About this report
This report explores the changes taking place in the global economy in terms of energy security, sustainability, and geopolitical influence. We also review the rise of emerging markets as commodity superpowers due to their natural resource allocations and the impact of this on evolving geopolitical associations. We consider the potential impact of ESG regulations on the development of renewables. We review how all of these factors may combine and what impact all of these factors are having on the influence and wealth of emerging markets. Finally, we consider what the impact may be for financial market investors in terms of currency, bonds and equity markets.
Executive Summary
What has emerged over the past few years following the Covid pandemic and the widening of geopolitical risks following the invasion of Ukraine by Russia, is that energy security and supply chains are critical to a country’s growth. As a result, many countries are trying to reshore commodity supply chains for security, geopolitical, or sustainability reasons. It is also becoming increasingly clear through the rise in extreme weather events that climate change is accelerating. The devastating consequences of climate change, along with advances in technology, may speed movements towards global decarbonisation with 140 countries having agreed to be “net zero” emitters by 2050. The transition to “green” energy is expensive as it requires significant investment in power generation, grid distribution, carbon storage and other energy infrastructure requirements. To achieve the move to a more sustainable, carbon neutral future and improve energy security, countries are coming to rely on a combination of regulatory changes, industrial policy, and fiscal expenditures. All of these may have positive implications for those countries, particularly emerging markets (EMs), with the natural resources necessary to create those renewable energy technologies.
However, there are certain issues that may impact the ability of commodity rich countries to become superpowers. Among these are:
- Geo-fragmentation of mineral markets would make not only the energy transition more costly, it may induce more supply shocks, volatility, and uncertainty in commodity markets. Developed markets will likely rely more on ‘re-shoring’ and ‘friend-shoring’ critical supply chain elements rather than investing in EMs.
- The elasticities of demand and supply of critical minerals are low, so trade disruptions could add to upward pressure on mineral prices. If it is too costly, there would be a drop in demand and these countries cannot reap the benefits from oversupply.
- Competition from well established commodity superpowers such as China and Brazil, who are already doing more processing and value-added manufacturing domestically.
The opportunities and risks for financial market investors exist in a number of spaces including direct investment in commodities, particularly rare earth metals as well as in companies associated with the sectors, EM currencies, and financial products that are “green” and/ or sustainable.
In short, there is both caution and hope for countries with significant rare earth mineral endowments. However, global relationships must be watched closely for changing geopolitical concerns and realignments. Investors and businesses need to remain alert to these changing dynamics as they consider their portfolio holdings.
Setting the Scene: Changing global patterns and power
As noted by the IMF in its October 2023 outlook, the invasion of Ukraine in 2022 caused major commodity markets to fragment. And, over a year and a half on, this geo-fragmentation has worsened as tensions have risen between China and the US over Taiwan and China’s activities in the South China Sea against US allies such as the Philippines, after the attacks against Israel by Hamas in October has threatened a widening of the conflict across the Middle East region, and as the tensions between NATO and Russia remain high. It appears that we are now facing a global question around energy production and supply. It has raised a trilemma that focuses on concerns around energy security, sustainability and affordability.
The question of sustainability has become an increasingly complicated one. It is becoming clearer that the pace of climate change is accelerating. The devastating consequences of climate change, along with advances in technology, may speed movements towards global decarbonisation. However, the transition to clean or “green” energy is a complex undertaking, requiring significant investment in power generation, grid distribution and other energy infrastructure requirements, energy and carbon storage, transport, and other infrastructure. The global 2050 carbon emissions targets, based on the 2015 Paris agreement to reach “net zero”, the amount of greenhouse gas (GHG) that's produced and the amount that's removed from the atmosphere, has, as noted by the United Nations, been adopted by more 140 countries, including the biggest polluters – China, the United States, India and the European Union. This covers about 88% of global emissions. This means that a green energy revolution will be required to meet the target. And the world remains unprepared to meet the level of raw-materials demand that will result over the next 5-10 years.
