One of the great ironies of the energy transition away from coal is that it relies massively on mining companies producing metals such as iron, copper and lithium.
The problem is that these mining operations are shunned by financiers, which in turn is likely to slow down the energy transition, according to Chris Holdsworth, chief investment strategist at Investec Wealth and Investment.
Energy transition winners and losers
“One of the big themes we see over the course of the next year is the energy transition and who benefits from that,” says Holdsworth.
“There is a push for the electrification of everything, which is ironically good for mining companies involved in the production of metals used in electrification, such as copper, lithium and others. This is reflected in the prices of these commodities. For example, the price of lithium in China is up six-fold over the last year.
“Companies are facing additional costs that were scarcely recognised just a few years ago – what are generally called externalities. We’re seeing an increase in carbon taxes and the pricing of carbon through the carbon trading mechanism. That’s just one externality, one of many that needs to be properly accounted for in any ESG [environmental, social, and governance] analysis.”
The energy transition requires massive construction over the coming years which in turn will drive the demand for materials, particularly metals.
The rise of ESG-focused investment
Therein lies the irony. Mining companies are in the crosshairs of environmentalists pushing for clean energy.
That’s put a chokehold on financing for new projects aimed at bringing about the very transition the environmentalists demand.
“This is likely to slow down investment into the companies needed for the energy transition,” says Holdsworth.
“This may have a positive effect on mining companies and force them to accelerate their compliance with more stringent ESG standards. The pressure is coming from two sides: environmental pressure groups and regulators.”
Mining companies that embrace clean energy and tighter ESG standards are likely to attract a premium, adds Holdsworth.
“We expect to see inflows into funds that focus on ESG. This will encourage regulators to push through regulations to reinforce this trend.”
Among active fund managers, only those focused on ESG received net inflows over the last two years, part of a trend that is likely to intensify over the next decade, as passive funds continue their dominance of the investment landscape.
Pessimism about SA appears misplaced
Given the recent report by the Zondo Commission into Allegations of State Capture and a slew of negative press reports, it is easy to allow this to influence investment decisions where SA companies are involved.
SA stocks are priced on a forward price-earnings (PE) ratio of 12, relative to 24 in the US.
“SA equities are at a 50% discount to the US,” says Holdsworth. “The expectations for SA growth in 2022 are very modest, which is somewhat surprising given a rather robust global environment.
“We have very low interest rates in SA, but the market is saying that interest rates will go up nine times, based on forward rate agreement market, which is anticipating nine increases in rates of 0.25% each.
“We don’t quite see it this way, for a number of reasons,” says Holdsworth.
“In addition, government revenue continues to be extraordinarily strong. Government has already revised up revenue expectations in the medium-term budget, but there could be R50 billion more revenue than was expected in November 2021, in large part because of strong commodity exports.
“Commodity exporters are required to render unto Caesar, and that has pushed up tax collections.”
Formal sector incomes are 7% higher than they were in 2019, and this has further pushed up tax collections.
This poses the interesting possibility of a tax cut, adds Holdsworth. “Very few people consider this as a real possibility, but we believe it cannot be discounted.”
SA is also blessed with relatively low inflation and low interest rates. Inflation in SA is slightly below 6%, and for the first time since 2004, SA’s interest rates are below the median for emerging markets.
The economic conditions are not unlike those the country enjoyed in 2004 at the start of the economic boom that ended in the late 2000s. The only problem this time is that Eskom lacks sufficient capacity to sustain economic growth rates of 5%, such as experienced in the late 2000s.
Holdsworth says sectors that are likely to benefit are commodities, banks, and retail.