The problem of stranded assets is on the radar screen of credit investors these days. Stranded assets are those whose value has diminished or may diminish because of some external change.

The threat to coal-fired power plants from the push to a low-carbon world is one of the best-known examples, and utilities and utility investors have already been grappling with its implications.

The metal and mining companies we follow also face some risk of being saddled with stranded assets, but the story for these companies is more complex and nuanced. For utility companies, there is a key risk: the global push to reduce carbon emissions. The carbon transition is a risk to some metal and mining companies, but it is not the only risk. A harsher climate—one with more flooding, for example, could potentially make some mines inaccessible. Drier conditions in already arid locations could leave miners with too little water to run their operations. And tougher government policies—everything from higher taxes to outright nationalization of mines in parts of the developing world—could also result in assets being stranded.

It is notable that not all metals and mined products are created equal. For example, some metals will be key ingredients in electric transportation and renewable power technologies, which could lower their chances of becoming stranded. We will lay out risks we see facing the metals and mining universe, and potential offsets to those risks, in the course of this paper.

But as we delve into the specifics, we don’t want to lose sight of our basic view on stranded assets. Simply put, we believe the large metal and mining companies with diverse businesses can handle the challenges ahead. They have strong balance sheets and solid cash flow generation. They also have time on their side as many of the threats they face will take years or even decades to play out. Stranded assets are a risk in this space, but, in our view, a manageable one.

 

What Could Lead to Stranded Assets?

As we noted above, a number of different forces are at work that could create stranded assets for metal and mining companies. They fall into four major categories: decarbonization, physical stranding, regulatory risk and recycling.

DECARBONIZATION

As countries work to cut emissions to reduce threats from climate change, certain commodities will feel the impact. Three so-called bulk commodities stand out as being especially vulnerable.

• Thermal coal. Thermal coal is burned in power plants to create electricity. In the developed world, thermal coal has been losing significant market share to cleaner fuels, a mix of natural gas and renewables. The same shift may happen eventually in the developing world, but the transition is likely to take place more slowly, creating a breathing space for thermal coal producers that participate in the export market.
  
  
• Metallurgical (“met”) coal. Steel is produced in two ways: in blast furnaces and in electric arc furnaces. The former use met coal and iron ore to create the steel; the latter substitute steel scrap for carbon-producing material. Importantly, electric arc furnaces (EAF) emit about 25% of the carbon dioxide created by blast furnaces and don’t require the smelting of virgin iron ore and coal. Roughly 50% of global steel production (excluding China) is now done using EAF.¹ In the US, EAF have been gradually displacing blast furnaces over the past several decades. We expect developing economies to follow suit, but again, at a slower pace. Effectively, technological change is challenging the use of met coal. That challenge could grow down the road as steelmakers work to eliminate the need for met coal in blast furnaces entirely.
  
  
• Low-grade iron ore. The story here is similar to that of met coal. Because low-grade iron ore is used in blast furnaces, it too is at risk for stranding as steelmakers strive to cut emissions. Steelmaking is far and away the leading source of emissions in the mining sector.

 

Metals & Mining Overview:  A Global & Wide-Ranging Industry The metals and mining industry includes mines, concentrators, smelters, refiners, furnaces and other production equipment located all over the globe. There are three major categories of mining products: base metals (copper, aluminum, nickel, zinc), bulk commodities (thermal coal, metallurgic coal, iron ore, steel) and precious metals (gold, silver, palladium, platinum, diamonds). Key mining regions include China, Australia, Canada, United States, Mexico, Peru, Chile, Brazil, South Africa, the Democratic Republic of Congo, Indonesia and Zambia. Customers are global as well; however, China has emerged as a key customer since the 2008-2009 financial crisis, representing 40%-50% of demand for commodities. Metal subsectors make different contributions to global greenhouse gases and the emissions associated with production, as shown on the right. These factors, along with each subsector’s carbon intensity per ton of metal produced and potential to participate in renewable energy technology, influence how vulnerable they are to carbon transition risks.

 

PHYSICAL STRANDING

Mining companies often work in remote locations under harsh conditions. They are also dependent on railroads and sea transport to get their products to market. Floods, accidents and climate change all represent potential threats to their operations.

• Water scarcity. Water is a critical ingredient in mining. It is used in processing, suppressing dust and cooling machinery. The world’s miners already do business in water-starved locations, and research suggests those regions could become more arid still in the coming decades. That is a threat to copper, which happens to be found in unusually dry geographies. Freshwater shortages can also have social implications and challenges as miners compete with farmers and others for a scarce resource. Mining companies are actively looking for ways to cut their use of water and minimize these issues. Some have set up desalination plants on the coast that turn sea water to fresh water, which is then pumped up to the mines at higher elevations.
  
