Critical minerals M&A outlook

The International Energy Agency (IEA) released its second annual Global Critical Minerals Outlook (the IEA Report) on 17 May 2024, which juxtaposed robust growth in demand for critical minerals in 2023 against a dramatic fall in prices of minerals including lithium, nickel and cobalt, owing to strong supply and high inventory levels. Despite these turbulent market conditions, the IEA Report highlights that investment in critical minerals mining grew 10% in 2023, and emphasises that, under currently stated policies, demand for critical minerals for clean energy technologies is set to double by 2030, meaning that market conditions are likely to change in the medium term. In this report, we examine the implications of this and other key trends for M&A activity in the critical minerals sector, as well as the key challenges which investors will have to navigate. 

M&A activity set to rise

Despite falling prices for most critical minerals throughout 2023, GlobalData's Mining M&A report for 2023 notes that total deal value exceeded USD 121bn – a 75% increase compared to 2022 – while deal volume rose a more modest 5%. In our view, this trend is set to continue in the short and medium term.

Existing policy commitments (such as the pledge made at COP28 to triple global renewable energy generation capacity by 2030) and legislative initiatives (such as the EU Critical Raw Materials Act which entered into force on 23 May 2024 and which we covered here and here) signal the continued emphasis placed by national governments on scaling up clean energy technologies and securing sustainable supplies of critical minerals required to do so. As a result, and as highlighted by the IEA Report, demand for critical minerals is likely to catch up to current supply levels and catalyse a recovery in price levels.

As prices recover and interest rates begin to fall – we note in this regard the European Central Bank's decision on 6 June 2024 to commence cutting interest rates – project economics are likely to materially improve, and investors will have greater room to manoeuvre in expanding and diversifying their portfolios, thereby fuelling M&A activity. BHP's bid for Anglo American, which has been described in the press as quintessentially a play to secure high quality copper mines, may be an early indication of this trend.

Key challenges in M&A processes

Against this backdrop, investors should be mindful of the following challenges which are likely to arise in critical minerals M&A processes in the short and medium term: 

• Valuation discrepancies;
• Geopolitical risks;
• Balancing resource nationalism and investment promotion; and  
• ESG due diligence and disclosure obligations.

We examine each of these challenges in turn.

Price volatility leading to valuation discrepancies

The sharp fall (and in some case increase) in prices of key critical minerals over the past 18 months has led to an acute divergence between acquirers' and vendors' valuations of specific assets, creating a complex environment where reconciling short-term price fluctuations with the enduring sentiment of strong demand in the medium and long term remains challenging. Having a consensus view on price in a structurally hanging commodity market is hard. With some commodities there are great differences in the way in which prices are struck.

Such pricing and valuation discrepancies are likely to continue to be a key commercial point in critical minerals M&A in the short and near term until the market and demand for critical minerals become more established. This challenge will affect different market participants in different ways and will also affect the types of transactions we are likely to see in the near term. A leading indicator in this regard is lithium which despite its volatility in price now has a much more established market, giving buyers and sellers more confidence in pricing their transactions.

In order to limit risk while capturing projected upside, we are likely to see more joint venture investments (and, in some cases, minority investments) in both producing and early-stage projects combined with call options for the investor to increase their stake over time if market conditions improve. Key issues in such transactions are likely to include the negotiation of exit provisions and the investor's influence on commercial and operational matters, including adherence to key policies regarding environmental and social issues.

Falling interest rates will lead to an uptick in investment activity by corporates and energy transition-oriented private equity funds which are reliant on easy credit to finance new acquisitions. In the near term, however, investment activity by cash-rich Middle Eastern investors is likely to remain elevated, as they look to diversify their commodity portfolios and allocate capital reserves built up as a result of high prices of oil and natural gas which had prevailed for much of 2022.  Key examples in this regard include the acquisition of a 51% stake in the Mopani copper mine by UAE-owned International Resources Holding in December 2023, and the acquisition of a 10% stake in Vale Base Metals by Saudi-owned Manara Minerals.

Geopolitical considerations

As noted above, national governments are increasingly rolling out policies focused on ensuring a stable and secure supply of critical minerals. Examples adopted over the past 18 months include the aforementioned EU Critical Raw Materials Act, Canada's Critical Minerals Strategy, Australia's Critical Minerals Strategy, India's Critical Minerals List and first-ever critical minerals auction, and the prominent role assigned to critical minerals in the Kingdom of Saudi Arabia's Vision 2030 objectives (which include attracting USD 170 bn to its mining sector by 2030).

While the aim of such policies is principally to increase the stability and independence of critical mineral supply chains, it is not clear how feasible those goals are. The IEA Report notes that the geographical concentration of critical minerals mining operations is set to increase or at least remain high over the near and medium term, with some 70 – 75% of projected supply growth for refined lithium, nickel, cobalt and rare earth elements set to come from the current top three producing countries. The implication for investors is that while the geographical concentration of critical mineral projects is not likely to decrease, critical mineral transactions are likely to be subject to ever greater geopolitical and regulatory risks. As a result, investors will have to carefully consider how to cater for regulatory clearances which may have to be sought and make contingency plans in case of adverse decisions.

