Author: Brian Cordischi, Chief Investment Officer, Carnegie Private Banking
July 14, 2022
The war in Ukraine has accelerated the need for a new energy system in Europe to reduce dependency on Russian oil and gas. This transition is going to require heavy investment in everything from renewable energy to energy storage, expansion of power grids and energy efficiency improvements. It is also going to raise demand for all the metals used in electrification, and the recent energy crisis has shown how dependent we still are on fossil fuels like oil and gas during a transition period.
In our Global Theme portfolio, where we gather our thematic investments, we have had exposures to renewable energy, the energy transition, natural resources and smart materials for some time. These kinds of exposure are even more top-of-mind in this situation. Batteries are another hot area of investment. High commodity and materials prices and the accelerating energy transition are making the segment even more interesting, as initiatives are likely to increase.
Battery investment opportunities
Electrification of the vehicle fleet is pivotal to creating a sustainable energy system, since greater prosperity usually leads to increased transport. Emissions from combustion engines are no longer declining and customers are showing a preference for larger cars. Aimed at reversing the emissions trend, the sector is in the midst of a historical transition that involves massive investment. Battery power has taken a big lead compared to alternatives like hydrogen.
There are plans for major expansion of battery manufacturing, but materials supply needs to be scaled at a similar pace
Batteries are also attractive for several other use cases, including heavy vehicles and stationary energy storage. Vehicles, especially passenger cars, are currently the biggest use case so far and are driving the battery market.
Battery-powered electric vehicles (EVs) are going to take over the automotive market, at least if the actions of carmakers and the financial market are anything to go by. American Tesla has the fifth-largest market cap in the world. Likewise, the American Ford Motor Company’s stock rose a full 150 percent in 2021 when the electrified F150 pickup was launched before Tesla’s Cybertruck. Leading traditional car manufacturers are investing heavily in electric power, even though they are not major players in the segment. The further development of combustion engines is being phased out.
In 2021, 6.6 million fully battery-powered passenger cars were sold globally, up by 120 percent from 2020 according to Bloomberg NEF (see Fig 1). So far, this is only a fraction of the total market of about 70 million passenger cars in 2021. Tesla’s volumes grew by an impressive 70 percent, in spite of component shortages. The total market in China has doubled in size in a single year. Domestic manufacturers dominate – but the market is suffering from fragmentation and weak profitability, which has made Chinese automotive equities volatile.
The most exceptional thing about Tesla is not its growth (Chinese electric vehicle manufacturer Xpeng grew by 275 percent in 2021 compared to 2020), but that Tesla has high and rising margins. The company is actually reporting a higher profit margin right now than quality leader BMW ever has. This has intensified focus on Tesla’s integrated business model, where not only software but also batteries are developed internally. Parallels are being drawn to Apple’s strategy in mobile phones, which explains why the valuation is so high.
Earlier forecasts talked about growth for all-electric vehicles of about 30–40 percent a year until the end of the decade. When the technical shifts really take off, however, it is tricky to make forecasts and growth could be underestimated – as mentioned, the growth rate was considerably higher in 2021.
Bottlenecks set limits
The battery is the most expensive component in an EV and costs the car manufacturer about SEK 100,000 ($10,000) to buy, for 70 kWh capacity. Huge technical advances have been made and the cost per kWh is a fraction of what it was in 2010. Many believe that demand for EVs will be driven by lower prices, especially for batteries. At present, however, we are seeing steep price upturns for the battery metals lithium and nickel, making both batteries and EVs more expensive.
Batteries use some materials that have never been mined on a large scale before, especially lithium. There are plans for major expansion of battery manufacturing, but materials supply needs to be scaled at a similar pace. This is a significant challenge, which is likely to be overcome with time but will create different cycles in the chain. At present, semiconductor shortages are constricting the supply of products including EVs more than battery supply.
This has already, for instance, meant that Tesla failed to launch products at prices as low as it intended. One explanation is that high expectations for EV range require bigger batteries. For the Tesla Model 3, range differs 30 percent between trim levels (versions), with a longer and shorter range respectively (the price difference is 12 percent). In addition, both trim levels have been upgraded with larger battery capacity. EVs are still premium cars and rapid price drops cannot be expected. Driving characteristics are pushing demand and subsidies are helping. At present, however, charging stations are still too few in number – a huge expansion is required here.
