Investing in the battery supply chain
As the battery and electric vehicle (EV) revolution gains momentum, attention is increasingly turning to the commodity supply chains required for their manufacture. The global storage market is expected to grow to 63GW / 158GWh by 2024 and researchers are predicting that EV usage will increase from 3.2m units in 2017 to 13-18m units by 2025 and 26-30m units in 2030. As a result, there is a natural focus on the raw commodity components required to develop batteries by not only trading houses and mine developers, but also battery and EV manufacturers. Indeed, some manufacturers are looking to invest directly into cobalt and lithium mines to secure supply of crucial commodities such as cobalt and lithium.
However, such investments present difficulties, both from a sustainability and ethical perspective, and also from a project and country risk perspective.
Sustainability and ethical issues
Given that approximately 65 per cent of the world’s cobalt production currently comes from the Democratic Republic of Congo (DRC), with some sources estimating that this will increase to as high as 73 per cent by 2023, the industry is heavily dependent on the DRC mining industry. The concerns about child labour issues and unsafe labour conditions in the DRC have been well documented.
Indeed, there have been increasingly loud calls for greater regulation and oversight. In response, the London Metal Exchange (LME) has recently launched a formal market-wide consultation on the introduction of responsible sourcing standards for all traded metals. Under the new rules, all LME listed brands will be required to undertake a phased approach to sourcing issues, starting with a Red Flag Assessment based on the OECD Guidelines for Multinational Enterprises by the end of 2020. Brands considered at risk will then be audited by the LME and must adopt OECD-aligned responsible sourcing standards as well as environmental standards by 2022. All brands will have to publish their Red Flag Assessments by the end of 2024 (subject to confidentiality requirements in their commercial contracts).
The lack of access to responsibly-sourced cobalt will render the negotiation of supply contracts all the more important for EV and battery manufacturers. Given the lack of visibility on market movements on a long-term basis, both buyers and sellers of the raw materials may want flexibility to suspend their obligations or reduce/increase volumes to be delivered when market conditions dictate.
Direct investment into difficult jurisdictions
With end users looking to invest directly in the battery supply chain, they will need to consider the risks associated with doing mining deals in emerging markets and what steps they can take can be put in place to mitigate those risks.
Some of the key risks include change in law risk, foreign exchange/currency issues and local content requirements (such as the obligation to invest alongside local partners, restrictions on foreign investor ownership, requirements to develop local infrastructure and financial and social obligations to assist local communities).
Historically, investors and lenders have taken comfort that change in law risk is minimised by including stabilisation provisions in concession agreements with government ministries so as to “freeze” the law in effect at the date of entering into these agreements. However, recent legislative action taken by some governments in Africa, including in the DRC, has seen governments reneging on such stabilisation provisions and implementing new legislation which negatively impacts mining companies operating in those nations. The legislative action taken has included measures such as:
- repealing existing “stabilisation” provisions which aimed to fix the laws applicable to the mining companies for the term of their respective mining agreements and introducing drastically reduced stabilisation arrangements;
- significantly increasing taxes beyond the rates previously agreed (including the introduction of a 50 per cent tax applicable on all profits for domestic operations when price of commodity increases by more than 25 per cent (compared to the price set out in feasibility study));
- increasing the percentage of equity ownership required to be held by the government;
- increasing the percentage of equity ownership required to be held by locals up to 10 per cent of the share capital of the mining company; and
- increasing requirements to source goods and services locally and to conduct beneficiation (i.e. undertaking processes that improve the economic value of ores) within the DRC.
Given the risk that stabilisation provisions are revoked or cease to have effect, investors need to consider alternative protections.
Political Risk Insurance (PRI)
Whilst a potentially expensive option, PRI may be obtained to cover financial losses as a result of certain change in law risks. Typically policies do not usually provide blanket cover for adverse changes of law, but rather may cover losses arising from two key areas of change in law risk:
- failure by a government to pay an arbitral award based on a breach of contract by the host state (e.g. as a result of breach of stabilisation provisions); and
- expropriation of funds and inconvertibility/transfer risk in relation to payments attempted to made by the mining company.
A change in law imposing, for example, higher taxation on the mining company is unlikely to be covered by PRI in and of itself, unless so substantial as to be confiscatory in nature. As such, other protections may need to be considered.
Development Finance Institution (DFI) involvement
Our experience indicates that the involvement of DFIs as an investor or a lender into a project can help to prevent governments from taking “investor unfriendly” action that would prejudice the interests of the DFI funder. There are also normally strong lines of direct communications between the respective DFI and the administration of the relevant nation. This allows the DFI to directly contact the relevant minister or leader to strongly encourage them to reconsider actions that will prejudice investments in which that DFI is involved. This ability to apply political pressure to the relevant leader or minister can be influential and may well be the most cost-effective and efficient form of protection.
Bilateral Investment Treaties (BITs)
BITs provide last-resort protection for investors where all other avenues of dispute resolution, political pressure or insurance have been exhausted. BITs typically provide for a range of protections including from expropriation, and an obligation that investments be afforded “fair and equitable treatment” by the host state. A key part of the “fair and equitable treatment” obligation is an obligation on the host state not to breach the investor’s “legitimate expectations”. Action akin to that taken in the DRC could give an investor grounds for a claim under a BIT. However, BIT protections are often vague, and there is no binding system of precedent in BIT arbitration. Nevertheless, investors should consider structuring their investment through appropriate vehicles in order to take the benefit of BITs.
 Wood Mackenzie’s Global Energy Storage Outlook 2019, figures include batteries and other forms of energy storage.