As a result, there has been a new focus on renewable energy and those technology products such as electric vehicles (EVs) that are perceived by many to be more sustainable. The focus on renewable energy may also be attributable to the desire of a growing number of countries to improve their energy security by reducing their reliance on volatile international energy markets that can be easily swayed by changes in supply and demand as well as by sudden geopolitical events and natural disasters. This was evidenced by the impact on oil, gas and grain markets that the invasion of Ukraine by Russia had. In its recent World Energy Outlook 2023 report, the International Energy Agency (IEA) said it expected demand for coal to peak before 2030 due to momentum and growth in clean energy. The IEA also said growth was especially notable given high interest rates, inflation, geopolitical conflict, and unsettled energy markets.
As the world slowly weans itself off polluting fuels such as coal, oil, and gas, it will need to switch to cleaner energy sources such as solar, water, hydrogen, and even nuclear. As noted by the IEA, the deployment of renewables in the power, heat and transport sectors is one of the main enablers of keeping the rise in average global temperatures below 1.5°C. In the Net Zero Emissions by 2050 scenario, renewables allow electricity generation to be almost completely decarbonised. In addition, renewable transport fuels and renewable heat can significantly reduce emissions in transport, buildings and industry. The IEA predicts that wind and solar could account for 70% of power generation by 2050, up from 9% in 2020. It also estimates that the global market for key mass-manufactured clean energy technologies will be worth around $650 bn a year by 2030 (approximately €600 bn) – more than three times today’s level. Research published by the International Renewable Energy Association (IRENA) in March 2023 found that annual energy transition investments would need to more than quadruple this decade if the world is to stay on a trajectory to limit warming to 1.5 degrees Celsius. It estimates that cumulative global investments required to achieve the Paris Agreement’s climate targets are $5 trn annually over 30 years.
This all potentially translates into massive demand for metals such as lithium, cobalt, copper and nickel, that are crucial for building renewable energy and transport technologies. The IEA says that by the end of this decade, the nascent lithium market needs to triple in size, while copper supply will be short by 2.4 mn tonnes. The global demand for these materials would transform the fortunes of the countries that produce them.
Transition: Regulation leading the way
Policy is important in changing the way energy is supplied and consumed across the globe. The speed of the energy transition is, as discussed by Reuters at its November Energy Transition Insights Event, dictated by varying factors such as global and domestic targets and policies, internal operations, and shareholder inputs. According to the European Commission, renewable energy is expected to grow further to reach over 70% of gross electricity generation in 2030. The European Commission has already noted that while electricity production has remained roughly stable over the past 15 years, the share of renewable energy sources has grown at a fast pace in the EU reaching 38% of gross electricity consumption in 2021 (compared to 16% in 2005).
One of the ways this change in energy production and use will take place is through legislation. In Europe the ‘Fit for 55’ policy package, which has a reduction target of 55% below 1990 greenhouse gas emission levels, puts forward a series of legislative proposals that will require greater investment in renewables. According to the European Commission, to achieve the objectives of the Fit for 55 package, lower total energy demand combined with a significant increase of renewables in gross inland consumption will be needed, with the energy mix of electricity generation already projected to be dominated by renewables in 2025. This means that the demand for base metals, battery materials, rare earths and related minerals and metals will need to increase exponentially as the EU divests from fossil fuels and turns to clean energy systems, which necessitate more minerals. In November 2023, the EU reached a provisional agreement on a European critical raw materials act. With the European Critical Raw Materials Act, the EU aims to ensure secure and sustainable supply of critical raw materials for Europe’s industry and significantly lower the EU’s dependency on imports from single country suppliers. It includes measures to strengthen domestic supply chains and reinforce international engagement to develop mutually beneficial partnerships with third countries. According to the EU, these measures include identifying a list of critical raw materials and a list of strategic raw materials crucial for technologies for the green and digital transition, as well as for defence and space. It also sets benchmarks for domestic capacities along the strategic raw material supply chain to be reached by 2030.
