Amid record high prices, are industrial metals the new oil in India?

Data providers such as Reliance Jio, Airtel and large tech startups such as Flipkart, Paytm have yet to earn big profits, while metal giants are becoming important in an emerging low-carbon world

In a world increasingly dominated by technology, countries typically move away from their historically heavy dependence on commodities such as oil and gas and industrial metals, and advance towards software and algorithms to drive economic growth. The catchphrase for this new emerging economy is that “data” is the new oil.

While the quote is originally attributed to British mathematician Clive Humby, who first used it in 2006, in India it has been popularised by Mukesh Ambani — India’s richest businessman and promoter of the country’s most valuable company, Reliance Industries (RIL), and the largest telecom operator, Reliance Jio.

“In this new world, data is the new oil. And data is the new wealth,” said Ambani during his speech at the Vibrant Gujarat Summit in January 2019.

In this new paradigm, the companies that control and process data are expected to be the biggest and most profitable. In this way they will mirror the oil and gas companies that have historically been the biggest and most profitable firms in most major economies.

For example, Oil & Natural Gas Corporation (ONGC) — India’s largest crude oil producer — was the country’s most profitable non-financial firm for nearly two decades since its stock exchange listing in 1995. In FY15, the baton was passed on to RIL, which, though not a major oil producer, still generates most of its revenue and profits from refining crude oil and converting it into petrochemicals, plastics and synthetic fibres.

RIL’s oil-to-chemicals (O2C) business accounted for 57 per cent of its consolidated net sales and 51.5 per cent of its profit before interest and taxes (PBIT) in the first nine months of FY22. The rest came from its new-age businesses, including telecom operations, retail, media and other ventures.

Companies such RIL, ONGC, Indian Oil Corporation, Bharat Petroleum Corporation and Gail (India), among others, have helped oil and gas remain the biggest and the most profitable sector in the non-financial space. The sector accounted for nearly 29 per cent of the combined net sales of BS1000 companies in the first nine months of FY22, and nearly a quarter of their combined net profit.

The new giants

Data service providers such as Reliance Jio, Bharti Airtel and Vodafone Idea and large tech startups such as Flipkart, Paytm, and Zomato, among others, have yet to generate big profits. However, mining and metal giants such as Tata Steel, JSW Steel, Hindalco, Vedanta and Hindustan Zinc have become the biggest profit-earners in the post-Covid world. Many analysts expect industrial metals to become the “new oil” in terms of their economic importance, profits and revenues in the emerging low-carbon world.

The 82 metals and mining companies that are part of the latest edition of BS1000 reported an all-time high combined net profit of around Rs 74,000 crore in FY21, which grew further to Rs 1.24 trillion during the first nine months of FY22 (9MFY22) — only 5 per cent lower than the combined net profit of oil and gas companies, at around Rs 1.3 trillion. By comparison, three years ago in FY19, the combined net profit of oil and gas companies was more than twice that of the metals and mining sector.

The numbers also suggest that while the oil and gas sector has lost some of its heft in the last few years, metal producers have got bigger. At 28.7 per cent, the oil and gas sector’s share in the combined revenues of BS1000 companies in 9MFY22 was 510 basis points lower than their record share of 33.8 per cent in FY14, despite a sharp rise in energy prices in 2021.

The sector has done poorly on profit, too. Its share in BS1000 companies’ combined net profit in 9MFY22, at 24.4 per cent, is the lowest since FY17. (One basis point is one-hundredth of a percentage point.)

In contrast, mining and metal companies have raised their revenue and profit share in recent years. They together accounted for 12.8 per cent of BS1000 companies’ combined net sales in 9MFY22, up from 10.4 per cent in FY20, and the highest since FY11. And their profit share surged to a record high of 23.2 per cent in 9MFY22, up from 13.9 per cent in FY20.

The recent trend in the prices of industrial metals such as steel, copper, aluminium, zinc and nickel points to a further rise in the revenue and profits of metals and mining companies in forthcoming quarters, even as the price of crude oil and gas has moved up further in recent months.

Electric vehicles use more metals than their diesel or gasoline counterparts. This means greater demand for steel and aluminium alloys used in making structural components, such as the chassis and the vehicle frame

Metals for energy transition

Not surprisingly, many experts now see metals as the new oil. “Metals may become the new oil in a net-zero emissions scenario. Low greenhouse gas technologies require more metals than their fossil fuel-based counterparts,” wrote Lukas Boer, Andrea Pescatori, Martin Stuermer and Nico Valckx in a research report for the London-based Centre for Economic Policy Research last November.

Electric vehicles (EVs), for example, use more metals than their diesel- or gasoline-powered counterparts. Similarly, wind turbines will push up the demand for aluminium, while silver and copper are critical raw materials in the manufacture of solar photovoltaic equipment.

“Buying an electric vehicle looks like a good investment — in commodities. The price of copper has more than doubled since the start of the pandemic, as an electric car is estimated to contain an average of more than 80 kilograms of the minerals,” wrote Stéphane Monier, chief investment officer of Lombard Odier Private Bank, in a February 2022 report.

