities and away from debt instruments. In this way, industrial metals remain a key part of the decarbonisation process.

Given China's efforts to cut pollution by curbing the output of steel as well as, so-called green metals, aluminium and nickel, Ole Hansen expects underlying strength will result in higher prices for these metals.

Copper, tin, silver, platinum, lithium, cobalt and rare earths will follow suit. Supply constraints have lifted nickel and aluminium while copper is still waiting for a pick up. A break above US$10,000/t would be the signal for a fresh move in copper towards new all-time highs, the analyst adds. [Last US$9977/t]

Lithium Equities

Petra Group has highlighted the significant M&A activity in the lithium sector globally, with Orocobre's ((ORE)) takeover of Galaxy Resources representing the major activity in Australia. There is also the CATL purchase of Millennial Lithium for $413m, the purchase of 60% of Moblan by Sayona ((SYA)) for $115m and, more recently, Zijin Mining purchasing NeoLithium for $1.01bn.

There are now fewer and fewer companies with advanced development projects, particularly in Argentina. Hence, Petra Capital highlights the heightened interest in stocks such as Argosy ((AGY)) and Galan Lithium ((GLN)) for which it has Buy ratings, along with Core Lithium ((CXO)) on a Hold rating.

Argosy is very close to production and a potential takeover valuation, based on the read-through of the Zijin takeover implies 77% upside to Petra Group's unrisked net present value (NPV).

Core Lithium is breaking ground on Finniss in the Northern Territory with first production expected in FY23 of around 3000tpa of spodumene concentrate. In this case using the Zijin comparable the value of Finniss equates to just $442m against the analyst's NPV of $681m, which implies -36% downside.

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