In the US, the policy push is the Inflation Reduction Act (IRA), which is linking green policy to industrial and trade policy. Also, as the majority of some renewable technologies, notably solar photovoltaic (PV) cells, are made in China and China also controls a high proportion of rare earth metals used in renewables including processing capacity for lithium and cobalt, the US seems to view this dominance as a national security threat. As a result, the US introduced legislation to “friendshore” the import of certain minerals, providing generous tax cuts to friendly nations. However, as noted by the Financial Times, the US is not alone in this concern around supply chains as other national and transnational governments are assessing where they can reliably source critical minerals without having to depend on China.
The IRA along with the CHIPS and Science Act, a federal statute signed into law by President Joe Biden on 9 August 2022, which provides approximately $280 billion in funding to boost US domestic research and manufacturing of semiconductors, could be interpreted as direct responses to the perceived threat from China’s resource dominance. As noted by metal, mining and minerals consultancy CRU, rather than just providing a subsidy at the point of power generation, or investment in capacity, the IRA also gives subsidies further upstream in the supply chain, creating incentives to manufacture systems and components for solar, wind, batteries, EVs and inverters within the US.
When will we know when we are in a commodity supercycle?
A new commodity supercycle has been anticipated since at least 2021 due to the need for countries to meet those 2050 targets. Instead, we have seen commodity deflation due to the central banks tightening policy over the past couple of years, raising the cost of capital and draining market liquidity, both physically and financially. Without sufficient capex to create enough supply capacity, commodity minerals needed for production of technologies to reduce emissions and meet those targets will remain stuck in a state of long run shortages, with higher and more volatile prices. According to S&P, a multiyear supercycle requires three indicators: Is supply surging? Is demand surging? Are prices surging? Without passing all three tests simultaneously, commodity markets are not in a supercycle.
However, just because we aren’t quite there yet, doesn’t mean that we won’t be there soon. The International Energy Agency has said that world fossil fuel demand is set to peak by 2030 as more electric cars hit the road and China's economy grows more slowly and shifts towards cleaner energy. According to a report from Bloomberg, “China’s Remote Deserts Are Hiding an Energy Revolution”, China is well on its way to deliver the largest ever deployment of man-made power capacity. It claims it will install more than 300 gigawatts of solar and wind capacity in 2023, almost double the volume a year earlier. The entire global total in 2022 was 338 gigawatts. S&P also notes that a more aggressive commitment to the energy transition across G-20 nations could also create the conditions for a sustained surge in demand, supply and prices. One of the main factors, beyond the cost of capital, that has resulted in underinvestment to date in renewables has been around the actual profitability of renewables. As noted by the European Commission, profitability depends on both the price level of energy commodities and the carbon price, i.e, the external costs of greenhouse gas (GHG) emissions, and the flexibility of the electricity system to reduce the cannibalisation effect that renewables have on their own revenues. To make them profitable and thereby ensure adequate investment, there need to be different types of long-term contracts to help stabilise market revenues of these investments, thereby benefiting both consumers and producers while ensuring market-based solutions. The underinvestment we have seen in this space to date has only made the entire energy system more vulnerable to demand shocks.
What will be needed for the “green” transition?
The elements critical to the energy transition include the 17 rare earth elements. They are called “rare” because they are seldom found in sufficient amounts to be extracted easily or economically.
Rare earth metals are used in a range of “traditional” IT devices such as smartphones, computer hard disks and screens, fluorescent and light-emitting-diode (LED) lights and even in flat screen televisions, lasers, radar screens, and permanent magnets. They are also increasingly used in clean energy technologies including battery production. Lithium, nickel, cobalt, manganese and graphite are crucial to battery performance, longevity and energy density. These metals are essential for use in lithium-ion batteries, so are necessary for energy storage, while other uses include permanent magnets used in wind turbines and electric vehicle motors. Copper is crucial for electricity-related technologies. Although prices in 2023 for lithium have fallen dramatically due to oversupply and a demand-supply imbalance in China in particular, looking ahead it is clear that there will, in part due to regulatory and legislative changes and other factors such as continuing electric vehicle adoption, be significant demand which will result in sustained price increases that suggest a bigger cycle is on its way within the next few years. Hydrogen and carbon markets are also beginning to show growth in both supply and demand. According to BCG, the global demand for rare earths is expected to reach 466 kilotons by 2035, up from 170 kilotons in 2022, an 8% compound annual growth rate. Reuters has noted that although solar PV has led the way as the most popular destination of investment for the last year, the technology is leapfrogged by energy storage, which attracted the greatest amount of investment.
