Global resources equity investing is in the midst of fast-paced and profound change. The transition from the ‘super’ to ‘normal’ commodity cycle has presented a host of challenges for many resource companies, perhaps felt most acutely by upstream commodity producers.
To focus attention only in this area, however, would be to miss a much bigger picture.
A number of structural growth opportunities are starting to emerge in the resources space. For example, look at the emerging structural growth area of lithium-ion batteries and the huge potential that cost-efficiency advances present for this market.
It is expected that this battery technology will be a transformative energy solution that will present long-term investment opportunities that are not reliant on the commodity cycle. The locus of this change is taking place in the electric vehicle (EV) market.
Today, we are at an inflection point in this demand-driven trend, that owes principally to the arrival of cost-effective rechargeable batteries. Spurred, but importantly not led, by the scandal surrounding Volkswagen’s emissions testing irregularities and the United Nations Climate Change Conference in Paris, we are now on the brink of the mass commercialisation of electric vehicles which will drive significant global battery demand growth for the next 10 years.
We expect EVs to soon become cost-competitive, with internal combustion engine vehicles (ICEs). The key driver behind this trend will be the rate of decline in rechargeable battery costs, as battery packs comprise 30 per cent to 50 per cent of total EV production costs.
One of the principal drivers that will enable EVs to reach full commercialisation is to have a sticker price on a par with an equivalent ICE on the showroom floor.One of the principal drivers that will enable EVs to reach full commercialisation is to have a sticker price on a par with an equivalent ICE on the showroom floor. In other words, we do not believe that consumers always evaluate price competitiveness on an ‘all-in’ cost basis – that is, including fuel and maintenance costs, both of which are currently competitive for EVs when compared to ICEs. It is unlikely that changing fuel costs and hence the oil price will act as a particularly important driver for the take-up of EVs.
The scale of the opportunity for this mass commercialisation can be seen in the chart, which projects rapid growth in the number of vehicles sold, through to 2020. Ultimately, we see EVs gaining a 7 per cent share of new sales by 2020 and eventually growing to become dominant within the automotive market by 2030.
Disruptive technologies
The notion that EVs could fully replace the ICE in the not too distant future may seem far-fetched, but it is important to remember that paradigm shifts are often only obvious retrospectively. The first commercial LCD TV was released in 1984 by Casio, and although it took until 1999 for LCD TVs to enter the mass market, LCDs had silently and completely replaced cathode ray tubes as the resident technology by 2014.
Clearly, TVs and cars are two completely different purchases. None the less, the timeframe for the change is not only relevant, but also disturbingly similar for the change to the car from the horse and cart, with some arguing that wholesale disruption in the early years of the last century took just 13 years. @Image-ae14a549-58ea-4400-9f82-2dee5c7daa91@
We believe a 15-year average timeframe for complete disruption of the ICE market (so that EVs make up 100 per cent of the global car pool by 2030) is probably a fair estimate, and that the key driver, currently overlooked, is the rapid and continuing decline of rechargeable lithium-ion battery costs.
While battery manufacturers should see strong production growth ahead, we remain sceptical of their ability to generate attractive returns in a market in which, ultimately, falling prices are not only necessary to grow volumes, but are already embedded in contract structures. As an industry, we believe that it is ripe for commoditisation in a manner similar to that witnessed by solar over the past decade.
In our opinion, the best investment opportunities are to be found in companies that offer genuine competitive advantages in niche areas further along the supply chain. In particular, our analysis shows that lithium miners, cathode and separator manufacturers will be the key beneficiaries.
Lithium producers: Until recently, lithium demand has been dominated by industrial applications and has historically grown at a factor of 1.1 times gross domestic product growth. While lithium accounts for just 3 per cent of battery production costs, we foresee demand and price rises ahead as it is the ever-present raw material in lithium-ion batteries.
Cathode manufacturers: Cathode manufacturers produce the chemistry, which largely determines the performance of the battery, and they own or licence the intellectual property surrounding it. Unlike battery manufacturing, it is a complicated process for the newer technologies and a more oligopolistic market overall.
Separator manufacturers: Separators provide a crucial safety function, and as such form an integral part of a battery-incorporating cathode technology. Together with high barriers to entry in this area, this should sustain demand, pricing rigidity and economic profits for producers. We see minimal scope for disruptive technologies to threaten this area over the coming five years.
The mass commercialisation of EVs is at an inflection point that is being underpinned by the increased cost-competitiveness of rechargeable lithium-ion batteries with traditional internal combustion engines. That presents a tremendous investment opportunity in particular, as analysis indicates that future demand for lithium-ion batteries and the falling production costs are materially underestimated by the market.
Duncan Goodwin, head of global resources at Baring Asset Management
| Key points |
A number of structural growth opportunities are starting to emerge in the resources space. The notion that EVs could fully replace the ICE in the not too distant future is not as farfetched as it sounds. The best investment opportunities are to be found in companies that offer genuine competitive advantages in niche areas further along the supply chain. |
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