Interview with Michael W. Scherb, CEO and Founder, Appian Capital Advisory

May 3, 2021

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How will the mining industry respond to the rising demand for clean tech metals?

Michael W. Scherb: Mining companies are classic ‘lag’ businesses with long lead times for mines to get into production, so they were slow off the mark in responding to clean tech demand. That’s reflected in the current prices for copper and nickel that are at seven-year highs. People realise that there is going to be a supply and demand mismatch. However, I don’t think that even current prices reflect the full extent of the gap between supply and demand, which will become more apparent in the future.

We’ve all seen the statements, pledges and commitments from policymakers and carmakers, that by 2040 or 2050 there will be no more internal combustion engines (ICEs). That’s a great target to have but it isn’t feasible from a copper supply standpoint. To replace all existing ICEs with electric vehicles would require using every piece of copper ever found. The standard response is that we have to find more copper. OK sure, but in the last ten years there has been just one major discovery – Kamoa in Congo. Yes, there are big mines that are about to come online but in terms of discovery most of the low-hanging fruit has already been picked.

That means Latin America has an important role to play in the transition, as it has the world’s largest copper and lithium resources so it’s going to be the key supplier of clean tech materials for the energy transition. Every EV on the road uses four times as much copper as a traditional ICE-powered car, then when you think about the charging stations and grid upgrades it’s clear that Latin America’s copper will be in demand, with Chile and Peru in pole position. Moreover, the dominant NCM battery technology will require immense amounts of nickel, cobalt and manganese, which are all abundant in the region. For example, last year we brought Atlantic Nickel into production in Brazil, as one of the largest sustainable nickel sulphide producers globally.

How can a long-lead time industry like mining supply materials for fast-moving technology?

MWS: It’s the perfect mismatch. You have ultra-fast changing technology supported by a slow, capital-intensive industry like mining. One solution would be if miners thought with more foresight but that is difficult because they are backed by such short-term capital. Another answer would be for governments to provide support and incentives for the development of certain commodities. But the problem is that policymakers don’t understand the mining sector well enough. They want to push EVs but they don’t even give a second thought to mining, or where the metal will come from. I think people focus on the technology and assume there will be enough materials.

As a result of these market and policy failures we will see spikes in particular metals prices. Another factor in this is that the quality of material mined is declining. The average copper grade will decrease from 1.8% to 0.8% by 2040, which means mining deeper for poorer quality ore, which will increase costs. That will feed into the industrial production chain, which will push inflation in the sector so it’s an important issue.

Has the pandemic accelerated the transition to green energy?

MWS: The pandemic has been a complete gamechanger. Social norms have had to adapt by necessity and Covid-19, for all its ills, was an accelerator of many trends that were already shaping society. Increased investment in healthcare, greater distribution of wealth, the reverse of urbanisation – are all themes that have sped up with this situation. Decarbonisation is another. So, despite all of the tragedy, there have been some positive consequences. The stress of coronavirus is forcing society to react and EV adoption is one of those changes. Mining has to adapt quickly to the society around it.

As a result of these market and policy failures we will see spikes in particular metals prices…

Miners have the responsibility to not only provide the commodities for the clean energy transition but also steward that process. You are seeing the big mining companies start to do that, by selling thermal coal mines. Increasingly solar energy is being used as an off-grid source of additional power at mine sites. At Appian, we try to take the environmental best practices from our operations around the world and codify them to improve all of our mines. So, for example, we used the stringent Canadian tailings dam standards in our Latin American mines, before it was a legal requirement in those countries.

At the moment investors don’t pay a premium for environmentally-friendly miners but as ESG investing becomes more mainstream that will change. Most investors don’t realise that ESG and strong returns are synonymous. BlackRock is the world’s largest asset manager and its new environmental principles show the direction that institutional investors are heading. We will probably get to the stage where different industries are ranked according to their ESG credentials, so mining needs to improve its act if it wants to attract investment.

Mining gets a lot of bad press; why don’t people acknowledge its crucial role in the energy transition?

MWS: The mining sector has done a terrible job of explaining the good that it does. In addition to its clean energy role, it brings foreign investment to remote parts of the world that wouldn’t otherwise receive it . Mining also has a multiplier effect where it creates between 3 to 5 indirect jobs for every direct employee.

The International Council of Mining and Metals could be more vocal. Or we could have more individuals and companies leading from the front. But the culture of the industry means that executives don’t want to stick their heads above the parapet. Because when things go wrong the backlash can be severe.

