Will the materials and supply chain to build out the energy transition be ready ‘on demand’? Policymakers and wider society want to accelerate the transition to deliver the Paris climate commitments. Yet the ability and willingness to ensure it happens are lacking.
Miners are constrained by investor reticence to sanction faster growth at the expense of dividends, long project lead times and rising above-ground risk. Policymakers are sending the wrong signals, claiming they are open for business and then constraining the development of mining projects that would deliver the metals required. They’re not fully on-board on the need for a massive expansion of primary extraction.
That the energy transition will be built using funding from the hydrocarbon sector either directly or indirectly, is, for some, an inconvenient truth. Oil and gas Majors, NOCs and mining companies are all awash with cash. Extractives are delivering record free cashflow, dividends and profits. With all the cash being generated, perhaps Big Oil offers a solution to kickstart a faster transition?
The involvement of the Majors and NOCs – with their financial clout and willingness to invest a greater proportion of operating cashflows into capex compared with miners – could spur an accelerated energy transition. One possibility is greater renewable energy integration that goes further than investing in wind farms, solar arrays and energy storage. This would mean investing in mining through either acquiring mining companies or equity in projects. If it were a corporate acquisition, a prerequisite would be the need for a healthy pipeline of projects in metals critical to the energy transition, including aluminium, cobalt, copper lithium and nickel.
The funding to build sufficient capacity to meet energy transition needs will be challenging
Over US$200 billion needs to be invested in the supply of critical minerals this decade to meet our base case energy transition outlook (ETO) requirements. This scenario puts the world on a pathway to a global average temperature increase of 2 °C from pre-industrial levels by 2050.
To jolt the world onto a 1.5 °C pathway consistent with the Paris climate goals – our accelerated energy transition AET-1.5 scenario – a further US$200 billion will be required, bringing the total to US$400 billion. Over the next two to three years, the seven oil and gas Majors are expected to deliver around US$90 billion a year in ex-dividend free-cashflow, which would enable the supply development for an accelerated transition to be fully funded in under five years. Including funding from NOCs would bring the timeline forward even more aggressively. Add in funding from the major mining houses, and getting onto the 1.5 °C pathway might just be possible.
Will the markets reward Majors investing in the low carbon economy?
It’s worth noting that upstream Majors that have invested in renewables or in low-carbon infrastructure have not been rewarded by the investment community recently. But their peers that remain more focused on hydrocarbon discovery and delivery have been, and have arguably generated superior returns. The challenge is that renewables have commoditised ungeared returns in the 5-6% range whereas investments in upstream would look to return IRRs of around 15% post-tax. In the mining space, typical project IRRs are in the 10-12% range.
The sceptic would argue that energy companies buying into metals and mining offer too many cons and very few pros. Upstream companies with a foot in mining are few and far between and the recent history is one focused on divestment rather than acquisition.
What’s the attraction of mining for upstream oil and gas companies?
- Investment: investing in multi-decade growth extractive industry which requires some US$400 billion in supply investment over the next three to five years to ensure an AET-1.5 pathway is achieved. This will offset the downside trajectory of upstream oil and gas.
- Returns: the mining of critical minerals required to deliver the energy transition will provide higher returns than renewables investments. This will also provide the necessary raw materials to support the build-out of renewables and charging infrastructure, enabling faster decarbonisation.
- Synergies: an opportunity to invest in an extractive industry with natural synergies which include strong exploration credentials in inhospitable environments, appetite for risk, ability to leverage government relationships, experience of joint venture partnerships for risk mitigation and the ability to provide large-cap funding.
- Diversification: NOC-driven economic diversification adds value to and replaces petro-dollars.
What are the negatives associated with upstream oil and gas companies investing in mining?
- Cyclicality of metals which have no ‘market balancing’ group of producers, such as OPEC.
- Investors in publicly listed oil and gas companies are resistant to diversification, preferring pure plays.
- ESG risks are potentially more problematic.
There are many examples of upstream companies investing in renewables but few are dipping their toe further into the energy transition material supply chain. The examples of co-investments are predominantly government-controlled, small in scale but possibly a taste of things to come.
- SAFT is a wholly owned affiliate of Total Energies, specialising in advanced technology battery solutions.
- GALP, the Portuguese energy company, has established a 50:50 JV with Northvolt, a Swedish Li-ion battery manufacturer, to develop a lithium chemical processing plant.
- YPF, the vertically integrated Argentinian state-owned energy company, has created a lithium unit to survey lithium salt deposits in Argentina. It has also had discussions with CATL, the Chinese Li-ion battery producer, on the potential for a joint venture.
- Kobold is a mineral exploration company set up with Breakthrough Energy Ventures, BHP, Equinor and private equity. The entity is using AI and cloud-based computing to explore critical minerals in Greenland.
NOCs and sovereign wealth funds can dive into the supply chain without being punished by capital markets. Whether it’s the integrated oil and gas Majors, NOCs or mid-caps that lead the charge into metal supply, the one certainty is that investors would benefit from access to mined commodity markets with explosive growth. There is the added benefit that this would make a significant contribution to delivering decarbonisation commitments.
It’s said that the definition of insanity is doing the same things the same way and expecting different results. Without the injection of capital that the Majors and the NOCs could deliver, I fear the continued lack of investment in the necessary metals supply critical to a faster energy transition will keep the Paris Climate goals out of reach. And that may be a form of climate insanity.
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