Is a Copper Crisis on the horizon?

Today's read (12 minutes):

• Is a Copper Crisis on the horizon?
• Why are Banks and Private Equity firms investing in Family Homes?
• Colombia and Venezuela border re-opens
• Case: Herbert Smith Freehills and DAC Beachcroft advise on ponzi-scheme insurance claim
• Deal: Travers Smith acts on Fraser offer for MySale
• Answers to your questions!

Is a Copper Crisis on the horizon?

A massive shortfall in the supply of copper could arise in a couple of years' time. This slump could hold back global growth, and raise manufacturing costs for a metal that is used in everything from computer chips to electric vehicles.

Global mining output is already dropping, and is expected to become dangerously low in the near future as producers hold back on investment.

Recently, mining giant Newmont cancelled plans for a $2 billion gold and copper project in Peru. Freeport-McMoRan, the world's biggest publicly traded copper supplier, has warned that prices are now “insufficient” to support new investments.

The issue is not limited to just companies. In Chile, the nation that’s long been the world’s largest supplier of copper, revenue from copper exports is falling because of production struggles.

The problem is that just as the copper supply falls, its demand is expected to continue to grow. A study by S&P Global predicts that as the world goes electric, net-zero emission goals will double demand for copper to 50 million metric tons annually by 2035. BloombergNEF estimates that demand will increase by more than 50% from 2022 to 2040.

Some analysts suggest that the demand for copper may also depend on the outlook for demand from China, the world’s biggest metals consumer. If China’s property sector shrinks significantly, that's structurally less copper demand. This could off-set some of the growing demand, but we can expect the deficit in supply to be caused by governments' need to meet net-zero goals.

Meanwhile, mine supply growth will peak by around 2024, with a number of new unfinished projects in the works and existing sources drying up. This could cause a deficit of as much as 10 million tons in 2035, according to the S&P Global research. In 2021 the global deficit came in at 441,000 tons. That was enough to send prices jumping about 25% that year.

Does Copper really matter?

In short, yes! The metal is considered the benchmark for conducting electricity, and it is also key to green initiatives. Millions of feet of copper wiring will be crucial to strengthening the world’s power grids, and tons will be needed to build wind and solar farms. Electric vehicles use more than twice as much copper as gasoline-powered cars.

How does this impact law firms' clients?

• Clients are struggling with higher production costs, and are avoiding investing into new projects. This is causing a slump in supply both in the short and long term.

If a supply deficit occurs, clients in a vast range of sectors will be heavily affected by the rising price of copper. This could be anyone from microchip producers, to electric vehicle companies, and air-conditioning businesses.

Goldman Sachs estimates that miners need to spend about $150 billion in the next decade to solve an 8 million-ton deficit. BloombergNEF predicts that by 2040 the mined-output gap could reach 14 million tons, which would have to be filled by recycling metal. The benchmark London Metal Exchange price is expected to almost double to an annual average of $15,000 a ton in 2025, from its current value of approximately $7,690 a. ton.

Client also have to deal with soaring inflation which is further driving up the cost of production. That means the average incentive price, or the value needed to make mining attractive, is now roughly 30% higher than it was 2018 at about $9,000 a ton.

Clients in this sector also know that increasing the supply of copper is neither easy nor quick. It takes at least 10 years to develop a new mine and get it running. This means that the decisions producers are making today will help determine supplies for at least a decade.

New projects would also require a large amount of investment capital to kickstart the process. Due to the current economic uncertainty many producers are holding off from embarking on risky investments into new mines, and would rather use cash flow for returns to their investors.

How does this impact law firms?

• Law firms can expect to advise on contractual issues for the supply of copper, disputes due to failed supply, and on regulatory approvals for new mines.
• Top Departments: Commercial, Corporate, Litigation, Regulatory.

Law firms will be asked to advise on quality requirements which form part of mining supply contracts. This type of advice will become increasingly prevalent since at mature mines, the quality of ore is already deteriorating. This means that output either falls or more rock has to be processed to produce the same amount.

Additionally, the industry’s pipeline of committed projects is running dry. New deposits are getting trickier and pricier to both find and develop. In Peru and Chile, which together account for more than a third of global output, some mining investments have stalled, partly amid regulatory uncertainty as politicians seek a greater portion of profits to resolve economic inequalities.

Law firm will also be required to advise on the regulatory side of mining, and particularly on the process of securing approvals for new projects. Copper is a crucial resource for a greener world, but digging it out of the earth can harm the environment. Governments worldwide are heightening their scrutiny of environmental and social issues, and this will make getting approvals for new projects much harder.

As copper supply decreases, the supply of scraps can be a solution to help fill mine-production gaps, especially as prices rise. This will drive more recycled metals to appear in the market. Recycled production will come to represent about 22% of the total refined copper market by 2035, up from about 16% in 2021, S&P Global estimates. Law firms may be asked to assist on drafting supply contracts consisting of scrap supply, and negotiating contracts based on the supply of copper to include provisions for the replacement with scrap supply.

