How do you see the current geopolitical situation and the deglobalization of supply chains impacting the growing relationships between the upstream and downstream industries?
It’s an interesting topic, given current geopolitics and the economic rationale for deglobalization of supply chains in general. A lot of this we’ve seen since Covid, combined with the impact of the war in Ukraine, influencing how materials are traded around the world.
Europe and North America are becoming much more active in the downstream, in domestic production of certain technologies, for the energy transition. That is incentivized by government policy, but also by lower total cost of ownership (TCOE) vs. traditional energy sources.
These require more and more critical materials, which were previously processed in China and re-entered the value chain as green energy end products for use domestically or for export.
As a result of higher domestic downstream investment, we’re seeing parts of the supply chain fall into place to be able to fulfill that demand.
Therefore, the demand for primary raw materials is increasing in Europe and North America faster than we have seen over the last 20 years, during which a lot of manufacturing has shifted to Asia, in particular China, and drawn in materials to that country.
How do new government policies and regulations fit into these changes?
The most important of late is the Inflation Reduction Act (IRA) in the US. That is providing large amounts of capital, in terms of grants, tax breaks, and government-backed loans to the industry on the downstream, midstream, and some upstream projects, although fewer on the mining side.
The aim is to ensure US energy security to create a competitive economy in a decarbonizing global market, partly through the delivery of renewable technologies, energy storage, and use.
The financial incentives of the IRA are very significant. So it’s attractive for value chains to set up under such requirements .
In Europe, a particular driver has been the war in Ukraine, the impact that has had on energy costs in Europe, and the supply in particular of gas from Russia.
The cornerstone REPowerEU policy is to move Europe away from Russian gas. However it’s one that also aligns with the EU’s decarbonization targets. Money has been made available for expansion of renewable energy development in the EU.
Then, there are two more regulations coming through: the Net Zero Industry Act (NZIA) and the Critical Raw Materials Act (CRMA). These policies aim to expand not just the rollout of renewable technology and energy storage in Europe, but also the production of such technology and the raw materials required for it.
Where in the US we’ve seen the all-encompassing IRA, in the EU it’s split between different policies.
As a result, when they come together, as they’re expected to over the next year, you’ll have a policy environment where whole value chains are incentivized to grow in Europe, similar to the US.
Let’s look at the emergence of Western OEMs as strategic partners within this story. Whether it’s through investments, offtake agreements, or project finance, what role do you see for the OEMs within this value chain? What is the allure of these future commodities to investors that haven’t been active in the industry previously?
This has been an interesting development over the last 12 to 18 months. It brings predominantly US OEMs, but also European OEMs, into an area that we’d previously seen more activity from Asia, particularly China.
From Asia, we’ve seen either the midstream of the value chain, refinery, and even downstream customer interest in raw material financing and supply deals outside of the country that those entities were based in.
A similar situation exists in North America and Europe as it does in Asia today, where a lot of the raw materials required for the energy transition are not available in sufficient supply domestically.
The Global South, alongside Canada, has significant resources of said materials, and therefore attracts partnership opportunities between mid and downstream entities, and upstream projects.
Building on that, we’re seeing a shift in industry demand in North America and Europe for raw materials vs. hydrocarbons. Given what they are replacing, they are becoming more strategic to those industries and eventual users, product manufacturers, as well as for national security.
We’ve also more recently seen downstream companies using their balance sheets to invest in upstream raw material supply and projects to catalyze developments. Largely because everyone’s aware that there’s only a finite amount of material available from current production, and that you need to bring along new production in order to continue that availability of the material with such high demand growth.
We’ve started to see companies like General Motors, Ford, and Stellantis becoming more active on partnering up with raw material projects, especially in the battery value chain.
We’ve seen a small amount of activity from Europe, but not as extensively nor with such significant capital associated, at least in terms of what’s been publicized. It’s possible that will come in the future, including from domestic projects given the ambition of the CRMA (for 10% mined and 40% processed critical and strategic raw material supply).
