Posted on the Value Lab 17/3/2022
The discussion around renewable energy has been particularly interesting in the context of the Ukraine-Russia war and the general geopolitical cascade that followed. Renewables have seen a major backlash, with much annoyance among voters that viable energy alternatives have been shunned for what the oil lobbies surely present as a pipe dream. Of course, with the withdrawal of coal, now back in action, and nuclear, unfortunately not back in action, energy has become incredibly expensive. With governments perhaps less keen on supporting renewables at the moment, exposed metals could take a hit. Fortunately, Anglo American (OTCQX:NGLOY)(OTCQX:AAUKF) is not very exposed to this risk, except perhaps in copper. However, we believe that other rumblings could take precedence over this still rather distant concern. Along with thinking about economic disintegration and thinking about strategic and defensive supply chains, a surge in semiconductors could be a compensating or even additive factor that could see more copper reserves held and better market momentum. demand in copper markets. In addition to the continued strength expected regardless of the revolving situation in PGMs, Anglo American looks extremely attractive.
Renewable backlash risk
With regard to copper, the risk of a backlash from renewables stems primarily from the fact that much of the recovery in copper has been fueled by an increasing intensity of the transition to renewables, in particular by Europe which launched initiatives in renewable technologies. Indeed, governments strongly support these initiatives in various ways, and in particular support renewable energy generation that is less capable of producing a strong economy without government assistance such as solar and wind power.
Electrification is also supported by power grids. Red Electrica (OTCPK:RDEIY) in Spain, for example, is defending its government compensation by proposing projects related to increasing the grid’s capacity to absorb energy from sources like solar and wind that produce less regularly. The aim is to increase capacity factors at renewable energy production sites and to support electric vehicles in particular, by ensuring that they are recharged from truly sustainable sources.
Copper is by far the most exposed to the renewables push, and renewables have been the main differential in its price rise over the past two years. As governments worry about how the production of solar panels and turbines could benefit governments that are now viewed with more hostility, especially thinking of China whose stance on the war in Ukraine has been very uncertain, government support for these renewable energy modes could decline. If incentives for electrification also falter, EV adoption will also fall, another major use case for copper. Our hope is that on the backbone of electrification, which is supported by network concession operators, tariff regimes have been in place long enough that concretely reduced support for these initiatives cannot take place until the situation calms down.
PGM, which is another major division for Anglo American, is a bit more agnostic to the renewable transition state. Palladium and other PGMs are not yet used extensively in hydrogen infrastructure as these efforts are still very nascent. Meanwhile, catalytic converters in cars will actually be a stronger market than expected if EV adoption doesn’t pick up as quickly, and indeed if the hydrogen push is also less powerful than expected. This segment is generally more resilient in the current circumstances, and as greater exposure anchors a large part of Anglo American’s results.
The other side of the strategic considerations comes from the situation of dependence on Taiwan for the production of semiconductors. Although Taiwan is a friendly entity, the concern is that depending on how the war between Ukraine and Russia develops, China may or may not be encouraged to enter Taiwan and seize these extremely valuable semiconductor assets. Production in Taiwan is significantly ahead technologically, to the point that a scorched earth strategy may be required to prevent these assets from enriching the Chinese in the event of a successful invasion.
These concerns caused Europe and the United States to start sitting together on councils to start funding their own semiconductor industries. The problem of China and outside forces controlling the semiconductor supply chain has already been serious enough when companies like ASML Holding (ASML) were not allowed to sell their advanced technology to Chinese entities in because of the risk that it will be copied, or at the very least the risk that Chinese entities will have access to the advantages provided by these technologies.
One of the big concerns about the push to support semiconductors in Europe and the United States is that it will lead to greater competition over scarce resources for semiconductor production, and that the ascendancy of these industries of explicit strategic geopolitical importance will mean that resources like copper could also become hoarded. Hoarding activity and the rise of copper as a major strategic resource could be the source of even more price increases.
Anglo American is quite exposed to copper. Around 17% of its EBITDA comes from this division. We believe there will be a setback for the renewables push due to its unfortunate timing, where a premature shift away from fossil fuels means major pressure on Europeans right now. However, with semiconductors now becoming something of a defense exposition, implicitly backed by national security interests, copper as a critical resource for semiconductors and computing will become more prominent.
The rest comes from PGMs and bulk. Bulks has its own history tied to China, where steel mill caps and other “green” measures have brought the price of iron ore down significantly. There are other reasons for this, such as concerns over overheated construction markets in China, where they have a major ghost palace problem on their hands.
As mentioned earlier, PGMs are going to be quite resilient on the demand side. Indeed, on the supply side, the potential blockage of Russian PGM supplies from the Western trading bloc has already pushed their prices up significantly. Although there has been a reversal, prices are still above previous local highs by a clear margin. We remain bullish on the commodity, hence our continued position in Anglo American Platinum (OTCPK:ANGPY).
While the only marginal pullback from the highs indicates continued enthusiasm for Anglo American’s mining portfolio, we believe the current geopolitical situation can only further support copper, subjecting its price to a lasting paradigm shift. While there are risks that would include a quick resolution to the Ukraine-Russia conflict beginning to ease pressure on commodities, with an increase in supply generally over the next couple of years, an impetus for even more drop in commodities, these risks are very marginal for the thesis. With bulks being the single most fragile area, we believe that PGMs and copper will continue to generate margins. As a result, Anglo American remains attractive both for its low value at just 7x PE and the prospect of continued stock momentum as semiconductor concerns only worsen, not fall. improve, with copper playing a central role.