Commodities needed to power the greenification of the world will likely see higher prices over the next decade. But investment implications could extend far beyond the metals crucial to this transition to a non-carbon world. Kim Parlee speaks with Daniel Ghali, VP Commodity Strategy, TD Securities.
Originally aired November 22, 2021
- Right, absolutely. And thank you, Kim, for having me on. So I'd say central to this idea is that decarbonization will be one of the dominant themes of the coming decade. And really, that's going to have widespread investment implications. So we bucket that in four different categories.
I'd say the game changer sectors are those that are going to have tremendous top-line growth. We're talking here the sectors that directly flow from the greenification. Here, easy examples think of would be renewables, electric vehicles, et cetera. A little bit less obvious would be the second category, which we call the greenification commodities, what we really mean by that is component suppliers. So raw materials for instance that will be inextricable from the game changer sectors. With more electric vehicles, we're going to need a lot more copper, a lot more nickel for battery technology, et cetera.
Now flowing a little bit further down the line will be the troublemaker sectors. These sectors are those that governments will proactively curtail their capacity in order to reach their carbon goals. So aluminum capacity in China, for instance, this year has been dramatically curtailed as governments have been trying to control carbon emissions. I'd say the final category here that is certainly worth noting are foregone essentials. These are those commodities that are going to remain crucial to the energy transition, but for which the supply is going to be naturally constrained by the industry, and petroleum products fit perfectly here.
- It really does, because you see prices surging in the short term, but of course, with less capital going to the sector, that's what you would expect to happen. You also have a line in your note that caught my attention that said, "While today's energy crisis could have important global macro ramifications, it's a canary in the coal mine for more significant energy crisis brewing on the horizon." Energy crisis, why do you say that?
- Well, absolutely. This year, we've already seen a pretty significant energy crisis with natural gas prices in Europe challenging the $200 per barrel in a barrel of oil equivalent terms. So we've already seen this. But this year, the crisis was mostly related to extreme weather and policy failures. But it's also highlighted some vulnerabilities in our energy infrastructure that warrants caution for the future.
So bringing it back to our framework of foregone essentials, there's two parts to that story really. The first is that the demand for oil is going to decline at a far slower pace than the supply, and that's because it's going to remain essential to the energy transition. Now we can say this with confidence, because modeling out electric vehicle sales, even assuming pretty aggressive market penetration, we still end up with a global passenger vehicle fleet that is 90% driven by internal combustion engines or traditional gasoline vehicles and diesel vehicles. So that suggests that over the next 10 years, the demand for oil really is only going to decline at a very slow pace.
But on the second part of that story, we have the supply that is being naturally constrained by the industry. And as you mentioned, we have oil prices today that are at decade-highs, but at the same time, when looking at the global oil rig count, it's really not living up to its historical relationship with prices. And that suggests that the industry as a whole is now looking to their net zero targets, and that's having an impact on supply today.
- I've got about three minutes, Daniel, I wouldn't mind getting into some specifics. How high do you see oil prices going?
- Well, in this kind of scenario, it really doesn't take much imagination to see oil prices challenge their previous historic highs and really, nearly double from current levels.
- What about if I think about the key commodities, the kinds of things that are going to be going into, you mentioned greenification and those types of things, the copper, the aluminums, what do you see happening with those markets?
- Right, well, of course, oil is one of the commodities that we see having a significant price impact, but it's not the only one. And greenification commodities, copper and nickel particularly stand out. Thinking about how we're going to electrify our entire economies, that's really going to be built on these metals. And we know that copper demand, for instance, is going to double over the net zero kind of time horizon. Nickel demand is going to quadruple as it's used in batteries. So really, we're looking at tremendous top line growth here are the direct result of greenification.
- The other sectors, going back to troublemakers, I'd say aluminum also stands out here. And we're already seeing governments across the world, but particularly in China this year, proactively curtail the capacity in the aluminum smelting industry. And as you know, China is a major behemoth producer of aluminum, and we might have seen their total capacity peak already today.
- The one thing, I guess, for an investor who's listening, what it sounds, of course, there's a lot of commodities moving up just based on this massive change that's happening. The tricky part, though, I know for many investors is, do you invest in the commodity through ETFs or futures, that type thing, or do you invest in the producers? And producers are tricky, of course, because they've got inflation, all sorts of things could happen. So where do you come out on that conversation?
- Right. Well, I think that's a great question. And I'd say these ingredients that we've spoken about really paint the picture of a commodity supercycle brewing on the horizon. But there is the risk of misapplying our funds and not capitalizing as much as possible. So I would say that it really depends on which commodity we're talking about here.
And those commodities that the prices are rising because supply is constrained, producers might actually underperform the commodity price itself. Whereas in those commodities that are really benefiting from structural demand growth, I'd say the producers are a good bet as well.
Now if I could just extend that thought a little bit further here and going back to the idea that this is really a commodity supercycle that's brewing on the horizon, I'd also mention that over the last 10 years, we've been in a bear market that has really seen the number of investors looking at these kinds of thematic and fundamental research kind of die out. So what we're left with here is really a fertile breeding ground for substantially higher prices as a result of these structural demand shifts and also of investor inflows.
- Daniel, you've given us a lot to think about. Great conversation. When you come back and join us again?
- Absolutely. Thank you for having me again.