The natural resources sector is changing. Olivia Markham, Portfolio Manager on the BlackRock Energy and Resources Income Trust plc, discusses why investors may want to rethink their long-held views.
The natural resources sector has seen considerable highs and lows in recent years. When China was experiencing significant economic growth, it created a sustained period of high demand for raw materials. But this fell away as the pace of China’s growth slowed. Investors may have been left with a lingering sense that the sector is just too unpredictable. However, on the BlackRock Energy & Resources Investment Trust, we believe there have been significant and enduring changes in recent years that have notably shifted the sector’s long-term prospects.
Long seen as a sector likely to thrive only at times of economic expansion, today it is hooked into several long-term structural trends in the economy. Resource companies are also improving their capital discipline and paying higher dividends to shareholders. This comes at a time when the supply of certain commodities is falling and when stock valuations look lower relative to history.
Climate change is becoming an increasingly insistent problem. As it moves from the focus of a few activists to a preoccupation for policymakers across the globe, the way energy is created and used is a puzzle that the resources sector has an important role in solving. Our portfolio is split approximately 50-50 between energy providers and mining, so the future of energy is an important consideration. The move to a lower carbon economy creates challenges for some companies but other areas are proving part of the solution.
The rapid adoption of electric vehicles, for example, has been well-documented but relatively little examination has been made of the supply chain. Possibly the most important component of the EV is the battery system, which is key to the vehicle’s overall performance and the driver’s experience. Perhaps more importantly, it also determines the difference in cost between an EV and vehicles with petrol engines. The speed with which battery costs can be reduced is likely to influence the adoption of electric vehicles.
EV batteries rely on key raw materials for their production. The lithium for lithium-ion batteries is produced through hard-rock mining and brine processing. Most hard-rock lithium mines extract a mineral called spodumene to produce a spodumene concentrate, which contains around 6% lithium. Increased demand has been met in recent years primarily by growth in spodumene mining, with several new mines coming into production in Australia and Brazil.
Other vital raw materials include cobalt, nickel, magnesium, copper and aluminium. For these elements, ores are mined, concentrated and converted into various compounds that go into the battery.
Key considerations for us, as investors in producers of these metals, include the grade of the companies’ deposits (concentration of metal in the ore), the scale of their deposits, any contaminating materials in their deposits and their geography. In this way, certain natural resource companies look set to be one of the key beneficiaries of the drive to a low-carbon economy. As investors, we need to make sure we are on the right side of this change.
Certain elements of the resources sector have earned a “Wild West” reputation in their approach, employing excessive capital expenditure at the wrong time in the cycle, entering reckless mergers and demonstrating poor corporate discipline. In some cases, this reputation was justified but the mining sector has seen a profound change in recent years.
Capital expenditure has more than halved since its peak in 2013, as investors have put pressure on companies to rein in spending and better match supply to demand. Management teams are not embarking on new capital spending programmes and debt has reduced.
Mining companies have always been cash-generative but have not been a particularly fruitful area for dividend investors. Previously, cash flow was directed towards capital spending programmes. Today, that is not happening, so free cash flow is being returned to shareholders, meaning the sector is seeing its highest level of dividend payouts in two years. The growth in dividend income received by the Trust between 2016 and 2018 has been 38%.
Supply side changes
In 2018, most commodities saw higher average prices compared with the previous year – notably nickel, coal, uranium and aluminium. This year, that has been compounded by supply difficulties in several sectors. The iron ore market, for example, has been hit by the tragedy at Vale’s Feijão Mine in Brazil in January. The copper market has also seen supply reduce. Copper mining companies continue to search for new projects across the globe, but it takes time to bring supply on stream. In the meantime, rating agency Fitch is forecasting that the copper market will remain under-supplied through to 2021. Across the board, visible commodity inventories are below their long-run averages in most cases. This should be supportive for the margins of commodity companies.
The resources sector looks more stable. The companies have improved their governance, while long-term structural trends, such as the drive for clean energy, are working in some companies’ favour. We believe the sector merits another look from investors.
For more information on this Trust and how to access the opportunities presented by the energy and resources markets, please visit www.blackrock.com/uk/beri
Capital at risk.
The value of investments and the income from them can fall as well as rise and are not guaranteed. The investor may not get back the amount originally invested.
Trust Specific Risks.
Exchange rate risk: The return of your investment may increase or decrease as a result of currency fluctuations.
Emerging markets: Emerging market investments are usually associated with higher investment risk than developed market investments. Therefore, the value of these investments may be unpredictable and subject to greater variation.
Mining investments: Mining shares typically experience above average volatility when compared to other investments. Trends which occur within the general equity market may not be mirrored within mining securities.
Gearing risk: Investment strategies, such as borrowing, used by the Trust can result in even larger losses suffered when the value of the underlying investments fall.
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 Source: Bank of America Merrill lynch, January 2019
 Source: BlackRock, December 2018
 Source: Datastream, January 2019.
 Global copper market under supplied, demand on the rise — report, Mining, January 2019
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