“The course of human history is strongly influenced by the growth of human knowledge…But it’s impossible to ‘predict’, by rational or scientific methods, the future growth of our scientific knowledge because doing so would require us to know that future knowledge and, if we did, it would be present knowledge, not future knowledge.”
This was how philosopher Karl Popper described the struggle to anticipate future innovations. Yet to understand the potential price dynamics of oil, lead, cobalt and every other commodity we need to make some assumption about how technology will make it easier to extract these commodities and how technological development will affect their demand.
Implicit in any forecast of commodity prices is an assumption of how technology could evolve and how its adoption will affect commodity prices. Yet true to Popper, innovation is unpredictable. No one predicted the invention of pig iron and how it would affect the nickel market. Neither did anyone anticipate the introduction of hydraulic fracking and how it would turn the market for oil on its head.
Commodity prices provide the incentive for new technology, yet also influence commodity production and consumption. Innovations, once introduced, may lead to higher yields from agriculture, more oil being extracted from offshore wells and deeper and deeper mines to extract metals and minerals. All of which could eventually lead to rising commodity supplies.
Technology doesn’t just affect the commodity in question, there are substitution factors too. Consider the outlook for coal prices. Anyone looking into the future of coal needs to consider the potential competitors to this fuel source. But how do you decide how current renewable energy technologies will evolve and its impact on costs and competition between sources of energy?
One example from the 1970’s is instructive. Late in the decade OPEC’s Long-Term Price Policy Committee recommended that the price of oil should be increased gradually until it was just below the cost of the nearest substitute.
OPEC identified its main competition as synthetic diesel and gasoline fuels processed from coal. Since the cost of producing synfuels was thought to be near $60 per barrel, almost $200 in today’s prices, that became OPEC’s implicit long-run target.
OPEC pushed average prices to a high of almost $37 per barrel in 1980 (around $107 per barrel in real terms). But then the market slumped over the next six years, hitting a low of just $14 in 1986, about $30 in real terms. As it turned out, the main competitors to OPEC’s were not expensive synfuels plants but rival oil producers in Alaska, the Gulf of Mexico and elsewhere that were much cheaper.
The same could be said now for the cost of renewable energy technologies such as solar. It is a mistake to draw the connection that just because the cost of solar is coming down the price of a barrel of oil will also come down.
Recent attention has focused on the potential growth of electric vehicles (EV’s). Recent estimates from UBS suggest that in a world where EVs reach 100% of the market demand for lithium will increase by 2,898%, cobalt by 1,928% and rare earths by 655% relative to today’s global production.
However, just as high oil prices arguably helped enabled the development of EV’s, so higher prices for those metals and minerals currently considered essential for the growth in EV development will also have their own impact. This could involve their substitution with other metals and minerals not currently thought economical or a product change resulting in a less resource intensive design. Or if neither of these are possible, demand for the final product (e.g. a Tesla) may not grow as much as anticipated if it costs too much relative to the alternatives.
Uncertainty over how current technology can be utilised and how technology could evolve that makes forecasting commodity demand under rapid change very difficult. This creates a problem for executives of resource companies trying to match supply with anticipated demand many years into the future. The allure for investors of many of the companies operating in the supply of ‘energy metals’ (those metals that could be used in applications as diverse as renewable energy, electric vehicles, batteries, etc.) is that the pace of innovation and therefore our demand for metals such as rare earths, lithium, cobalt and others could increase at a much far faster pace the ability to supply.
Just as earlier this decade rare earth miners and their investors extrapolated several months of price gains years into the future, there is a risk now that investors in the ‘EV theme’ and the commodities that could underpin it extrapolate the past year’s growth in EV use and commodity price gains ad infinitum over-paying for assets that may never generate a return.
Expectations matter elsewhere too, which can create opportunities. For example, if oil producers are worried about the growth in EV’s they may decide to postpone large scale, multi decade, multi billion dollar investments. If they get it wrong and EV’s don’t take off as fast as expected then oil prices may rise sharply if there isn’t enough supply to meet demand.
Rapid change inevitably involves lots of failed experiments as the market weeds out those most likely to survive. Its often said that you could have lost your shirt betting that the internal combustion engine would replace the horse and cart. While that was certainly the case for the early automobile manufacturers that era also holds some important lessons for today’s investors in cobalt, lithium and other metals. If you had bet that crude oil and its derivative was the fuel of the future back in 1908 when the Model T Ford was introduced the price of oil was about $15 per barrel in today’s money. Oil prices doubled in real terms over the next ten years, but fast forward to 1927 when production on the car stopped oil prices were back to where they had been less than 20 years earlier.
I’ll finish with a great quote from George Soros.
“Economic history is a never-ending series of episodes based on falsehoods and lies, not truths. It represents the path to big money. The object is to recognize the trend whose premise is false, ride that trend, and step off before it is discredited.”