Chris Stevens, Senior Director, Diversifying Strategies, bfinance writes that the energy transition is set to drive a significant increase in demand for certain commodities in the coming years.
As a result, a new category of investment strategies focusing on “energy transition commodities” has emerged, offering exposure to metals like copper, aluminium, silver, and platinum, often coupled with a component of carbon allowances. Yet, investors must be mindful of the volatility and long-term nature of these investments. Attempts to profit from the anticipated “green supercycle” face obstacles from sluggish global economic growth, policy uncertainty and rapidly changing market conditions..
An old asset class with renewed potential?
Since the 2008 financial crisis, commodities have not regained their former popularity among institutional investors. The upcoming 2024 bfinance Global Asset Owner Survey will show that fewer than a quarter of pension funds, insurers, and other large asset owners have direct investments in commodities. This figure has barely shifted since the 2022 survey. It’s clear why: despite strong returns in recent years, with the Bloomberg Commodities Index (BCOM) up 27 per cent in 2021 and 16 per cent in 2022, the long-term performance from 2008 to 2022 was incredibly disappointing, with an annualised return of -2.6 per cent and high volatility at 17 per cent.
Nevertheless, there is a growing argument for incorporating commodities into portfolios as a hedge against inflation and a way to mitigate increased stock/bond correlation . The 2022 spike in commodity prices, during a period when both equities and bonds posted losses, underscored the potential of commodities to offer diversification benefits.
The long-term case for investing in energy transition-related commodities is particularly compelling. The global shift from fossil fuels to renewable energy will generate massive demand for raw materials needed for electrification, energy storage, and modernising infrastructure. However, supply constraints—driven by years of underinvestment, environmental regulations, and geopolitical factors—create a challenging environment. Prices are therefore predicted to increase.
Investors cannot be complacent with their exposures, however. For example, lithium prices dropped 80 per cent in 2023, despite its critical role in the batteries of electric vehicles. Mining companies ramped up supply as prices soared in 2021-22, before running into a demand slowdown, particularly in China. This highlights how short-term supply and demand mismatches can disrupt a long-term growth story.
Emerging strategies for energy transition commodities
An increasing number of commodity investment strategies are now directly targeting the energy transition theme. These strategies span various investment approaches, from hedge funds and commodity-focused equity strategies to diversified portfolios that include a broad range of commodity futures. However, there is also a smaller, but rapidly growing, group of strategies that place energy transition commodities at their core.
While many of these strategies are relatively new, they are often built on the foundations of established commodity expertise. There’s certainly a marketing element at play, with firms capitalising on the popularity of energy transition narratives. Nonetheless, these strategies are rooted in genuine investment beliefs, with many asset managers overweighting key transition commodities regardless of whether or not the strategy carries an energy transition label.
A recent bfinance analysis of commodity strategies with an energy transition focus identified four key trends compared to standard commodity allocations:
1. Less Exposure to Conventional Energy: These strategies significantly reduce their exposure to oil and gas compared to traditional indices like BCOM (30 per cent in oil and gas) or the S&P GSCI (58 per cent). While some strategies entirely exclude natural gas, others maintain exposure to it, given its status as a “bridge fuel” – cleaner than other fossil fuels and a reliable backup for the intermittency of renewavles. Ethanol and uranium also appear in some portfolios, but liquidity issues limit their prominence.
2. Increased Focus on Industrial Metals: Industrial metals such as copper and aluminium play a central role in these strategies, as they are crucial for energy storage, renewable energy production, and electrification. Commodity managers are betting on significant demand growth, supported by commitments to clean energy and underinvestment in mining.
3. Minimal Agricultural and Livestock Exposure: Most agricultural commodities are considered irrelevant to the energy transition theme, while livestock is seen as problematic due to its carbon-intensive nature. However, a few strategies include biofuel-related crops like corn and soybeans.
4. Inclusion of Carbon: Carbon allowances, particularly from the European market, are a key feature of energy transition strategies, even though they are absent from traditional commodity indices. UK and US carbon markets also play a role in some portfolios.
The role of copper
Copper is a standout example within energy transition commodity strategies, typically representing the largest single exposure, averaging12 per cent. Its importance in electric vehicles, renewable energy, and power infrastructure is clear. According to the IMF, copper production will meet just 60 per cent of expected demand between 2021 and 2050. An electric vehicle, for instance, requires over 80kg of copper, and renewable energy installations such as wind and solar farms also rely heavily on it.
Despite this, copper prices have remained relatively flat, with weak global economic growth—particularly in China—dampening demand. This price stagnation could discourage further investment in copper mining, exacerbating future supply shortages. Many commodity managers believe that copper prices will inevitably rise to correct this imbalance.
Conclusion
Commodities linked to the energy transition hold significant potential for long-term growth, but they are not without risks. Short-term factors, such as global economic fluctuations, political instability, and shifting demand patterns, can pose challenges for investors. Moreover, many raw materials come from emerging markets, which are particularly vulnerable to political risk, and China remains a major driver of commodity demand.
Active management is essential in navigating these complex markets. By adjusting portfolios in response to evolving supply and demand dynamics, asset managers can tap into the opportunities offered by the green supercycle while mitigating potential downside risks.