What Trend can we see here?

The results from the supply issues we mentioned above will largely be felt in the long term. The world is becoming more electrified, with the increasing demand for anything from micro-chips to electric vehicles. These, matched with the ambitions of governments' worldwide to achieve net zero targets will prop up the demand for copper to new heights.

Once this growing demand meets the slowing supply of copper, producers will face huge challenges and the cost of copper may rise exponentially causing issue for anyone that relies on this metal. As mentioned, the problem is that supplies can't be easily rectified. Mines take a long time (10 years) to be made operational, which means the actions of parties now are set to have an impact on this sector for a decade.

Why are Banks and Private Equity firms investing in Family Homes?

Private equity firms and big banks have been investing heavily in single family residential homes. Despite a slight slow-down in recent times due to the current economic uncertainty, this is set to be a long-term trend to watch for the property market and law firms.

The boom in investment in single family homes is mainly due to the extremely attractive return on investment rate they offer. In the US, between 2016 and 2021, annual returns from family rentals (of 21%) have outperformed those of housing for old folk (7%), offices (5%), shopping malls (-1%) and even apartments (12%). In the past decade, the value of homes owned by institutions has doubled to $4.7trn, a figure that towers over the estimated value of America’s offices, at $1.9trn.

The trend has also spread to Europe. Investors such as Aviva and Legal & General are building thousands of rental homes across Britain, which now has more than 73,000 “build to rent” properties. Institutional investors are also buying up property in Germany, Ireland, the Netherlands and the Nordic markets, which have high shares of renters.

We have seen a slight pull-back in recent times as institutional investors evaluate the current uncertainty but the trend is set to continue in the longer term. Home Partners of America, the single-family landlord owned by Blackstone said it will stop buying homes in 38 US cities, however it highlighted it would resume purchasing homes in these markets in the future.

What’s behind the boom?

One explanation is that ageing millennials offer a growing market. As they approach their late 30s and early 40s many want better schools for their children or space for pets. In the US, population growth in this age category will nearly double over the next five years. In England, the proportion of those aged 55 to 64 who are renting has almost doubled since 2011.

The ever-growing cost of buying a house is another crucial factor. Those unable to buy homes have little choice but to rent, meaning landlords are confident of their ability to find and keep new tenants, especially for entry-level homes. In the US, rents for family homes rose by more than 13% in June compared with a year earlier. In Orlando, they were up by 23%. In Miami, by more than a third.

How does this impact law firms' clients?

• Clients in this sector will be keen to capitalise on opportunities in this real estate sector, whilst managing costs and current economic uncertainty.

Clients such as private equity firms, or banks will be looking to capitalise on this trend and continue to invest in the residential market to build a solid property portfolio.

However, this process does not come without challenges. Inflation means the cost of renovating and maintaining homes is rising. Invitation Homes says the amount it spent on these things rose by nearly 8% in the second quarter of this year. Construction costs have also risen, posing risk for investors building from scratch. Prices for building materials, including concrete, lumber and steel, have surged by 38% since the start of 2020. Interest-rate rises are another worry; as the market softens, investors are taking a more cautious approach. Home Partners of America, owned by Blackstone, announced in August that it would pause home purchases in 38 cities, markets that represent 5% of its activity.

Landlord clients will also have to contend with the impact of economic cycles on their pricing. Indeed, rents are unlikely to continue to climb at a record pace. However, history suggests that residential rents are more resilient than those from other property types, especially in periods when supply is tight. From 1974 to 1985, another period of high inflation, rents actually increased by 7-12% a year, notes Jay Parsons, an economist at RealPage, a data firm. Even as homebuyer demand crashed during the global financial crisis, demand from residential tenants did not waver. Although the housing splurge of institutional investors may calm a bit, it is unlikely to cease

How does this impact law firms?

• Law firms can advise on the process of acquiring land, constructing developments, managing houses, and compliance with new regulations for these institutional investors.
• Top Departments: Real Estate, Commercial, Corporate, Construction, Regulatory.

There is plenty of room for further expansion. In America, real-estate investment trusts (REITS) own just 1% of single-family rentals, compared with 5-10% of offices and warehouses, 15% of housing for old people and 50% of shopping malls. Law firms will be instructed to advise on the contractual and corporate side of these investments. These can range from private equity investments to organising joint ventures for investment in this space, re-structuring shareholdings of property companies, or even advising on acquisition of smaller property owner companies to expand the portfolio of institutional investors.

Law firms will also be asked to advise on earlier stages of this process such as the construction of the housing developments to be offered for rent. Big investors are already starting to build more, rather than just buying up existing stock. Last year, they built a record 7,705 family units, up from an average of 5,500 in 2015-20. By 2030, institutions are expected to have amassed 7.6m homes, more than two-fifths of all family rentals. This could include advise from real estate lawyers on the acquisition of land to build on, and from construction lawyers on securing permits and structuring the construction process of the development.