  
• Tailing dam breaches. Tailing dams are used to store the byproducts of mining operations. In a number of high-profile incidents, the dams have failed, leading to loss of life, expensive environmental problems and cessation of mining operations.

These physical risks are serious and can lead to supply shocks. But interestingly, those supply shocks can create unexpected outcomes. For commodities with strong or stable demand, the rules of economics apply: when supply is reduced, prices go up. Therefore, a mining company that has to halt production in one location may find that it can command higher prices at its other locations, potentially offsetting the economic damage. From a credit perspective, this is one reason we favor mining companies whose assets are broadly diversified across geographies and products.

 

REGULATORY RISK

Mining companies operate all over the world and are subject to the laws of a long list of governments. Those governments can raise the taxes and royalties the miners must pay, potentially threatening the viability of operations. In extreme cases, governments can and have nationalized mines.

These are very real threats, but here again there are important potential offsets. Mines are a key source of tax revenues and employment in many countries, and governments should have a powerful incentive to keep them operating. Put another way, governments may want to squeeze mining companies, but they understand that by squeezing too hard, they can inflict lasting damage on their economies.

 

RECYCLING

Recycled materials are a substitute for metal that is taken out of the ground. For example, if you can procure steel from a scrapyard, you don’t need to mine as much iron ore. As economies develop, supplies of recycled materials become more plentiful. Longer term, recycling can be a threat to production, and therefore another potential cause of stranded assets. The risk posed by recycling is higher for steel than it is for aluminum and copper in our view.

A Greener Future: Mixed Implications for Mining

We mentioned earlier that copper is a major component in electric vehicles. In fact, there is up to four times as much copper in an electric vehicle as there is in a standard internal combustion engine vehicle. Copper is also used in charging stations for electric vehicles and in the production of renewable energy. Other so-called base metals, such as nickel and aluminum, will also play a role in these clean technologies.

The takeaway here is important: while these metals may be part of the problem, they can also be part of the solution as the world transitions to a lower-carbon future. As such, they are less vulnerable to becoming stranded assets than are bulk commodities like thermal coal, met coal and low-grade iron ore.

Positive Steps from Mining Companies

Mining companies appear to understand the risks stranded assets pose. Many have begun managing their balance sheets more conservatively to help navigate downturns stemming from either a commodity event or ongoing environmental risks. They are also keenly aware investors have a heightened interest in environmental, social and governance issues and want to see tangible progress toward reducing emissions. Over the next decade, we expect to see mining firms take actions to improve power and water efficiency, increase their use of renewable power sources, electrify their vehicle fleets and invest in safer waste storage. The companies have a lot of work to do, and so far, they have been better at laying out broad strategies than at providing a timeline for specific actions. Still, it is encouraging that they understand the need to be better stewards of the environment.

Conclusion

As we said at the outset, we are becoming increasingly confident that the big metal and mining companies we follow generally will be able to manage the costs associated with stranded assets. Our optimism rests on three main observations:

• These companies are financially solid. They have strong balance sheets, good cash flow and flexible dividend policies. They also have diversified product portfolios, which makes them less vulnerable in the event that demand for any one commodity falls.
  
  
• They have time to make adjustments. Many of the challenges the companies face—the rise of recycling and the decline of coal use in the developing world—will unfold over years or decades. Because the companies understand these risks, they have already been taking actions to mitigate them.
  
  
• They produce materials much of the world needs. These companies make the building blocks of today’s economies. Some of the materials, such as the base metals, will also be the building blocks of tomorrow’s economies. We believe assets with enduring value are less likely to wind up stranded.

 

Endnotes

¹ Source: World Steel Association

Disclosure
Commodity, interest and derivative trading involves substantial risk of loss.

This is not an offer of, or a solicitation of an offer for, any investment strategy or product. Any investment that has the possibility for profits also has the possibility of losses.

Diversification does not ensure a profit or guarantee against a loss.

Indexes are unmanaged and do not incur fees. It is not possible to invest directly in an index.

Past performance is no guarantee of, and not necessarily indicative of, future results.

This paper is provided for informational purposes only and should not be construed as investment advice. Opinions or forecasts contained herein reflect the subjective judgments and assumptions of the authors only and do not necessarily reflect the views of Loomis, Sayles & Company, L.P. Investment recommendations may be inconsistent with these opinions. There is no assurance that developments will transpire as forecasted, and actual results will be different. Data and analysis does not represent the actual or expected future performance of any investment product. We believe the information, including that obtained from outside sources, to be correct, but we cannot guarantee its accuracy. The information is subject to change at any time without notice.

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