Miners should focus on countercyclical exploration, output

The rush to decarbonise has created unprecedented demand for battery metals. The International Energy Agency (IEA) has estimated that by 2040 demand for lithium will grow by a factor of 40, as it will for cobalt and nickel.

It therefore feels counterintuitive that metal prices and drilling have declined considerably since the beginning of the year. Lithium prices have come down 70% and nickel prices 40%. Copper prices are edging towards a low for the year and cobalt is nearing record lows.

If decarbonisation will generate demand, and by extension shortages and upward price pressure, what explains the downturn? It is being shaped by the downturn in China’s economy, combined with increased supply of these metals.

Let’s unpack these. China’s economy has been facing a range of challenges, including slow growth, curtailed demand, high youth unemployment and a collapsing real estate market. These factors have created a vicious cycle that the Chinese central bank’s interest rate cut in August — the second in three months — has been unable to break. 

China’s consumer electronic sales contracted by double digits in 2022, and another double-digit decline is expected for this year. Growth in electric vehicle sales have tapered off, and on the real estate front more than half of China’s top 50 property developers have defaulted on debt repayments.

Country Gardens, China’s biggest private sector developer, had a 44% decline in year-on-year sales during the first half of 2023, and its share price has dropped 70%. It too is moving towards defaulting on its debt. 

The second factor is a growing surplus of key metals. This is a result of a number of new mining projects entering production in emerging markets. Indonesia’s uptick in nickel production has had a downward effect on prices, even forcing mines such as Glencore’s New Caledonia nickel mine into unprofitability.

The nickel surplus has been exacerbated by China’s falling demand — with a population of 1.2-billion, the Chinese market has a profound effect on global demand. 

The decline in prices has accompanied a decline in broader mining sector activity. S&P’s Global Market Intelligence releases the pipeline activity index (PAI), a single score that measures the level of activity in the commodity supply pipeline, incorporating drill results, initial resource announcements, financing and positive project development milestones. In September, the PAI reached its lowest level since May 2020, the height of the pandemic.

An important question to ask is whether the curtailment in mining activity is short-sighted. Aggregate demand for critical minerals is still forecast to increase from 10-million tonnes in 2020 to 100-million tonnes in 2040, and to reach 150-million tonnes in 2050. Most of this surge will be driven by a large increase in electric vehicle sales. 

Unlike manufacturing and agriculture, the mining sector has a lag in responding to market conditions. Consider that mining exploration has about a 1% success rate — 99% of projects never make it to production — and it can take up to a decade from exploration to production.

If demand surges in 2030 and mining companies decide to boost exploration and mine construction efforts the world won’t see the consequent increase in supply for five to 10 years. 

There is therefore a compelling argument that mining companies should engage in countercyclical exploration and production. When discussing the state of the sector with mining executives from some of the world’s largest firms recently they reminded me that the sector is facing structural challenges — most notably that high-quality ores are quickly running out and firms are having to dig deeper to find lower quality ore. This makes greenfield investment a time-sensitive priority. 

It is short-sighted though. Long-term market fundamentals are good. The lag in exploration and production will not serve mining companies or consumers well.