You talked about the criticality of these metals and why the downstream is looking to get involved at the project level. Is this type of financing the missing link in helping to ensure supply of these key materials needed for the energy transition? Are these investments meaningful to the industry?
I think this is a key feature that has really dragged on the growth of critical and strategic materials projects. It’s not a well-understood, mature sector that the mainstream project finance banks are comfortable with investing in either (through equity or debt.)
That means that critical and strategic raw material projects have typically struggled in the past to attract similar financing to precious or base metals, where the market is a little bit better understood and markets or exchanges exist, where investors are able to de-risk the price for raw materials. Projects need to be competitive in the current global market.
A lot of critical and strategic raw material projects typically have a small number of users, and those products are still a rather nascent market in terms of size and value. Any one project can look quite significant vs. base or precious metals where even a significantly sized project may not move the supply/demand needle.
That raises questions about the price of the commodity, the destination for it, reliability of demand, and the economics long term. That’s more difficult for typical financing sources to accommodate and be comfortable with.
Having some strategic partners involved in these projects helps to de-risk. Either the capital they’re investing to secure the material, offsets the wider project finance requirements, creating more comfort for the commercial entities with the proposition, or it guarantees that a market for the product exists through offtake, (sometimes with price boundaries that guarantee revenue.)
Downstream investment is almost a seal of approval given the financing de-risking elements baked into it.
Downstream investment is almost a seal of approval given the financing de-risking elements baked into it
Would you say that downstream investment is more ESG driven because it’s so tied into the energy transition?
That’s definitely a component of it. When you think about ultimate product manufacturers, you’re expecting them to have a supply chain that is also aligned to your requirements as a consumer.
ESG is front and centre of that focus in terms of projects. Also, carbon footprints are becoming increasingly more important.
Those two factors are a big driver of the interest and the appetite for some of these new investors that also have a more strategic requirement for the product.
The other area is around wider incentives and how that fits into the equation. With the IRA and the tax credits available for electric vehicle production in the US, for example, a proportion of the materials need to come from countries that are free trade partners with the US, or potentially, will have some kind of raw material partnership agreement with (now or in the future.)
Possibly, the EU approach will go somewhat in the same direction. Therefore, the location of the projects is also important, as it ultimately translates down to incentives and savings for those companies that are investing in them.
That’s why we’re seeing particularly strong interest from North American OEMs into Australia, because of the ESG stamp on those projects, and the free trade proposition that delivers savings.
Also, some products may be more aligned with domestic value chains rather than having to send them through Asia or a third party, to process into a useable form.
To summarize, the four components are probably ESG, carbon footprint, incentives, and the supply chain fit.
Any final thoughts on the further direction that you see this whole industry and value chain moving?
We have not yet seen much movement from places like North America, Europe, and Korea in terms of state funding or guarantees to commercial banks or industry, moving into sectors aligned to either industry or government relationship building.
If you take the example of Japan, it has been very active in overseas raw material project developments in the past, like with copper in Chile, but has been very light on what you’d say are true critical and strategic materials of the more nuanced sense, barring a few exceptions (Lynas for REEs and Alkem for lithium at the start of the 2010s).
As it stands today, there isn’t a similar mechanism set up in North America and Europe on the state-based approach of financing and securing raw materials. The US DFC and ExIm Bank have been charged with this task by the US government, but, with commercial project finance banks, they don’t have significant experience in this particular area.
To leverage political partnerships on raw materials, what may emerge is more of a JOGMEC-type entity out of the USA and Europe, that will become the cornerstone institution to de-risk financing using state bank or government capital to finance the development and the production of raw materials.
That set up could benefit the downstream industries that are traditionally the big driver of economic development, but it needs to be part of long-term economic planning, something China has excelled in to elevate it to the leading player in many energy transition industries now coveted by other nations.