As the economies look to move production back home, investors should consider investment opportunities that are related to “enablers”.
The number one source causing CO2 emission is transportation, so trucking, aircraft (leisure traveling), ships, and cars (commuting). Moving part of this activity to electric or green hydrogen represents a compelling investment opportunity for institutional as well as for main-street investors. In fact, the energy transition is a major opportunity for the larger industry to innovate and master the future. The innovation is not just about lithium-ion batteries or making hydrogen main-street, it is about writing a new chapter to the economic evolution.
Engaging in the energy transition raises a host of geopolitical, environmental, and economic issues. For companies to succeed in this new landscape, they will need a tricky combination of elements: cost efficiency, sustainable technologies, and access to resources. Up to now, developed markets had unlimited and unrestricted access to resources, given the strong affiliation with developing market countries. Given the sensible issue, let’s look at the battery business in more detail, as we believe that hydrogen developments will be pushed mainly in DM or fossil energy-rich regions.
It is all about the Supply Chain
As of today, about 90% of the EV battery supply chain relies on Chinese output. The country is responsible for refining about 75 % of all REE resources, and it has the two largest battery companies. Chinese companies have spent decades developing technologies in both fields at the expense of environmental considerations. Given this and due to cheap labor, the manufacturing infrastructure is mainly in mainland China, and it will be difficult to undo this dominant position.
China’s first-mover advantage will make it difficult for other manufacturers to catch up quickly. Not only do they need to deal with higher environmental protection requirements, but also, in order to compete successfully, they need to impose new technology standards that can deliver batteries with faster charging facilities and better utilization ratios. Becoming profitable fast while maintaining efficient production ratios is the most challenging aspect. Given the strong demand for batteries, prices are expected to stay elevated until further notice, which will benefit first and foremost the Chinese manufacturer.
We see two main issues: Firstly: Onshoring the battery production will be slow while the demand is expected to stay high which in turn favors ongoing pricing power by the incumbent. Remember what happened in 2008/2007, with the advent of the mass deployment of photovoltaics, the Chinese manufacturer smashed prices to eliminate all foreign competition. Secondly: Developed markets will spend about over $7 trillion in investments through 2040 to build vehicle factories, develop battery capacity, and recycling, and upgrade mining and refining infrastructure. The concern we have is, amongst others, whether there are sufficient resources (both iron-ore and money) available to perform the energy transition and to re-arm. Example: one windmill requires equal low-quality iron-ore resources as building 22 tanks type Leopard 2!
The catch22 with Lithium
Making batteries is carbon-intensive. It requires significant fresh water to extract lithium. The key battery metal is prized for its lightweight as well as its ability to hold energy. Hence, its main application is for long distance travel and the capacity to be repeatedly charged. A 2021 study by the International Energy Agency found that EVs require six times more mineral inputs than traditional cars. Furthermore, the energy intensity required to produce, extract and process those minerals (lithium, nickel, and cobalt, to name a few) is higher than that of commodities used in traditional internal combustion engines (ICE), which are primarily copper and manganese. But even though EVs require minerals with a significant environmental footprint, they’re still more efficient in the long run than ICE vehicles.
There are a few difficulties in meeting the demand for minerals needed to make EVs:
- The mining and refining of key battery metals is highly concentrated, China holds about 75% of the overall refining capacity. This fact is heightening a potential geopolitical risk. The crux of the story is that 50% of global lithium is mined in Australia and Latin America, but the refining is done in China. In the case of Nickel, Indonesia has the largest supply share, while the Democratic Republic of Congo represents 75% of cobalt extraction.
- To meet global net-zero goals by 2040, lithium demand alone would grow by about 40 times. The demand for graphite, cobalt, and nickel, the demand would need to rise by about 25%. With the existing deposits short of these required capacities, new deposits need to become online. The expected leap in minerals production and processing is expected to generate a variety of sustainability issues, including loss of biodiversity, air and noise pollution, and more.
- China-based mining and battery companies, with government support, have made substantial investments in overseas mineral assets, most notably in international early-stage lithium projects. The main driver of the ventures has been a combination of government support and Chinese companies’ willingness to pay above market value to shore up the EV production supply chain. This interlink may have some political ramifications.
The sheer magnitude of Chinese business ventures locking up critical minerals, particularly lithium supply, globally places all other lithium battery manufacturers at a disadvantage, especially as developed market-based companies are held to more restrictive environmental standards.
Engaging with the next steps
Disrupting the current world order of EV battery component supply and manufacturing will require technology and innovation. Existing advancements such as in-situ extraction, which uses a modified process that can yield up to 90% of the high-value mineral versus 50% to 60% from the traditional solar evaporation method, present a compelling opportunity to circumvent some of the challenges associated with the current supply chain. Additionally, advanced battery recycling could one day lessen manufacturers’ dependence on raw mineral extraction.
In the U.S., the Inflation Reduction Act (IRA) passed in 2022 is geared toward driving the adoption of clean technologies such as EVs, allocating government funds to industries critical to the forthcoming energy transition. But this strategy is missing legs. While the program incentivizes onshoring, it is missing measures that focus on efficiency and innovation. Hence, the program may favor the creation of old-style factories focusing on kilowatt-hour production! On the positive side of the IRA program is that it entices globally, new onshore investments, which generates jobs and a virtuous money flow. This phase-in period provided it is done carefully can generate some compelling investment opportunities.