Metals and mining can provide investors with a returns-enhancing way to gain exposure to large thematic trends, including the energy transition, says Appian Capital Advisory founder and CEO Michael W. Scherb.
Q: In what sense can the metals and mining industry be considered an impact investment?
There are sometimes negative connotations around mining, but the reality is that by investing in this industry, you are getting a high level of exposure to the energy transition. Electric vehicles require significantly more commodities than traditional combustion engine vehicles given their reliance on batteries. Wind turbines are just big turning magnets, which require rare earth materials. Solar panels are made from a whole range of mined metals, most notably silicon.
In fact, a scarcity of basic raw materials is one of the biggest bottlenecks impeding the energy transition. The global economy requires 3 billion metric tonnes of mined metals between 2024 and 2050 to power the transition required to reach net zero, according to BloombergNEF’s Transition Metals Outlook 2024.
Q: Why not just invest in one of the many renewables funds that now exist in the market?
First, I would say that investing in a renewables fund may typically result in a single-digit IRR, but by investing in all the raw materials required to create renewable energy plants, the feedstock, you can generate a return in the mid-20s while being exposed to the same thematics.
However, barriers to entry are high. It is challenging for large private equity firms to set up a metals and mining fund. The traditional leveraged buyout model doesn’t work. Cashflows are dependent on commodity prices, so leverage is inevitably limited. Instead, investors need to create hands-on value, which most typical private equity funds cannot price or pursue.
Our approach is driven by technical arbitrage. We have a 90-strong team, primarily comprising geologists, engineers and metallurgists, all focused on creating value at the asset level. Competition in the space is limited, which makes it an excellent sector for investors to get exposure to.
Q: What is the traditional ownership structure in metals and mining, and why do you think more long-term capital is needed?
Traditionally, mining has been financed through junior exploration. A geologist will notice some discolouration in the earth in Brazil or Mexico, for example. They will stake that land with the local ministry of mines and then raise a few million dollars from friends and family to support the initial exploration. If the findings look promising, they typically then raise a few more million dollars on the public markets, where they then find there is insufficient liquidity in the stock, and they get stuck.
While Appian doesn’t get involved at the very early, speculative stage, we do comb through these projects to find the most interesting opportunities and support their progression to construction and production. We look at over 1,000 targets yearly but only invest in three to four select assets closely aligned to our investment strategy.
However, there isn’t that much long-term, supportive capital like us. Most of the investment in the sector is either speculative retail or hedge fund money looking for exposure to commodity prices. It is beta exposure, while we are creating alpha. Private equity is the ideal source of capital for this industry because we can invest through the cycles, rather than just looking to benefit from short-term movements.
Q: Would you say there is a funding gap in this space?
Absolutely. Mines are very capital-intensive. The mining industry needs $2.1 trillion investment in new supply by 2050 to meet net-zero demand for raw materials, per estimates from BloombergNEF. Upwards of $300 billion is required to fund near-term copper and gold projects alone. The short-term financial performance pressures on large, listed mining companies mean that their investment is focused on consolidation rather than building new supply. At Appian, we will have brought 12 assets into production by the end of 2024. This is more than the five largest international mining companies combined.
At the same time, the project finance banks traditionally operating in this space tend to be very procyclical and have pulled back from lending. That creates an opportunity for us to fill that funding gap with value-add credit. Even if a mining company could raise credit from a bank, it would then likely be partnering with financiers who don’t understand the sector. We, by contrast, can have a technical expert on-site within 24 hours, no matter the problem, because we have that expertise in-house.
Q: Beyond exposure to the energy transition, what is your approach to ESG at a more localised level?
We have an in-house ESG team and work closely with the local communities where our mines are located. Approximately 80 percent of our assets’ workforce comes from those local communities. Mining employment also creates a multiplier effect. For every direct job created, three to five indirect jobs are created across its close supply chain and through training, typically all within the local area. Our projects’ capacity building, job creation and economic contribution have a lasting positive legacy in parts of the world that are often less well off.
Furthermore, we are signatories to the UN Principles for Responsible Investment and several other ESG initiatives. The International Finance Corporation has been our co-investment partner on numerous projects, giving you a sense of the rigour and importance we place on ESG standards and responsible mining.
Q: What are the geopolitical considerations that need to be considered?
The world of geopolitics is becoming ever more complex, so it is now essential for every LP and GP to have a geopolitical strategy.
The metals and mining sector intersects national economic interests and international relations, giving investors exposure to favourable geopolitical trends. There is an increasing understanding that government and industry must collaborate to build critical mineral supply chains. At Appian, we have set up an advisory committee in partnership with SAFE, a leading US think tank, which is chaired by our head of global affairs and former UK deputy prime minister and foreign secretary, Dominic Raab, and includes other prominent private capital sources in mining with a combined AUM of over $20 billion. The committee advises international governments on which policies can incentivise more investment and advance geopolitically strategic critical minerals projects.
Q: Aside from the energy transition, what are the other big trends that are likely to impact this sector?
Artificial intelligence is an important theme that will increase the demand for critical minerals. Investors can get exposure to the growth of AI technology by investing in developers, semiconductor manufacturers or even data centres. But they can also go back one step further, because AI’s growth will require a huge amount of critical minerals. For example, the energy consumption required to power AI and other technologies through data centres is a fascinating dynamic. We are looking into the use of uranium to provide more energy feedstock.
Metals and mining also represent an important inflation hedge. Inflation typically means there is increased commodity demand, and because it is the first piece of the entire economy, costs inevitably filter downstream to other parts of supply chains. Over the last 30 years, the increase in prices across most metals has outpaced both inflation and the increase in operating costs, resulting in a margin increase.
Every commodity has a different supply and demand pattern, so by investing in a mining fund, it is possible to build a diversified portfolio across key macroeconomic and industry themes.
This article appeared in Private Equity International on 12 November 2024.
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