Will a recession stall or just pause the great energy transition gold rush?

The war in Ukraine and the sanctions that followed are disrupting trade flows. Concerns that the US and European economies will tip into recession are growing. China, while not immune, will most likely avoid a sharp slowdown. Politicians are increasingly focused on weaning their economies off Russian hydrocarbons and accelerating the move to low-carbon energy supply.

Yet there is a well-flagged concern that the industry cannot deliver the metals required to achieve the Paris accord decarbonisation targets. The great energy transition gold rush may have started but could an economic slowdown provide the breathing space that the metals industry needs?

A demand slowdown would enable miners to catch up on projects – but it would be no panacea

Recessions are a double-edged sword for principals seeking to invest in additional production capacity. On the one hand, lower or negative growth reduces the need for investment in future supply. On the other, as prices and margins fall, the ability to greenlight projects becomes more challenging. Even if there were a recession outside China – it accounts for around 50% to 60% of global demand for most commodities – absolute levels of demand would recover within a year.

In short, there’s no real respite from the challenge of supply development. An acceleration of energy transition uses would also mitigate the downside; in other words, demand growth could just slow.

Rampant demand and supply chain constraints – compounded by the war in Ukraine and Russian sanctions – mean that commodity prices are currently significantly above incentive or marginal cost levels across the metals and mining complex. So even if margins are squeezed under an economic slowdown scenario, opportunities to invest in supply still exist – but the room that miners and metals producers have to manoeuvre will be further constrained.

Are undersupplied markets the new equilibrium?

Principals argue that their ability to sanction projects is not necessarily a feature of a lack of investment capital but rather the inability to obtain permitting, as well as the pace of it. Others argue that prices and returns need to be higher to trigger investment.

There is also a narrative that prices will be higher because projects aren’t happening quickly enough, leading to a ‘new equilibrium’ of markets being perpetually undersupplied. All of these arguments are plausible.

Structural medium-term mined commodity shortages: how will the market respond?

The scramble for access to energy transition resources has well and truly begun. Just like in a game of musical chairs, someone may be left without a seat in the end. Consumers will go short when the transition accelerates. Ultimately, the market will balance with either supply being incentivised to meet demand or demand being tempered to meet supply.

How will the challenge of supply and demand pan out as the energy transition accelerates?

• A race to secure contracts for raw materials leading to higher prices and premia.

Consumers are increasingly scrambling for access to those resources that are ESG compliant, particularly in the battery raw materials space. While long-term contracts provide some guarantee of supply, it does not mitigate extreme price volatility and inflation.

• End users and governments taking equity positions up the value chain.

Governments are raising the stakes with rapidly evolving and expanding critical minerals plans aimed at providing supply security. Absent shareholder appetite for public companies to provide the necessary funding, governments will have to step in to fund or backstop investments to ensure sufficient supply is in place to meet commitments. Consumers will also have to follow a similar path. For instance, electric vehicle (EV) manufacturers will move up the value chain to take up equity stakes to guarantee supply and mitigate extreme price variability and inflation.

But it’s not just auto producers feeling the pressure, energy companies building large-scale renewable energy facilities may need to secure raw materials supply to ensure they can deliver. Auto manufacturers have contemplated equity ownership in mining before but to no avail, while governments tend to shy away from direct involvement.

• Technological innovation adding to a rising risk of substitution.

Thrifting or elimination of commodities that expose consumers to excessive supply chain risk and price volatility has already started. If a commodity is structurally undersupplied and there is sufficient supply of a techno-economic alternative there is a risk of substitution. And the development or adoption of alternative technologies, like eliminating cobalt in NMC chemistries, or the use of LFP batteries and ultimately solid-state batteries, will help alleviate potential structural shortfalls.

• Higher rates of recycling reducing the need for primary supply.

Greater recycling will be a feature of the market bringing with it a lower requirement for primary supply development, lower waste, more security of supply and a lower carbon footprint. The prerequisite for increased recycling will be policy and societal adoption, neither of which will be quick.

So, the simple answer to the original question – whether a recession will provide the breathing space for producers to bring on necessary supply in a timely manner – is no. Recessions are short-lived and, while demand can decline markedly, recovery can be quick, with absolute demand back to ‘normal’ in one to two years.

For energy transition commodities, demand will continue to rise despite an economic slowdown. With typical prices lower and margins tighter during a slowdown, project funding decisions will become more problematic.

The result? The supply shortage actually grows. Consumers will have to get used to volatile markets, elevated prices and a scramble to secure supply. The only guarantee of delivery is ownership – something that consumers and governments will have to embrace if we are to accelerate the energy transition.

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