Baker Steel, the natural resources company that runs several funds and trusts, has celebrated the three year anniversary of its Electrum Fund with a comprehensive analysis of the graphite market.
The Electrum Fund is an actively managed equity fund focused on investing in the producers of critical “future-facing” metals and materials.
Since its inception, the Fund has faced turbulent global markets since its launch in March 2019 and has delivered strong relative returns, compared to its peer group and the EMIX Global Mining Index.
It will shortly be available as a UK OEIC.
“Graphite,” says the Baker Steel analysis, “presents a particular opportunity for investors looking for exposure to the growth of green technology. While often overlooked, graphite is among the primary beneficiaries of the green energy revolution, being a core material for battery production and green steel, with demand forecast to soar.”
Baker Steel points out several key factors.
Graphite is required for lithium-ion batteries used in electric vehicles and represents between 20 and 24% of the material needs in a battery. It is also used in refractory, metallurgy, and industrial applications, and plays a key role in the development of grid storage.
In that context, between 2020 and 2040, a 22-fold increase in graphite for energy technology demand is forecast, and a 10-fold increase across all applications, an increase second only to lithium.
What’s more, given that graphite supply and processing for batteries is highly concentrated in China, there is clearly an opportunity for new Tier 1 suppliers to emerge.
Accordingly, as an active investment manager specialising in natural resources, Baker Steel has built exposure to high quality producers and processors of graphite.
Natural graphite is formed when carbon is subjected to heat and pressure in the earth’s crust and in the upper mantle.
A primary issue is that, despite strong demand growth in recent years, graphite has so far been a difficult sector for investors to generate returns from.
“Yet as specialists in the resources sector, the opportunity we see in the graphite sector illustrates the benefits of the sub-sector focus which we undertake as a core element of our Electrum strategy, as the new green commodity supercycle gains pace,” said Baker Steel.
As is often the case with industrial minerals, the high-level numbers conceal a more interesting and nuanced picture of demand. The first level of analysis is the demand for synthetic graphite versus natural graphite.
Presently synthetic graphite is the preferred feedstock in batteries as the product quality is more consistent. Synthetic graphite is more expensive than natural graphite, yet high energy ‘silicon’ doped anodes work better with a higher ratio of natural graphite. Baker Steel therefore expects natural graphite prices to benefit more from rising EV sales relative to synthetic graphite.
The second major growth area for graphite demand is from electric arc furnaces for making steel. Steel production using EAF technology has a much lower carbon footprint than traditional blast furnaces and are expected to continue to gain market share over the coming decades. Using an EAF, graphite is consumed in the furnace as the electrode via which electricity is transmitted to the furnaces.
Depending on the quality of the electrode, between 1.7kg and 2.5kg of graphite is consumed for every tonne of steel produced. The graphite used is always synthetic.
The largest supply increases over the last five years have come from the synthetic graphite market, which is a derivative of needle coke. Needle coke is produced from oil or coal through fluid catalytic cracking.
Petcoke produces a higher quality product, more suitable for use in EAF or EVs. The current utilisation of needle coke capacity is low but forecast to increase substantially over the coming years. Substantial fresh capacity is also being built. China makes up the bulk of needle coke production capacity, with an estimated 1.1mln tonnes per year of petroleum-based and 1.03mln tonnes of coal tar pitch-based capacity, although typical annual production is estimated to be only around half this amount.
There is no shortage of natural graphite mines, however there are only a very limited number of processing projects outside of China to make the product suitable for batteries.
It’s also worth noting that end-markets for graphite have considerable pricing variations. This isn’t only driven by the different end uses but by the fact that each graphite mine produces a range of different flake sizes which dictates how they are used.
To get the flakes into a usable form the material must first be mined and then processed into greater than 95% concentrate. In many instances, notably for batteries, this concentrate is an intermediate step which then has to be purified to a level above 99.95%.
The danger for non-battery market producers is that as this market increases in scale, more by-product non-battery grade material will be produced that swamps those markets.
“Amid rising graphite prices and strong demand projections from the fast-growing EV sector, our view is that the market opportunity for natural graphite producers is to go as far down the value chain as they can towards producing the anode itself for use in batteries,” said Baker Steel.
“Doing so however is a costly, complicated and in many instances a ‘dirty’ process. Production is also dominated by China and there continues to be a lack of technical expertise in the Western World regarding the construction and management of upgrading plants. In the West, fully or partially integrated suppliers of synthetic graphite will also increasingly attract a strategic premium over the coming years. The permitting and financing of needle coke production facilities remains a challenge, so those facilities which are already built and have the potential to expand will be major beneficiaries.”
Most graphite development companies understand this, and consequently aim to use their mines to develop industrial operations, with the goal to achieve superior margins. The skill set required is different though, which explains in part why the graphite sector has been a laggard in terms of generating investor returns.
Successful industrial mineral companies must have extremely good customer relationships, which is also true of suppliers to the battery industry. As a result, when investing in the graphite sector the analysis must go well beyond the geology - as demonstrated by some high-profile business failures of world class deposits due to a lack of market and technical knowledge.
“As sector specialists with many decades of experience investing in resources market, our investment team seek selective opportunities in niche markets, such as the graphite sector, with the goal of identifying undervalued miners with strong margins and competent management, which offer exposure to the growth areas of the natural resources investment universe,” said Baker Steel.