The supply chain disruptions which marked the early months of the coronavirus pandemic have cast a long shadow. Once economies around the globe began to reopen in the second half of 2020, numerous shortages cropped up across a variety of industries.
Commodity prices skyrocketed. Crude oil, lumber, and important metals like copper and aluminum all saw prices surge to multi-year highs, sending negative effects rippling across the wide range of sectors that depend on these commodities.
Copper Price Surge Eroding Renewable Margins
The clean energy sector, in particular, has seen its margins squeezed. While renewable energy technologies become more competitive when oil prices are high, the sector is also highly dependent on base metals—including copper, which hit record high prices earlier this year.
Copper, one of the best conductors of electricity, is extensively used in the production of electric vehicles, wind turbines, and solar panels. Offshore wind farms, due to their extensive cabling, are particularly copper-intensive, requiring 9.6 metric tons of copper per megawatt (MW) of energy capacity. Onshore wind farms and solar photovoltaics (PV) are also highly copper-intensive, requiring 4.3 tons and 5 tons of copper per MW, respectively.
The copper market will come under increased pressure as each of these renewable energy technologies is projected to grow rapidly over the next three decades, with knock-on effects for investors in the renewables sector. Indeed, the surge in copper prices is already eroding margins on many clean energy projects.
Norwegian oil and gas company Equinor (formerly Statoil)—now a major developer of wind farms— has begun lowering investor expectations on its renewable projects. The company recently dropped its guidance from 6-10% returns in 2020 to 4-8% this year. Denmark’s Ørsted A/S (formerly DONG Energy), the world’s largest offshore wind farm developer, said returns on capital employed fell from 11% in the first quarter of 2020 to 7.5% a year later. Danish competitor Vestas Wind Systems saw returns fall from 17.4% to 12.2% over the same period.
If this trend continues unchecked, many renewable projects might become financially unfeasible for all but the biggest companies with the deepest pockets.
The Cure to High Prices
Will copper supply challenges derail the energy transition in its infancy? There are certainly concerns about a looming copper shortfall. Citigroup estimates that the global copper market will reach a 521,000 metric ton deficit in 2021, a gap which only threatens to deepen as the green transition accelerates. Analysts have warned that the copper industry needs to invest more than $100 billion to avoid what could be an annual supply deficit of 4.7 million metric tons by 2030. Such a substantial gap would undoubtedly keep copper prices high and continue to erode margins on renewable projects.
There’s truth, however, in the old adage that “the cure to high prices is high prices.” Commodity markets are cyclical precisely because high prices spur investment. Eventually the new investments cause production of the commodity to increase, prompting the commodity’s price to drop. If prices drop too much, then investment dries up and oversupply eventually turns into deficit — completing the cycle.
When oil prices surged to over $100 a barrel, projects that were once economically unfeasible suddenly became more attractive and investment poured into the oil industry. The shale oil boom ensued, and a number of heavy oil projects were implemented.
Likewise, the copper deficit that has sent prices soaring has sparked short term pain, but there’s a silver lining: copper’s elevated prices are leading to a flurry of investments in projects that once would have been financially unfeasible.
Fresh Supply from Udokan and Codelco Could Change the Game
Take the Udokan deposit, for example, which is Russia’s largest untapped copper deposit and the third largest in the world. Despite the fact that Udokan holds estimated reserves of 26.7 million tons of copper, the site has remained undeveloped since its discovery in 1949 due to the technological and logistical challenges involved in exploiting the remote site near Lake Baikal.
For decades, the biggest obstacle to mining the Udokan deposit was simply that the technical challenges drove the extraction costs to an uneconomical level. Each time enthusiasm for developing the project grew, the economic risks deterred investors. High copper prices and projections of strong demand growth in the decades ahead, however, have finally swung the pendulum back in the direction of development.
Russian billionaire Alisher Usmanov won the right to develop Udokan more than a decade ago, paying $500 million for the license to the substantial copper deposit. Usmanov formed the Baikal Mining Company, later rebranded as Udokan Copper, to develop the site, and the project is expected to become operational next year. The ramifications are likely to be substantial, both for the region as well as for the broader copper market. By being built in the 2020s, the Udokan project is expected to place ESG guidelines at the core of its operations in ways that older mines never did.
Usmanov is not the only investor taking advantage of high copper prices and demand. Average ore grades in Chile, the world’s largest copper producer, have fallen by 30% over the last 15 years—but state-owned Codelco is finally sinking cash into its deposits after decades of underinvestment.
Chilean President Sebastián Piñera recently kicked off the Rajo Inca expansion of Codelco Salvador copper ops. The $1.4 billion expansion will shift extraction from underground mining to open pit mining and is projected to increase production by 50%. Copper grades are expected to be 40% higher than present operations, and the lifetime of the project will be extended to 2070.
What’s more, the Rajo Inca expansion is only one pillar in Codelco’s plans to re-energize Chilean copper mining: the state copper company intends to execute some $35 billion in structural investments over the next decade.
With this new investment expanding copper supply, the prevailing doom and gloom may prove short-lived. Today’s high copper prices may well bankroll the mines which will supply tomorrow’s renewable revolution.
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