Law firms may also advise on the management side of renting. This can include negotiating supplier contracts to deal with the maintenance of the property, advising on enforcing terms where a supplier fails to deliver, and potentially employment contracts if the clients decide to onboard their own staff to do the maintenance work. The largest institutions hold tens of thousands of properties, which are offered renovated and have constant maintenance. For example, Invitation Homes says it spends an average of $39,000 fixing up each one, kitting them out with new flooring, upgraded plumbing and the latest tech, such as video doorbells and smart locks.

The drafting and negotiation of maintenance, and improvement contracts is crucial for clients in this space, as it allows them to attract richer tenants. Between 2010 and 2018, those with incomes of above $75,000 accounted for three-quarters of the growth in renters. Covid-19 accelerated this, as bidding wars forced high-earners to rent. Invitation Homes says its residents now have an annual household income of above $131,000, nearly twice the country’s median.

The trend toward corporate investors scooping up houses has produced a backlash in some cities, where affordable housing advocates have argued that the trend is cutting into the supply of for-sale homes, making homeownership more difficult to achieve. They are calling for greater regulation of that segment of the market, including purchasing restrictions and rent control. This could create additional opportunities for law firms to advise on the regulatory aspects of investing in residential housing, and on complying with any restrictions that are imposed.

Did you know?

The important South American border between Colombia and Venezuela fully re-opened on Monday. Vehicles carrying passengers and goods will be able to cross between the two countries for the first time since 2019.

The border was shut when Colombia’s then-president, Iván Duque, refused to recognise Nicolás Maduro as Venezuela’s leader after disputed elections in 2018. The election in June of Gustavo Petro, a leftist, as Colombia’s president has improved relations. Flights will also resume.

The opening should help both economies. Exports from Colombia to Venezuela, such as palm oil, were only worth $331m last year. Colombia’s trade minister reckons the figure could reach $1.2bn this year—double previous estimates. But that relies on Venezuela’s fragile economic recovery continuing. Colombia’s exports to Venezuela had already fallen after Venezuela’s economic collapse in 2014. And the neighbours will also have to tackle gang activity and rampant smuggling across the border.

Top Court Case:

Vistra Group Holdings has settled with its insurers, Zurich Insurance, over a lawsuit in which it sought to be indemnified for costs for suits accusing it of being negligent when auditing a business involved in a $1 billion Ponzi scheme. Vistra had alleged that Zurich and 29 other insurers wrongly refused to pay out for costs it ran up over lawsuits accusing it of wrongdoing while it was working for DC Solar Solutions Inc., the U.S. renewable energy business involved in the fraud. Vistra and other companies in its group had taken out professional liability, management liability and crime insurance policies with Zurich to cover them between July 2019 and June 2020.

Vistra became the target of lawsuits over auditing work done by a company it acquired (Montage) for DC Solar Solutions even though it did not buy Montage's continuing auditing operations.DC Solar manufactured and sold mobile solar generator units, but became a Ponzi scheme in which older investors were paid off with new investors' funds, U.S. authorities said. The company had defrauded investors out of more than $1 billion by the time the scheme ended.

Herbert Smith Freehills represented Vistra Group. DAC Beachcroft represented the defendants.

Top Deal:

Frasers Group said on Monday that it will make a mandatory £14 million cash offer for MySale, after securing receiving irrevocable commitments from Jackson Family Capital that it will sell its shares to the U.K. group, which owns retail chains Sports Direct and House of Fraser. The owner's shareholding will increase Frasers Group's holding to 48.5% of the voting rights in MySale. Under Rule 9 of the U.K. Takeover Code compels Frasers Group to make an offer for MySale because the shareholding will amount to more than 30%.

Travers Smith advised MySale.

Answering your questions!

Q: Why does the pound keep dropping in value? Does it have to do with the recent mini-budget or is it just the uncertainty in the economy? Thank you, Ludo! - Holly (London, UK)

Ludo: The pound dropped against the dollar testing $1.04, bringing it extremely close to a parity of value. There are two main reasons for this. Firstly, the drop was mainly caused by a sell-off on Friday after the Chancellor announced the mini-Budget. Secondly, the pounds has been weakened by the growing strength of the dollar which investors are seeing as a safe haven. Other currencies like the euro and the Japanese yen have experienced similar declines against the dollar.

The drop in the pound suggest that investors are not confident in the UK economy's ability to recover. This is emphasised by the five-year British yields rising from .5% at the beginning of August to above 4.5% now. A rising yield indicates falling demand for British bonds, and lower investor confidence in the economy.

The most simple explanation for the sell-off is that investors do not believe that the government’s tax cuts will lead to the real economic growth Kwasi Kwarteng wants. Instead, they expect higher inflation that the Bank of England will be unwilling to fully offset with interest-rate increases. Currency analysts at the Bank of America have suggested that a combination of Britain’s changing fiscal stance and the long-running effects of its decision to leave the European Union have led to a profound rethink of the pound by investors. That leaves the currency more vulnerable in the years ahead.

Want to ask a question? You can reply to this email and write in (it goes straight to my inbox) or fill out this form.