Latin America: the key to net zero

Latin America’s Century

The US recession isn’t great news for investors but at least it lets them retell an old joke. Dr Copper’s diagnosis was accurate once again, with prices of ‘the only metal with a PhD in Economics’ dropping before the current economic downturn.

Yet while copper may be a great predictor of GDP movements it is rubbish at spotting energy transitions. Over the next three decades, governments, investors and companies are going to spend trillions of dollars electrifying the global economy. The goal is to fight climate change by replacing carbon-emitting fossil fuels with renewable energy. The ‘great electrification’ will require immense amounts of copper for the generation, transmission and consumption of this clean power.

So, the copper price is falling ahead of a huge supply crunch. The largest mine in the world is La Escondida in Chile. Mining analysts, Wood Mackenzie estimate that five more Escondidas would need to come online over the next eight years to prevent a copper shortfall. Those huge deposits haven’t been found yet, never mind built.

We don’t know exactly where we will find the copper but we do know that most of it will come from Latin America. The region holds most of the world’s copper and lithium – the two key energy transition commodities. The demand for metals will place Latin America at the centre of the world’s most important investment story. We look at the companies best placed to benefit.

Driving demand and struggling supply

Company CEOs and government leaders love making ambitious renewable energy pledges. And you can understand why. The commitments are popular with consumers, investors and voters but require little action in the short-term. The UK, and most other developed countries, is committed to being net zero – when all of our yearly manmade greenhouse gas emissions are balanced by removing the same amount from the atmosphere – by 2050. There is just one problem – the world can’t produce enough copper, quickly or cheaply enough to fulfil these promises.

Analysts at S&P Global estimate that annual copper demand will double between now and 2035 to reach 50 million tonnes per year. In the 15 years from 2035 to 2050 we will need more copper than we have used in the last 4,000 years. The demand is being driven by the energy transition. Renewable energy generation is far more copper-intensive than traditional power plants. S&P estimate that solar and wind use between two and five times more copper for each megawatt of electricity produced compared to coal or gas-fired plants.

As the world uses more electricity, it requires more electric infrastructure – from substations to car charging points – which means more copper. Finally, the consumption of all this green electricity also needs lots of copper. For example, electric vehicles contain around three times more copper than a traditional internal combustion engine. The excellent S&P Report has optimistic and pessimistic scenarios. But it is clear about one thing – there is no way the world will be net zero by 2050.

Yet nobody seems to have got the memo. Politicians love talking about climate change but are less keen to allow the miners to dig up the metals needed to combat it. “The reality is the right now it is harder than ever to build a copper mine”, says Tristan Pascall, CEO of First Quantum Minerals, the world’s sixth-largest copper producer. “It probably takes 16 years from discovering a deposit to building a mine, where two decades ago it took between six to ten years.” Ironically the same environmental consciousness that is pushing electrification, also turns public opinion against mining.

It’s easy to bash politicians but most investors also misunderstand the biggest investment story of the 21st century. The market focuses on tech solutions, such as batteries and electric vehicles, but the real bottleneck is metals supply. “Mining companies trade on a 15.4% free cashflow yield”, says Michael W. Scherb, CEO and Founder of Appian Capital Advisory, a mining private equity firm. “Compare that to a prominent EV manufacturer that trades on a 0.5% FCF yield or renewable energy companies that also have a 0.5% FCF yield. Indeed, your average EV battery company trades at a FCF yield of minus 0.6%. The mining sector is making the most money from the energy transition but mining still isn’t attracting sufficient capital for some reason.”

The lack of capital and political support means the world won’t produce enough copper. But other factors are also at play. Falling copper grades at older operations means miners have to dig more ore to get the same amount of copper. That also means more energy has to be used, pushing up carbon emissions at mines, which undermines the rationale for producing the metals in the first place. Solutions are being developed, such as electric mining vehicles, but they will add to costs.