Although these metals are located around the globe, the vast majority of these metals can be found in emerging markets such as Brazil, China, Chile, India, Vietnam, South Africa, Tanzania, Thailand, and Russia with smaller reserves in Australia, the US, Canada, Greenland and other countries. According to the IMF, Latin American countries with large reserves of critical minerals—like Chile, Peru, Brazil, Mexico, and Argentina—could benefit substantially from rising demand for copper, lithium, magnesium, and other essential inputs for green technologies and decarbonisation. With the appropriate policy frameworks, these resources could attract significant investments and may help develop opportunities for Latin American countries to increase their participation in global value chains.
The impact on emerging economies
The rise in the price of commodities has, due to the geographical location of many of these rare earth metals and minerals, potentially immense benefits to many emerging market economies. Although there have been expectations of a commodity supercycle i.e., when the price of commodities rises above their long term average for an extended period of time, it appears to have been delayed both by the emergence of Covid-19 and the tightening of credit that followed by global central banks. The last commodity supercycle was really in the early 2000’s, driven by raw material demand from China’s rapid industrialisation.
Who’s in the lead?
When it comes to renewables production and supply chains, some countries are already far ahead in terms of global production. China controls about 80% of the world’s battery production capacity and also holds a dominant position in the production of solar photovoltaic (PV) supply chain. According to the Financial Times, the leading lithium producers are countries such as China, Australia and Chile, accounting for around 90% of the global market. Other countries are beginning to ramp up production of cobalt, and with regards to nickel, the top three producers are Indonesia, Philippines and Russia, countries that account for two thirds of the market. These countries are now known as “commodity superpowers.” As noted by the Financial Times, many are trying to capture more of the value of their minerals, by doing more processing and value-added manufacturing domestically. Some are also attempting to control the supply, by nationalising mineral resources, introducing export controls, and even proposing cartels.
Dr Yueh at London Business School believes that the focus of the expected supercycle increasingly falls on supply chain resilience, noting that China has had such a head start and that it will continue to be a major player for years to come. Whether US or EU subsidies and trade restrictions, as suggested by the US’ IRA, will prove effective at building up domestic capacity, in the face of competition from China, will depend on the sector. What is clear is that the expected commodity supercycle that this transition will fuel will be very different from prior supercycles. This is in large part due to the vastly differing drivers with the most recent supercycle being driven by one country’s need to industrialise and urbanise quickly. As noted by The Economist, the green transition stems from the decisions of many governments, not one. And decarbonising the world is likely to be the job of decades.
The geopolitical impact
What is clear is that commodity production is often highly concentrated because of natural endowments, and many commodities are difficult to substitute in the short term. The further fragmentation of commodity markets could cause large price changes and more price volatility. As noted by the IMF, the three biggest suppliers of minerals account for about 70% of global production, on average. Coupled with low demand elasticities and their upstream use in many manufacturing processes and key technologies, this means that commodities are highly traded. However, many importers rely on just a few suppliers. This means that when there are trade disruptions, the economic damage will be greater. Emerging markets with high concentrations of rare earth metals are aware of this. According to the Financial Times, over the past year or so, Zimbabwe and Namibia banned exports of raw lithium; Chile increased state control over lithium mining, and Mexico created uncertainty in its lithium industry with a new review of mining concessions. Meanwhile, Indonesia added export controls on bauxite (a key ingredient in aluminium) to its pre-existing ban on exports of raw nickel ore.
