From our Fund Manager’s Desk
Anglo American & BHP
Our quarterly reports regularly explore the investment rationale of one of the companies we own in the Melville Douglas Equity funds and across client portfolios, to articulate what we find compelling. This time, we have chosen to discuss the significance of copper and its anticipated benefits for Anglo American and BHP.
Copper’s Critical Moment: The Strategic Moves of Anglo American and BHP Amid Impending Supply Shortages
Will copper become the new oil?
For decades, the oil market has exceeded the combined dollar value of all raw metal markets. Contributing over three percent to the global economy, oil is not only a crucial energy source but also a cornerstone of economic stability. Its applications extend across various industries, including plastic production, chemicals, clothing, motor gasoline, distillate fuel oil, hydrocarbon gas liquids, jet fuel, and aviation gasoline. These sectors generate billions in transactions worldwide, with many countries heavily dependent on oil for national income. As a result, oil has long been regarded as a reliable barometer of economic strength and weakness.
Beyond oil, copper stands as a vital indicator of economic health due to its extensive range of applications. It plays a crucial role in manufacturing automobiles, powering smartphones and computers, and is indispensable in various electrical appliances for both residential and industrial use. Copper’s widespread utility makes it a cornerstone of the global economy, with its price movements closely tied to overall economic performance and global trade dynamics.
Both copper and oil prices are influenced by similar macroeconomic factors and have generally moved in tandem over the past two decades. However, recent years have seen a notable divergence between the two commodities, driven primarily by rising copper demand, supply constraints, and escalating geopolitical tensions. This decoupling signals a strategic shift in investment focus, with copper gaining prominence over oil as the latter’s demand is projected to peak in the coming decades. In contrast, copper demand appears to be on a sustained upward trajectory. As long-term investors, we favor copper over oil, given its strong growth prospects and the margin of safety it provides.
This divergence prompts an important question: What factors have contributed to this significant dislocation? We believe it comes down to a few key drivers:
01 / Copper is the cornerstone of the green evolution
Copper plays a critical role in the electrical grid, electric vehicles (EVs), and AI data centers. Beyond these sectors, it is also essential in defense, transportation, and construction. The rapid expansion of the EV market, driven by government subsidies and the global push for decarbonization—particularly in China—has significantly boosted copper demand. This ongoing trend is expected to further reduce oil consumption while increasing copper usage in the world's largest commodity-consuming nation. Notably, EVs require more than double the amount of copper compared to internal combustion vehicles. As EV adoption continues to grow over time, higher copper demand may contribute to elevated copper prices while suppressing oil demand and prices, further widening the performance gap between the two commodities.
The global economy is undergoing increased electrification in alignment with the goals set by the Conference of Parties (COP) and countries' net-zero ambitions, which are expected to drive copper demand higher and exacerbate the existing supply deficit. In contrast, oil lacks a major near-term demand catalyst, as China's slowing economic growth continues to require government intervention through stimulus measures to stabilize the economy.
At the United Nations COP28 climate summit in 2023, 118 governments pledged to triple global renewable energy capacity by 2030, aiming to reduce dependence on fossil fuels. This shift positions copper as a key transmission metal vital for decarbonizing manufacturing and infrastructure. The growth of renewable energy and EV adoption is projected to persist, with market estimates forecasting copper demand to increase by approximately 70% through 2050. Additionally, copper demand will be further supported by structural drivers such as population growth, urbanization, industrialization, and rising living standards.
02 / Copper output growth is muted, and the supply outlook looks bleak
The investment case for copper is compelling. Producers have underinvested in the capital expenditure needed to meet rising demand, which is expected to result in significant supply shortfalls in the coming years. Factors such as a lack of new discoveries, environmental concerns, resource nationalization, and geopolitical risks further constrain supply. We expect these bullish supply dynamics to drive copper prices higher amid this looming deficit as shown in the graph above.
03 / The copper conundrum: Time required to build a mine
The incoming supply constraints for miners present a trade-off between investing in high-risk greenfield projects or paying a premium for existing brownfield mines. With dwindling copper reserves and new mines taking close to two decades to develop, there is an urgent race to meet rising demand. This situation may lead to bidding wars for prime copper projects, driving prices higher over time.
Over the past decade, major copper discoveries have proved to be scarce. The majority of the world’s copper mines are old, facing reserve declines, geological challenges, and regulatory hurdles. As future supply remains constrained, the copper market is likely to enter a prolonged period of deficits, further supporting our view of rising copper prices over time.