More than just copper

So, the world needs more copper, ideally new high-grade deposits with a low environmental footprint. Step forward Latin America. Chile and Peru are already the world’s number one and two copper producers. Controlling almost 40% of world supply, these two small nations have similar market share to 13-nation OPEC. Their massive reserves, first and third in the world, means they will play a central role in the energy transition. Mexico, which has the world’s fifth largest copper reserves also deserves a mention. When it comes to new discoveries underexplored Ecuador and Argentina stand out. Mining accounts for less than 2% of GDP in these countries, compared to 15% in Chile, yet they likely contain similar copper reserves.

The region isn’t just rich in copper. The lithium triangle of Chile, Bolivia and Peru contain more than 50% of the world’s reserves of the white metal, which is vital for the batteries needed to store all of this new electric power. Brazil has the world’s third largest supplies of nickel, another vital battery metal. But the shift to an electric-powered economy will benefit more than just the specific ‘greentech’ metals. Other metals will be used to build the new infrastructure to support the electric economy. One obvious example is iron ore, of which Brazil has the world’s second-largest reserves and Peru has the seventh. Another is zinc, which is the main tool for preventing corrosion of steel and iron. Peru and Mexico jointly have the fourth-biggest reserves of zinc, while Bolivia has the ninth. Tin is another important metal in an electrified world as it is used in every circuit board in existence. Again, Latin America dominates the rankings with Brazil having the fourth-largest reserves, Bolivia the fifth and Peru the seventh.

Another factor in Latin America’s favour are the vast hydro power plants that give it the world’s greenest electricity grid. More than 60% of the region’s electricity comes from renewable energy. That means miners can connect to a green grid, reduce their emissions profile and produce low-carbon metals. That allows them to attract lower-cost ESG financing. It also gives the end product a market advantage as many environmental conscious industrial customers don’t want to use ‘dirty’ copper. This will become even more significant as carbon taxes are introduced.

The challenge in Latin America is not the geology – it’s the politics. By this I am not referring to the wave of left-wing governments that have assumed power in the region in recent years – although it’s true many of those administrations want to increase taxes on miners. The bigger problem is local politics. Independence in the early 19th century created several massive, sparsely populated weak states. For example, the 45 million Argentines inhabit a territory only 15% smaller than India, which has a population of 1.4 billion. What’s more the cash-strapped governments lacked the wherewithal to build the infrastructure needed to connect remote areas with the urban centres. Many of these states were also home to dozens of distinct indigenous cultures and languages that were either ignored or oppressed by the creole elites that seized power from the Spanish. Over the last thirty years governments around the region have tried to rectify these historical injustices with transport infrastructure, decentralised constitutions and indigenous rights.

All politics is local

The result is that local communities in the remote areas where mining projects are developed often oppose new mines. Indeed, in Peru there are $60billion worth of stalled projects that have been delayed by community protests. Sometimes the protests are genuine. Often, they are manipulated by local politicians or crime bosses who don’t want the scrutiny, or competition for manpower, that a mine would bring to the area. Being anti-mining is a vote-winner for lots of local politicians around Latin America.

Bizarre as it seems, the key to humanity’s battle against climate change lies in local politics in the Andes. It’s also the key factor in determining if projects succeed or fail. Some zones are no go areas and very hard to develop mines. For example, Guatemala shut down the world’s third-largest silver mine, and is struggling to develop other promising projects. Sometimes the problem is the mining company. Firms are under financial pressure to get mines into operation as quickly as possible, but those that don’t invest sufficient time and money in getting locals on board will face protests later.

Building community consensus in Latin America might be a headache but recent geopolitical conflicts in Ukraine and Taiwan demonstrate the region’s strengths. Latin America is more peaceful than Eastern Europe and more democratic than Africa or Asia. Moreover, as the US tries to react to China’s dominance in critical minerals and secure its own supply chains, Latin American metals will receive a strategic premium.

A version of this article was first published in MoneyWeek on the 26th of August 2022