It is not just individual governments that investors have to worry about. As we see an increase in geo-fragmentation due to changing geopolitical alliances, commodity producers have a powerful incentive to switch allegiances given potentially significant differences in commodity prices among trading blocs. This would, as noted by the IMF, induce more supply shocks, volatility, and uncertainty in commodity markets, challenging fiscal, monetary, and financial stability. In essence, as geopolitical risks rise, countries, particularly developed markets, will likely become less open and rely more on ‘re-shoring’ and ‘friend-shoring’ critical supply chains that remain highly interdependent and, in some cases, over-concentrated. This may drive up prices. In short, increasing geo-fragmentation in mineral markets driven by security fears could make the clean energy transition more costly.
One example of geo-fragmentation was in July 2023 when China decided to limit the export of gallium and germanium, metals used in the production of a number of strategically important products, including electric vehicles, microchips and some military weapons systems. This further strained its relationship with the US and Europe and has led them to develop their own industrial policies, such as the EU’s Net Zero Industry Act.
So what is very clear is that fragmented minerals markets would make not only the energy transition more costly, but also affect the development of more sustainable and potentially, in the longer run, cheaper technologies. As noted by the IMF, these minerals are highly concentrated geographically, and their elasticities of demand and supply are low, so trade disruptions could add to upward pressure on mineral prices in the bloc where demand exceeds supply after fragmentation. But the mineral-rich bloc cannot reap the benefits from oversupply, as refining capacity cannot be scaled up quickly. And, as noted by The Economist, important investments can become victims of local conditions and geopolitics. Huge rents (corruption) could corrode domestic markets and political institutions. Emerging market autocrats, enriched by these inflows, could create problems beyond their borders by engaging in regional skirmishes or encouraging civil unrest in neighbouring countries and/or regions.
How will this affect financial markets?
The movement towards net zero has also resulted in the rise of sustainable or ESG investing. This market has grown significantly over the past several years with total global ESG AUM at $2.2 trn in 2015 to $18.4 trn in 2021. Investments typically include a focus on equities or ETFs that meet certain ESG criteria or “green” bonds, ie, bonds issued with a commitment to exclusively use the funds raised to finance or refinance “green” projects, assets or business activities. PwC estimates that in the US the ESG AUM of the asset and wealth management industry was $4.5 trn at the end of 2021, but that it could, thanks to regulation, more than double to $10.5 trn in 2026. Globally, PwC forecasts the share of ESG of total AUM would increase from 14.4% in 2021 to 21.5% in 2026, soaring to $33.9 trn. According to Morningstar, global sustainable funds attracted inflows of $13.7 bn in the third quarter of 2023, half of the revised $23.6 bn in the previous quarter. Although there has been a significant growth in interest by retail and institutional investors that exclude the oil and gas industry and focus on what are termed “sustainable” or ESG funds, these industries are still thriving. At present, according to research done by Gautam Jain at the Center on Global Energy Policy at Columbia University, evidence of restricted access to financing for oil and gas companies due to financial institutions’ ESG considerations appears scant at best.
The development of new commodity superpowers would potentially also significantly affect emerging markets along with some developed markets. The Economist has estimated that these new commodity superpowers could pocket more than $1.2 trn in annual revenue from energy-related metals by 2040. However, the history of commodity booms shows that this resource blessing can also be a curse as they may contribute to domestic income inequality and create civil unrest as factions vie to control resources. Resource nationalism tends to increase when commodity prices are high, or when elections are approaching.
Global financial markets are therefore likely to be affected in a number of ways. As noted by Reuters from their survey of participants during their November 2023 Energy Transition event, the two most common drivers for developing an energy transition strategy are compliance with a longer-term business strategy and an opportunity for growth. Equity markets will be affected by changes in financial and operational regulations that may reduce overall profits and hence share values. The EU introduced a Carbon Border Adjustment Mechanism from October 2023, which, as observed by KPMG, will eventually require those importing some goods to pay an equivalent price for their emissions to manufacturers based in the bloc. Australia and the UK, which both have emissions trading, are considering similar mechanisms. According to KPMG, India may challenge the EU mechanism and South Africa is considering how it should respond, but over time border adjustments look likely to reinforce the importance of low carbon production as a source of competitive advantage.
