There are all sorts of wars, a shorthand term beloved by politicians, economists and journalists. There is the trade war, the diplomatic war, the new Cold War, the war against the pandemic.
Yet another one is on the horizon – the infrastructure war – and it goes a long way to explain why commodity prices are soaring, with some of them, including copper and iron ore, hitting record prices in recent days. The war could trigger a new commodities “super cycle,” if we’re not in one already.
The infrastructure war is as much geopolitical as economic. It pits America against China, each of which is trying to lock up the resources required to rebuild their infrastructure and ramp up the transition to a clean economy, which will require vast amounts of copper, cobalt, nickel, zinc and steel to produce everything from electric vehicles (EVs) and wind turbines to “smart” power grids and solar panels. CRU, a London metals consultancy, estimated that an EV requires 84 kilos of copper, 30 kilos of nickel and eight kilos of cobalt.
The problem for America and the rest of the Western world is that China probably has a decade-long lead in securing the supplies of these metals.
China, for instance, dominates cobalt production in the Democratic Republic of Congo, source of three-quarters of the world’s supply. It dominates nickel production in Indonesia, one of the world’s biggest producers of that metal. It dominates the production of bauxite, the main source of aluminum, in Guinea, which holds the world’s biggest reserves of aluminum ores, and is an enormous player in the rich copper belts of Chile and Peru.
The Chinese mining companies send all those metals back to China, essentially removing them from the world market. Everyone else has to compete for increasingly scarce supplies, driving the price up.
Rising demand is hard to meet. Saudi Arabia can dial oil production up and down on short notice. By definition, mines operate at 100 per cent of capacity, or close to it. Boosting capacity can take years, sometimes a decade or longer. The resource has to be found, environmental studies have to be written and building permits secured. The mine has to be built, sometimes the smelter too.
The scramble for commodities that are in short supply has sent prices soaring. Last week, the Bloomberg Commodity Spot Index reached its highest level in a decade after climbing 70 per cent since its pandemic low in March, 2020. On Monday, copper went to a record US$10,747 a tonne, more than double its pandemic low. On the same day, iron ore, the main steelmaking ingredient, also went to a record high, reaching almost US$230 a tonne.
To be sure, competition from China for metals is not the only factor driving up prices (oil, timber and food commodities such as corn and soybeans are also on a tear). The Western mining industry intentionally cut back in recent years in the name of capital discipline.
Almost two decades ago, China’s demand for every commodity climbed relentlessly as it tooled up its industrialization program and began to move hundreds of millions of people into cities. Demand forecasting came into vogue and analysts assumed that the hunger for metals would almost double between 2005 and 2020 – twice the historical growth line.
The big mining companies – BHP, Rio Tinto , Anglo American , Glencore , Vale, Teck Resources among them – went on spending sprees that were supported by shareholders. Bank of America Merrill Lynch estimated that capital spending between 2003 and 2016 reached US$1-trillion, boosting the supplies of key commodities – aluminum, iron ore, coal, copper, nickel, zinc – by 50 per cent to 100 per cent.
The cycle peaked about 2012, after which prices began to soften. By 2015, the party was definitely over and the heavily indebted mining companies saw their free cash flow (operating cash flow less capital spending) shrink alarmingly. Capital spending was slashed as shareholders suddenly demanded dividends, not growth. Share prices sank and several big-name chief executives were shown the door. There were even whispers of mining equity values going to zero.
Mine development all but stopped. At the same time, Chinese mining companies were taking advantage of low prices and jumping into regions where others fear to tread, like the DRC. Then the pandemic came and commodity prices fell off a cliff.
Judging from today’s commodity markets, it’s hard to imagine the pandemic ever happened. Economies are rebounding as the vaccine rollout gains momentum and stimulus measures remain lavish, lifting prices. EVs are going from fringe to mainstream products. Their demand – about three million cars last year – will double, then double again in the coming years.
For Europe and America, especially America, the big difference is infrastructure. U.S. President Joe Biden wants to unleash US$2.3-trillion of infrastructure spending, running for almost a decade. It is the biggest program of its kind since the late 1950s, when construction began on the interstate highway network. The Chinese are diving back into infrastructure and plan to dominate the EV market, including the commodities required to build those products.
Mining companies inevitably will get back in the business of opening mines. But stung by the 2015 experience, they will move cautiously and the new mine opportunities will be scarce, since big undeveloped deposits are rare or owned by the Chinese. If ever there were a bullish scenario for commodities, this is it, but the scenario favours China, not the West. China has won the first round of the infrastructure war.
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