Commodities, Congress and cutting carbon emissions

Commodities outlook

The market has spent the past few months fixated on monetary policy and Covid progress. The flip of the calendar to September could change investors’ focus.

Congress has begun debate increasing taxes by $1-2 trillion — potentially the largest tax increase in 50 years. The tax proposals include large tax increases on the oil and gas industry, as well as changes to capital gains, estate and international taxes. They also include healthcare reforms, such as drug pricing and Medicare expansion.

A large spending package is part of the debate, too. The initial proposal was for $3.5 trillion, which would be the largest spending increase since the Great Depression. However, it’s likely to be halved during the negotiation process.

There is also a debt ceiling debate and a potential government shutdown looming. The statutory debt ceiling expires September 30, but funding flexibility could extend the effective deadline until late October. After this, we could see a government shutdown. So far, Democrats and Republicans have not blinked on potential compromises, which is par for the course. Past resolutions occurred at the last possible minute.

President Biden's lower approval rating may bring into question the probability of passing an infrastructure bill and spending bill. But in the past when presidential approval ratings have dropped below 50% (as they are now), Congress has shifted into self-preservation mode. This has historically allowed them to get things done and overcome differences of opinion. The lower approval rating may help foster compromise within the democratic party that helps them achieve consensus on the infrastructure and spending legislation.

The spending increases will need to be paid for with tax increases. This could reduce the 2022 S&P 500 Indexconsensus earnings growth expectations from 9% to 4%.This would represent a meaningful scenario change. Bloomberg reported that of the 15 strategists publishing S&P 500 Index earnings estimates, only one-third have adjusted earnings next year for a potential tax hike. So not everyone has factored in tax hikes.

It's important to realize that the renewables expansion story is not one that lives or dies based on the outcome of these admittedly large policy discussions.

It's important to realize that the renewables expansion story is not one that lives or dies based on the outcome of these admittedly large policy discussions. One hundred ninety one countries signed onto the Paris climate agreement.So, whether the US social infrastructure package is $3.5 trillion or $2 trillion, there could be shortages of industrial metals and battery materials for years as those 191 countries transition toward more electrified economies.

Part of our confidence in that view comes from recent European and US actions to protect raw material supplies. The European Union has formed the European Raw Material Alliance, whose purpose is to ensure domestic security of raw materials for the expansion of renewable energy. The US Department of Energy also rushed out a National Blueprint for Batteries earlier this year and it’s also focused on developing and protecting domestic sources of key materials.

It’s clear why they’re concerned. After years of meager prices, copper supply has been relatively flat for the last three years. But technologies and developments crucial to the transition toward a lower-carbon economy are copper intensive, pushing demand higher in spite of this flat supply (Table 1).

Table 1: Copper-intensive clean energy

Technology Copper use
Electric vehicle (EV) 200 pounds
3 megawatt wind turbine 5.5 tons
1 megawatt solar panel installation 4.7 tons
Grid-scale battery 4 tons (per megawatt)

And this doesn't even include the copper that additional transmission lines or home and public charging stations would require.

Aluminum is key to increasing both electric vehicle (EV) and traditional internal combustion engine (ICE) automobile efficiency at one-third the weight of steel. Using aluminum instead of steel has already cut CO2emissions by 44 million tons via lighter-weight autos.

On top of this, aluminum is economically beneficial to recycle, contributing to an impressive 75% recycling rate. Zinc is used in a galvanization process that can extend the lifeline of steel to as much as 170 years. Nickel is in a wide range of batteries and is used to create stainless steel for sanitary hospital and medical environments.

If the last 18 months have taught us anything, it’s that even a small change in behavior across a large population base can cause disruptive shifts in demand. EVs require copper, aluminum and battery materials that all come from mines and take five-10 years to bring online. If you thought the scarcity of items with short production cycles like paper products was dramatic, wait until you see the effect of a $12,500 per vehicle subsidy on EVs.