The most obvious way that a supercycle would impact these new commodity superpowers is through their currency. The capital inflows from renewable energy and sustainability projects would lead to the appreciation of the domestic currency. This would have both a positive and negative impact. These inflows may help overall economic growth as it could lead to a relaxation of domestic credit constraints, thereby making domestic investment easier. However, the appreciation of the currency would hurt exporters. Nevertheless, there are significant opportunities for investors in equity markets as mining companies, along with renewable energy companies and technology companies will all have a role to play in the green transition.
A potentially improved growth outlook could have a wider positive knock on effect. With higher economic growth, comes higher government revenues as the tax base widens. This means that for many emerging economies, fiscal outlay would no longer be dependent on issuing bonds at high interest rates. Unfortunately, as noted by The Economist, history has shown that what tends to happen is that governments engage in debt binges during boom times which trigger fiscal crises when the cycle turns. Hopefully, this time around, history will not repeat itself, and mineral rich countries can capture more of the economic value of those resources.
Conclusion
The devastating consequences of climate change, along with advances in technology and concerns around energy and supply chain security are pushing governments towards global decarbonisation. However, the transition to “green” energy from renewables and the use of “green” products like electric vehicles is complicated and will require a significant rethink in how energy is generated, distributed, stored and priced. The next commodity super cycle, based on demand for the minerals required in the green transition, has been anticipated for the past few years, but, largely due extreme events such as Covid and the tightening of global capital that followed, hasn’t yet arrived. However, unlike previous supercycles, the next super cycle is likely to last much longer given that the main impetus, the green transition, will take place over decades.
If countries now decide to start investing in earnest into renewable energy and technologies, they are likely to push through change via regulation and industrial policy to help ensure their own energy and technology security.
For the countries that hold the rare earth minerals and other natural resources necessary for the green transition, their ability to become commodity superpowers will depend on their ability to avoid geo-fragmentation as this will only drive up the cost of the transition with the consequent result of depressing investment and global demand.
For investors the opportunities in the green transition are manifold and include the potential rise in company shares that are engaged in developing transition technologies and mining the resources necessary to do so as well as higher returns on currency trading in these economies. There are also significant opportunities in ESG instruments such as green bonds and in ESG friendly equities.
What is clear is that the transition to renewable energy and sustainable technologies will continue over the next several decades. Whether or not countries will truly be able to become commodity superpowers will very much depend on how well they learn from the lessons of the past and avoid the behaviours and acts that can stifle the global growth in renewables.
References
- Emile Detry, Antoine Gauduel, Frédéric Geurts, Lisa Ivers, Michael McAdoo, Tycho Möncks, and Tom Butler, Boston Consulting Group (BCG): Five Steps for Solving the Rare-Earth Metals Shortage
- Bloomberg: China’s Remote Deserts Are Hiding an Energy Revolution
- CRU, Competing with China in green tech will not be easy
- Gautum Jain, Center on Global Energy Policy, Columbia University, Is ESG Driving Debt Costs Higher for Oil and Gas Companies?
- The Economist: The transition to clean energy will mint new commodity superpowers
- Sebastian Busch, Ruben Kasdorp, Derck Koolen, Arnaud Mercier and Magdalena Spooner, European Commission: The Development of Renewable Energy in the Electricity Market
- EMBER, Electricity Data Explorer
- Eurostat, Statistics Explained. Renewable energy statistics
- The Financial Times: The new commodity superpowers
- The Hill: Documents reveal how fossil fuel industry created, pushed anti-ESG campaign
- International Energy Agency, The Oil and Gas Industry in Net Zero Transitions, November 2023
- Chapter 3: Fragmentation and Commodity Markets: Vulnerabilities and Risks, The International Monetary Fund: Navigating Global Divergences, World Economic Outlook October 2023
- International Renewable Energy Agency (IRENA), Renewable Energy Statistics 2023
- KPMG, Turning the tide in scaling renewables
- Linda Yeuh, London Business School: Green tech is driving the next commodities supercycle
- The New York Times: Is E.S.G. Falling Out of Favor?
- Our World in Data
- PwC: Asset and wealth management revolution 2022: Exponential expectations for ESG
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