04 / Grade decline has been a consistent long-term trend
The extraction of high-grade, near-surface copper deposits has largely been completed, making it increasingly difficult to find readily available copper projects and raising the costs of extraction. Subsequently, producers will require higher copper prices to offset the increasing cost of production, which reinforces our view that the supply dynamics will be supportive of copper prices going forward.
05 / Copper inventory levels are at multi-year lows
Copper inventory levels have fallen significantly since 2018, as strong demand has resulted in the reduction of above-ground stocks. Therefore, any material disruptions to primary mine supply may serve as a positive catalyst for copper prices, especially given these low inventory levels relative to historical norms.
How are we playing the copper theme?
We currently own both BHP and Anglo American (AGL) in client portfolios.
Why BHP?
BHP has been transitioning away from fossil fuels and towards future-facing commodities like copper over the past few years. This shift has been driven by copper’s growth prospects, the need to reduce stranded asset risk, and the goal of providing long-term value for shareholders. Concerns about the sustainability of oil demand, in contrast to copper’s enduring relevance, have further propelled BHP’s strategic pivot.
BHP’s outlook for copper is evident in its multiple attempts to acquire AGL, aimed at enhancing its market leadership and positioning in the green metals sector. The company viewed AGL’s portfolio of South American copper assets as highly desirable, offering significant synergy potential with its existing operations. In our view, BHP’s interest in AGL’s portfolio marks the beginning of a decade-long trend where miners will increasingly compete for high-quality, tier-one copper projects. Regardless of the potential outcome with AGL, we expect BHP to remain acquisitive as it seeks to expand its copper portfolio, as demonstrated by its recent bolt-on acquisition of Filo Corp.
Besides BHP’s solid copper strategy, the company also looks attractive from a valuation perspective, as it is currently trading one standard deviation below its 15-year EV/EBITDA average multiple. These undemanding levels relative to its historical valuation provide investors with a significant margin of safety.
BHP's balance sheet is in a healthy position, with a net debt/EBITDA ratio of 0.28x, offering the Group the flexibility to pursue its copper growth strategy. The company’s competitive cost positioning, driven by its efficient operations, enables it to maintain strong cash flows. This financial stability reinforces BHP’s ability to sustain dividend payments, which are expected to yield around 5% over the next few years.
Why AGL?
AGL is undergoing a business restructuring that, once completed, will focus on high-grade copper and iron ore. The company’s organic growth potential in copper is unique among global diversified miners, and the simplification of its business structure will provide investors with greater exposure to the metal.
Following the restructuring, “AGL 2.0” will concentrate on optimizing assets, reducing costs, and increasing copper production as we approach 2030. If executed effectively, this strategy should deliver significant value for shareholders. Management's increased focus on copper will create a more refined commodity mix, which we expect to result in greater profitability throughout the market cycle.
Elementary, my dear
AGL has re-rated from a valuation perspective due to its successful restructuring efforts thus far. The stock is currently trading one standard deviation above its 15-year EV/EBITDA average multiple. Despite its current valuation, we believe there is still potential for further re-rating as copper becomes a more significant component of the company’s portfolio.
AGL’s balance sheet remains in solid financial standing, with a net debt/EBITDA ratio of 1.27x. The company’s restructuring initiatives have streamlined operations and sharpened its focus on a superior commodity mix. This strategic shift is expected to enhance profitability and cash flow, reinforcing the Group’s ability to continue delivering attractive returns to shareholders.
Conclusion
The demand outlook for copper remains strong, driven by the ongoing energy transition, particularly in China. This, combined with persistent supply challenges, suggests a higher long-term copper price, which we expect to benefit producers such as BHP and AGL. Additionally, reshoring and protectionism efforts in both the U.S. and China are expected to diversify and de-risk supply chains, further bolstering copper demand. However, in the near term, price fluctuations will likely be influenced by factors such as Chinese stimulus measures, trade disputes, and global economic growth.
Over the coming decades, oil consumption is projected to peak, in stark contrast to copper, which has a strong pipeline of growth levers. As long-term investors, we are inclined towards commodities with solid fundamentals and quality companies that offer attractive valuations. With both BHP and AGL increasing their focus on copper, we believe they are well positioned to capitalize on the favorable market dynamics. As a result, we are confident in holding both shares across our clients’ portfolios.