Oil companies have been far more vocal about their green credentials but that’s because they have to be. If Big Oil doesn’t change it will go the way of Big Tobacco and gradually become irrelevant. That’s essentially because the oil and gas industry just has one major demand component, energy, whereas mining is naturally more diversified as each metal has its own set of markets. Of course, mining needs to change, but the process isn’t as radical as the transition facing oil and gas companies.

Will the clean tech boom spark a new supercycle for mining commodities?

MWS: All the leading indicators point to an upcycle. You have an intertwined feedback loop between US dollar movements, emerging market growth, a lack of supply and sharp demand spikes. But for that to turn into a supercycle for the whole industry you would need the generalist investors to revive their enthusiasm for the space. In London you have a lot of smart institutional mining money, compared to the speculative retail bases elsewhere.

I think we will start to see more generalist investors attracted to mining because the commodity price increases will make miners cashflow generative. But there are still a lot of inefficiencies in publicly-listed mining companies that are off-putting to generalist investors. There is a lack of corporate governance, with management teams not properly aligned with shareholder goals. If mining wants to attract ‘sticky’ investment then it needs to fix these issues, or it will remain a niche investment field and become the target of activist investors.

I don’t believe in big portfolio diversification but prefer concentrated high conviction bets…

Cleantech metals have particularly solid growth fundamentals. Of course, there will be bumps on the way, for example fresh Indonesian supply will threaten nickel, as will big production announcements of different metals. But in the medium to long-term the trend looks positive. Indeed, for copper it always has. The metal has had a 3.5% compound annual growth rate for 170 years so there is a fairly consistent demand expansion, but prices are volatile because of the lag and leap in supply.

We are bullish about some commodities and less so about others but we have a broad-based diversification. I don’t believe in big portfolio diversification but prefer concentrated high conviction bets. If you have a portfolio with 65% clean tech metals and the rest in base metals, you will be well placed.

Since you last spoke to us in Q1 2020, Appian has launched Fund II; was it a success?

MWS: First, I should note that Fund I is still progressing. The last time we spoke Fund I had eight investments, with six already brought to production. Now seven of those mines are operating. Meanwhile our overall employee count in portfolio companies is up to 4,500 from around 3,000 last year.

Because of the pandemic we haven’t seen investors since February, so raising funding for Fund II was a fascinating experience. Of course, we now have the track record after Fund I, so I am pleased to say that Fund II was significantly oversubscribed. We stuck to our limit of $775million but put the excess into a co-investment component that can be used if we see the right opportunity. Around 40% of the capital raised has already been deployed. Some of that was increasing the stake in existing Fund I holdings, but there were also some exciting new investments including a mineral sands mine in Australia. We are eager to find more and if your readers have projects, they should contact us.

Likewise, in the future there will be a Fund III and Fund IV, which will maintain our Latin America focus, so family offices or institutional investors in the region should contact us if they are looking for long-term mining returns. Our typical investors are tier-one, blue chip names that want exposure to cleantech metals. In particular they want the alpha you get from Appian managing and developing the projects – they don’t just want to be passive.

How has Appian reacted to the pandemic?

MWS: We use our local teams more now. London remains the technical and financial hub but we have offices on five continents. We use new technology to monitor mines in real time, as if we were there, or we can scroll through them at a later date and go on a virtual site visit. None of this fully replaces being able to jump on a plane and visit things in person, but crucially it means that we haven’t slowed down our investment process. It also creates a myriad of challenges for the management teams of portfolio companies, for example managing supply chains with the emphasis on sourcing materials closer to the mine sites.

London remains the technical and financial hub but we have offices on five continents…

We stepped in during Covid-19 and supported a large number of individuals, particularly in Brazil, which was hard hit. We spent 1.5 million reais on tests and PPE and we trained local communities about the best Covid-19 prevention techniques – so far over 37,000 people have directly benefited from these measures. It’s the type of  stakeholder engagement that mining excels at. Latin America is so well endowed with mineralogy that it can attract fantastic mining companies but they need to give back to the communities located around the mines.

As an organisation we learned some important lessons. We realised you need to prioritise people and show empathy in challenging situations. We discovered that it’s good to overcommunicate so you allow people to talk through their problems. We were fortunate to be funded by long-term capital, so we didn’t face a liquidity squeeze during the pandemic. We found that if we helped people, whether it’s our employees, business partners or mine-site communities, then they appreciated it a lot. So, it was an opportunity for us to strengthen our relationships with key stakeholders. Finally, I realised that we couldn’t allow ourselves to get sucked into firefighting mode. In addition to dealing with the short-term challenges created by the pandemic, we also had to focus on our long-term strategic goals.