Sector outlooks:

  • Oil prices range from $70-80 per barrel as we dismiss more bullish stories given the 4 million barrels of spare capacity and the political sensitivity to higher prices in the US, India and China. The outlook may change in the second half of 2022, when we will need the remaining spare capacity for demand.
  • Natural gas may look like a good short idea given the strange confluence of global events creating scarcity, but the winter has yet to begin and inventories are already low and unable to normalize before extraction season begins in November. The potential for a very volatile winter pricing season is high.
  • Gasoline cues come from New York City traffic data which show EZ-Pass (electronic toll taking) data that has bridge and tunnel auto traffic down only 5% from pre-pandemic levels, while regional train traffic is down 60%. Time will tell if this shift away from mass transit to personal travel persists.
  • Grains positioning is back within normal ranges despite the potential for a second La Niñayear, which would lower rainfall in North and South America for a second year. The price implications could be large, but it is still too early to make a call with much conviction.
  • Platinum and palladium have had a jarring sell-off on disappointing production outlooks from automakers. This runs contrary to chip makers, who have promised to increase supply to automakers in the coming months. Whether this was the ultimate price washout or not is unclear, but it bears watching.
  • We expect the outlook for gold to remain positive for the foreseeable future given global debt levels — $16 trillion of negative-yielding sovereign debt, $8 trillion balance sheets in the US and EU. We can't recall a more one-sided push against an asset class than we have seen versus cryptocurrencies, which have occasionally competed with gold for assets. The public detractors of cryptocurrencies include the IRS,US Federal Reserve, US Treasury,US Securities and Exchange Commission,European Central Bank,10 UK Financial Conduct Authority,11 International Monetary Fund12 and the People’s Bank of China.The upcoming Chinese and Indian festivals may bring more gold purchases than last year, supporting retail demand in the two largest purchasing areas given improved coronavirus conditions locally.
  • Copper prices have held up well considering the negative China credit impulse. Perhaps others see the potential for more expansionary policies to return shortly in China as we do. The importance of copper to the renewables transition is hard to overstate and will be a key theme going forward.
  • Aluminum is well supported given China's cap on production and the coming 2022 Winter Olympics in China, where emissions may be cut to ensure inviting blue skies for the global TV audience. If aluminum producers were required to pay $50 a ton for carbon emissions, the cost of aluminum production would rise by 50% because of its energy intensity. Elon Musk views a one-piece aluminum frame as a key competitive advantage of Tesla going forward, emphasizing its importance in EV construction.
  • Zinc is used for galvanizing steel to extend the usable life of steel and may see increased demand from infrastructure projects across the globe amid structural project growth in the US and Russia among others.
S&P 500 Index - is a market-capitalization-weighted index of the 500 largest publicly traded companies in the U.S.
Yahoo Finance, “Biden tax hikes bigger threat to stock market than slowing economy,” September 13, 2021
Paris Climate Agreement - is an international treaty on climate change, adopted in 2015.
CO2 – carbon dioxide
Bloomberg, “US democrats propose hike to EV tax credits that favor big 3” September 11, 2021
La Niña – weather pattern that is characterized by unusually low temperatures in the equatorial Pacific Ocean and is linked to floods and drought.
The Internal Revenue Service (IRS) is a U.S. government agency responsible for the collection of taxes and enforcement of tax laws.
US Treasury is the government department responsible for issuing all Treasury bonds, notes and bills.
The Securities and Exchange Commission (SEC) is a U.S. government agency created by Congress to regulate the securities markets and protect investors.
10 The European Central Bank (ECB) is the central bank responsible for monetary policy of those European Union(EU) member countries which have adopted the euro currency.
11 The Financial Conduct Authority (FCA) is responsible for the functioning of the U.K.'s financial markets
12 The International Monetary Fund (IMF) is an international organization that promotes global economic growth and financial stability, encourages international trade, and reduces poverty.
13 The People's Bank of China is the central bank of the People's Republic of China responsible for carrying out monetary policy and regulation of financial institutions in mainland China

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ETF001768 9/17/22