Friday, 8 September 2023

By Nickolai Hubble Editor, Fat Tail Commodities

[4 min read]

Editor’s Note: With regular Fat Tail Commodities Editor James Cooper currently on a long-haul flight from the US back to Australia, we thought we’d have Nickolai Hubble — Investment Director and Editor of Strategic Intelligence Australia — make a special guest appearance for today’s article. Nick has been extensively researching net zero for the past few months and agrees with James that it is impossible to achieve. That said, Nick contends Australia is ‘disproportionately likely’ to be the greatest beneficiary of this impossible race. Read on…

Dear Reader,

I moved to Australia on New Year’s Eve 2003–04. What followed was a commodities boom that defined the nation’s prosperity. It even sent our currency soaring past parity with the US dollar. According to Credit Suisse Group, this helped send Australia’s ‘wealth per adult’ measure over US$300,000 just before the 2008 Global Financial Crisis, even matching world leaders in Switzerland.

What followed was a bit of a debacle as the commodity bubble burst and dragged down our currency and the stock market with it. Our wealth levels plunged at a remarkable pace, even if we did remain the best place in the world to live…

But then another boom began with commodities soaring and lifting Australian households to become the wealthiest in the world in 2022 according to Credit Suisse’s annual report.

My point is that Australia’s prosperity is built on commodity cycles. That’s disproportionately true because our mining industry exports what it produces. Therefore, it has a disproportionate impact on the exchange rate by which international wealth comparisons are made.

On the upswing, we literally become the wealthiest people in the world. And while the downswing isn’t exactly as disastrous as it might be in many countries, it has an outsized impact relative to other developed nations.

Therefore, if you can predict the commodity cycle, you can predict Australia’s fate…

Now, usually the fact that it’s called a ‘commodity cycle’ is a bit of a giveaway. Commodities are notoriously boom and bust affairs. Largely because of the time and money it takes to develop a mine.

During the boom, there was overinvestment in new mines. By the time they all come online, there’s oversupply as a result, and so prices plunge. Those low prices discourage investment in future production, setting up the supply shock that triggers a new price boom. Rinse and repeat with investors gaining and losing a lot of money along the way.

What I’d like to suggest to you next is heresy in commodity investing circles…

The commodity cycle is about to be undermined altogether

Recently, I was happily sitting in Black Swan Park on the Sunshine Coast waiting for something to happen when it hit me: net zero is going to completely upend both the supply and demand for commodities at the same time.

Specifically, it’ll create such a vast spike in commodity demand, while also crushing supply, that a dangerous price surge will define financial markets, economies, and Australia’s fate for decades.

Here’s why…

Let’s examine demand first. The energy transition to renewables is one from liquids and gasses to metals. Rather than burning liquid and gas fuels, we’ll build infrastructure like wind turbines and solar power panels. This completely upends not only the types of resources used, and the amount, but also the timing.

For gas to generate electricity, you need to build a gas power station and supply gas continuously. For a wind farm or solar farm to produce power, no fuel is needed on an ongoing basis. But vastly more power installations and infrastructure must be built at the outset.

Estimates vary wildly depending on the power infrastructure needed for a renewable energy project (the long-distance power lines, for example), but renewable energy may be up to 20 times more resource-intensive than gas per unit of energy. More importantly, that resource demand is needed upfront, not over long periods of time, such as for fossil fuel power plants that are continuously refuelled.

This implies a surge in commodity demand that is, well, off the charts, unprecedented and impossible according to some analysts. This brings us to supply…

Destroying the planet to save it

The same green machine that is driving the world to renewable energy is, of course, also undermining the mining industry. It is, after all, incredibly energy-intensive and dirty to dig up resources, not to mention environmentally unfriendly.

As a result of the strenuous constraints on mining activity, investment in future mines is declining badly for many resources needed for the energy transition. Wood Mackenzie analysed the numbers:

‘Based on our tracking of over 3,000 assets and myriad corporates, their collective committed capex spend is sobering from a growth perspective. Far from tilting into the transition, the investment capex has essentially flat-lined since the lows of 2015.

‘Of even greater concern is the forward trajectory over the next few years, with total capex set to fall by over 70% to 2026. Without the contribution from lithium, the fall is even more dramatic, dropping by over 80% over the next five years. Excluding lithium would leave capex in 2026 at just 6% of the 2012 total.

‘The prevailing market environment will hamper the room to manoeuvre for miners and their investors. This puts their ability to deliver the necessary metals for the energy transition at extreme risk. Some US$400 billion needs to be mobilised by 2030 and it needs to be front-end loaded, given industry lead times. It all seems implausible at best, and impossible at worst.’

Do you remember the days when saying the energy transition is ‘implausible’ or ‘impossible’ would get you cancelled? Well, these days, the maths is coming out…

I’m sure you can see the overall irony here. The net-zero movement, which includes governments around the world, is simultaneously transitioning their energy systems to become vastly more resource-intensive while also trying to limit the supply of resources, both for the same reason — to protect the planet.

The consequences will be a bit terrifying if you ask me. I mean, what happens when the metals needed to build out renewable energy run short?

Will we just abandon renewables?

Will we be forced to reduce our quality of life to match whatever level of energy supply that governments can deliver?

Will spiking metals prices cause inflation right across the economy?

I’m not sure how these questions will be answered. But here’s what I do know: Australia is disproportionately likely to benefit from the possible scenarios.

That’s because our mining industry is disproportionately likely to survive the environmentalists’ onslaught relative to those in the US, Canada, and Europe. Australia is disproportionately likely to source its metals ethically relative to those in Africa, South America and elsewhere. And Australia is disproportionately likely to profit from resource prices spiking thanks to existing mining investments and projects.

We’re talking about a new commodities boom that sends Australia on another burst towards world-leading prosperity, again.

The big question is who will be on board for the latest commodity boom. Next week, we’ll find out.

Regards,

Nick Hubble,
For Fat Tail Commodities