EVs are also 30-40 per cent heavier than internal combustion engine (ICE)-powered vehicles. This means greater demand for steel and aluminium alloys that are used to make structural components of an EV, such as the chassis and the vehicle frame.

“A fast energy transition, for example, could require a 40-fold increase in the consumption of lithium for electric cars and renewables, while the consumption of graphite, cobalt, and nickel for these purposes may rise around 20 to 25 times, according to the International Energy Agency (IEA). Ambitious infrastructure programmes in the European Union and the United States would drive up the demand for copper, iron ore, and other industrial metals,” wrote Boer, Pescatori, Stuermer and Valckx in a blog for the IMF last November.

A better demand for metals compared to hydrocarbon-based energy also shows up in commodity prices. For example, crude oil prices are up around 50 per cent relative to their pre-pandemic levels, much lower than the rise in industrial metals such as steel, copper and aluminium.

Metal prices are rising faster

Brent crude is now trading at around $100 per barrel, up 50 per cent compared to $66.4 in December 2019. By comparison, the London Metal Exchange Index (LMEX), which tracks the price of the six most commonly used industrial metals — aluminium, copper, zinc, nickel, lead and tin — has risen nearly 83 per cent during this period. In fact, the LMEX went past the 5,000 mark for the first time in early March this year, in the wake of the sanctions imposed by the US and EU on Russia.

The Russia-Ukraine conflict also led to a sharp rally in oil prices, but they have failed to scale a new high thus far. In fact, the war premium has now evaporated, and the benchmark Brent crude has crashed 23 per cent from its recent (March 2022) peak of $128, to below $100 per barrel. Many analysts fear a decline in energy demand in the major economies if crude oil prices stay too high for an extended period.

The price dichotomy between crude oil and metals has been even sharper in the last 10 years. Brent crude is currently 10 per cent cheaper than it was in January 2012, while the LME Index is up 40 per cent and steel prices in China have risen 20 per cent in this period.

Most analysts expect this trend to continue, given a better demand outlook for industrial metals — unlike fossil fuels, which would face demand compression owing to the energy transition.

“The combination of soaring metal demand and slower supply changes can spur prices to climb. In fact, if mining had to satisfy consumption under the IEA’s net-zero scenario, our recent analysis shows prices could reach historical peaks for an unprecedented length of time,” wrote Boer, Pescatori, Stuermer and Valckx in their IMF blog last November.

The authors argue that in the net-zero emissions scenario, the demand boom could lead to an over four-fold increase in the value of metal output, rivalling the estimated value of oil production over the 2020-2040 period.

Boost from market concentration

In India, large metals and mining companies have also gained from a rise in market concentration resulting from a slew of mergers and acquisitions since 2016. This is especially true in the iron and steel space, which is also the biggest segment in terms of revenues. The top three steelmakers — Tata Steel, JSW Steel and Steel Authority of India Ltd (SAIL) — together accounted for 74.5 per cent of the industry’s revenues in FY21, up from 61.5 per cent in FY16.

The big three’s revenues rose further to 76 per cent during the first nine months of FY22. As a result, the Herfindahl-Hirschman Index (HHI) score, which indicates competitive intensity (or lack of it), in the steel industry, reached a new high of 2,166 in 9MFY22, up from 1,479 in FY16.

An industry with an HHI score of 2,500 or more is believed to be highly concentrated, while an industry with a score of anything between 1,500 and 2,500 is considered moderately concentrated, and a score of less than 1,500 indicates a competitive industry.

Market concentration is even higher in non-ferrous metals such as aluminium, copper and zinc, where nearly 80 per cent of industry revenues are accounted for by just two companies — Hindalco and Vedanta.  This provides metal producers with significant pricing power in the domestic market.

“A combination of record high global price and a market concentration resulted in a doubling of price realisation for domestic steel producers, and EBITDA margins and profits reached a new high in 9MFY22,” says Dhananjay Sinha, managing director and chief strategist, JM Finance Institutional Equity.

However, Sinha raises doubts over the industry’s ability to sustain earnings at current levels for long: “The recent surge in metal prices may fizzle out, as demand growth has been muted in all major economies. In India, for example, steel demand is growing at 2 per cent per annum, down from 8-10 per cent growth a decade ago.”

The industry also faces risks from a rise in energy and other operating costs. “Metal production is energy-intensive and the rise in crude oil, natural gas and coal prices could compress industry margins in forthcoming quarters,” says G Chokkalingam, founder and managing director, Equinomics Research & Advisory Services.

A majority of equity investors also believe that metals producers may not be able to sustain the surge in their earnings in recent quarters. Mining and metals firms together account for only 6 per cent of the combined market capitalisation of all BS1000 companies, up from their 4.2 per cent share in FY20, but down from their record high share of 15.2 per cent in FY13.

Mining and metals companies are also trading at a huge discount to the valuation in the broader market. Their current trailing price-to-earnings (P/E) multiple of 9.4x is nearly 75 per cent lower than the average P/E multiple of 36.1x for BS1000 companies, indicating that investors are not confident about the industry’s future.