The car battery market is currently dominated by Chinese CATL, Japanese Panasonic and the South Korean companies LG Energy and Samsung SDI. Minor players like the Chinese EVE and Svolt have aggressive investment plans. A Swedish company, Northvolt, will begin production this year.
The growth rate for battery manufacturers basically tracks EV volumes with additions for increased battery capacity and subtractions for price erosion. 2021 was exceptional, with 100 percent growth due to the post-pandemic recovery and strong EV market. The market is tough, with expectations of constant efficiency improvements and heavy investments. Strong partnerships between battery and car manufacturers have become common to avoid under- or overinvestment. These agreements improve the battery manufacturers’ potential to achieve high capacity utilisation while securing volumes for the carmakers. But shared risk-taking can also reduce the battery manufacturers’ ability to boost margins when demand is strong. The car manufacturers take volume and price risks and must correctly forecast their market shares. Selecting a better battery technology than the competition is also important, of course.
The transformation of the power system is creating increasingly stronger incentives to invest in stationary energy storage
Chinese CATL is now the leading independent battery manufacturer, with high growth and profit margins. CATL has also been successful with both Chinese and foreign manufacturers, partly by having the capacity to offer different types of batteries. CATL’s sales this year are expected to be four times higher than in 2019 and the company has the biggest expansion plans in the sector. The share has been rewarded with high valuations.
LG Energy executed a highly sought-after IPO in late January and is building an even larger battery factory in partnership with GM in the US. Panasonic has mainly been a supplier to Tesla, which has driven the trend. Tesla and Panasonic are not as transparent about their capacity plans as other manufacturers. On Tesla Battery Day in 2020, the company stated production targets of 100 GWh for 2022 and 3,000 GWh for 2030.
Technical advances with new materials
Car batteries for EV operation consist of thousands of linked cells. Packaging them in a smart way can give car manufacturers a competitive advantage. Better packaging has compensated for the lower density of the LFP battery chemistry. Building the vehicle chassis where the battery cells have a structural function is another efficiency improvement initiated by Tesla. Processes to bypass energy-intensive furnaces have tremendous potential to reduce costs and environmental impact. Acids with lithium salt are currently being used as electrolytes. Research is in progress to replace such fluid electrolytes with solid state ceramic materials that produce higher energy density and reduced leakage and fire risk. The listed US company QuantumScape has carved out a profile here, although the company currently has no revenues. The market leader CATL and the Indian Reliance are studying sodium as a low-cost alternative to lithium. In addition, sodium-based batteries can be charged quickly.
Next market: Stationary energy storage
EVs are currently dominating the demand for large batteries. Meanwhile, the transformation of the power system is creating increasingly stronger incentives to invest in stationary energy storage to compensate for fluctuations in production. In particular, the shortage of natural gas has driven European electricity prices up by several hundred percent. Storage imposes different demands than EVs: A low price per charge is critical, while weight and size do not matter much. Both markets use similar batteries today, but the stationary market is going to be driven towards cheaper materials. The segment is going to rise when storage gets cheap enough that solar and wind power can compete with fossil energy sources, regardless of weather and demand. The market is in its infancy. Examples of equities with dedicated exposure are Fluence (US) and Freyr (Norway/US). Private individuals can also benefit from stationary storage in connection with power cuts or take advantage of cheap electricity hours – Tesla launched the lithium-ion powered Powerwall 2015 and has sold more than 250,000 units.
The balance of power is going to change as the journey continues. This should also be the point of departure for those who want to invest in the battery sector. Investors can choose among vehicle manufacturers, manufacturers of batteries and battery components, producers of the input commodities and companies involved in charging stations.
There is a lot to be said for using a specialised EFT to gain broad coverage in the battery segment, including equities in China and South Korea that can be difficult to trade in. An actively managed fund is preferable for profiting from sector dynamics. Carnegie Private Banking launched a discretionary portfolio, Global Stockpicking, this spring, which will be active in areas including this one. Some battery exposure is also gained through our Global Theme portfolio via thematic investments in smart materials and the energy transition. If there is one thing to be certain of, it’s an exciting time to be investing in the battery sector and there are plenty of investment opportunities for those focusing on the green transition.