As a broader trend, businesses in Europe, North America and other Western aligned countries are being encouraged by national governments and regulators to "risk-off China".  We are seeing foreign direct investment (FDI) policies aligning with trade alliances, especially when they match security alliances between the same countries. We explore these trends in FDI policies in our article Geopolitics: Shaping the Transactional Landscape.

Balancing resource nationalism and investment promotion

In order to capitalise on the growing global demand for critical minerals, mineral-rich developing countries are continuing to employ a combination of incentives and pressure exertion in order to direct investment towards (or away from) particular geographies. Onshoring of processing and refining continues to be a key demand by host governments, with a number of African jurisdictions announcing bans on the export of critical minerals including lithium. This culminated in September 2023 in the announcement of the construction of a US$500 million lithium refining facility in Ghana, which is set to open its doors in 2026.

More recently, however, host governments have been taking action in response to growing backlash from local communities relating to perceived adverse social and environmental impacts. Examples include Panama's ordered closure of First Quantum's Cobre Panama copper mine in December 2023 in response to growing community backlash about the environmental impacts of the mine, as well as Chile's decision in April 2023 to mandate the use of Direct Lithium Extraction (DLE) for all projects to minimise water use in the Atacama Desert, notwithstanding the fact that this extraction method is yet to be commercialised at scale.

Effective government engagement strategies, coupled with investment structuring to maximise the available investment protections, will therefore continue to be priority issues for investors making cross-border investments in emerging markets.

Decarbonisation and ESG

The general increase in prominence given to ESG considerations in corporate strategy and M&A activity in recent years has led to political and investor pushback in some geographies, amid growing concern that the expanding onset of ESG-related regulation may be stifling financial returns. This is particularly true of the US – for example, in February 2024, JP Morgan and State Street announced that they were leaving the investor-led initiative Climate Action 100, and BlackRock announced that it was transferring its membership from its US arm (Black Rock Inc) to its international arm (BlackRock International). It is reported that these changes combined removed nearly US$14 trillion of assets from Climate Action 100.

The critical minerals sector, however, has always been particularly sensitive to ESG considerations given its outsized impacts on the environment and host communities, and therefore ESG considerations are poised to remain an important factor in critical minerals transactions.

As mandatory due diligence requirements and disclosure standards continue to be adopted and enter into force in key jurisdictions, investors will be required to adopt more rigorous due diligence practices which cover their entire value chains in response. Any divergence in the scope of the mandatory disclosure and due diligence requirements adopted in key jurisdictions which investors are subject to are likely only to exacerbate this trend, as investors seek to minimise the risks of potential non-compliance.

Key elements of transactions which will be impacted by this trend include:

• Conduct of due diligence: Acquirers will be required to conduct more rigorous due diligence on elements such as GHG emissions, water use and impact on biodiversity, workforce and local communities, in order to inform their disclosures and rationalise the contributions of their investments vis-à-vis their decarbonization and sustainability objectives. Lenders will place increasing emphasis on data accuracy and third-party assurance in order to inform their own climate disclosures. By the same token, vendors will conduct more extensive vendor due diligence as a means of facilitating clean and responsible exits and minimising ongoing liabilities, both from a regulatory and a reputational perspective.
• Transaction structuring: The introduction of various phase-in requirements under key disclosure standards, such as the EU's Corporate Sustainability Reporting Directive, under which non-EU parent entities are required to report at group-level much later than in-scope EU entities, are informing transaction structuring alongside tax and investment protection considerations, and will continue to do so. For example, acquirers of assets with poor sustainability metrics such as Scope 1 and 2 emissions (e.g. coal mines) are increasingly structuring investments which would ordinarily fall within business lines sitting under EU holding entities through non-EU companies in order to avoid being required to make sustainability disclosures in respect of those investments at an earlier date. 
• Transaction documentation: Given the relatively nascent stage of development of the mandatory reporting regimes which parties might be subject to in some jurisdictions, parties are increasingly negotiating broad information rights relating to sustainability-related data, in order to inform any future disclosures, they might be required to make in respect of the relevant asset. As a result of more rigorous ESG-related due diligence processes, parties will negotiate more complex and extensive packages of representations, warranties and indemnities in respect of issues arising out of due diligence. This might include drafting more elaborate provisions in respect of 'business as usual' issues such as environmental liability and health and safety issues. However, acquirers will also seek contractual protections in respect of data points they know they will have to disclose under applicable mandatory reporting regimes in order to reduce greenwashing risk which might arise if the data relied on proves to be inaccurate. Accordingly, in some cases, acquirers may seek representations or assurances regarding the accuracy of key data required to be disclosed, such as data relating to greenhouse gas emissions or environmental impact studies previously conducted by the vendor.

Future outlook

As set out above, we expect to see very high levels of M&A activity in the critical minerals sector in the near and medium term,  particularly as interest rates are expected to ease through 2025. The rate and nature of investment, however, is likely to evolve in response to rapidly changing conditions. While this is likely to create attractive investment opportunities, investors will need to carefully manage the expectations placed on them by key stakeholders and host governments in order to safely realise the value of their investments.

For more information, see our Mining insights hub here, which will include future articles in our Beneath the Surface series.