4 months ago • 4:29 mins
Legendary investor Howard Marks has constantly stressed the importance of “second-level thinking” – identifying the less-obvious consequences of a market-moving event – over the easy conclusions of “first-level thinking”. But with so many investors falling for a classic example of the latter right now, this seems like the perfect moment to make sure you’re in the esteemed group of second-level thinkers.
The conflict in Ukraine sent the price of oil to a 14-year high earlier this week, and that’s brought many investors to a straightforward conclusion: that surging oil prices will cause prices at the gas pump to rise, which should incentivize more people to make the switch to electric vehicles (EVs).
It’s the obvious conclusion – first-level thinking at its finest. But second-level thinkers would develop this idea in two main ways.
First, the conflict has also sent natural gas prices and, in turn, the cost of electricity soaring. After all, short-term electricity prices have surged 1,000% over the past year or two in many parts of Europe – the world’s biggest EV market. That matters because when consumers consider making the switch to EVs, they factor in the total cost of ownership – that is, operating and fuel expenses over the vehicle’s life – as well as the upfront cost of the car.
Second, an EV’s engine-equivalent – its battery – is the most expensive component of the vehicle: it accounts for around 40% of an EV’s total cost, according to consultancy Oliver Wyman. And while battery costs have dropped every year for the last 10 years, they’re set to increase in 2022 as the prices of key metals – nickel, cobalt, aluminum, and lithium – hit multi-year highs.
But here’s the thing: the calculations above were made before the conflict broke out, and that conflict has changed things. The supply of nickel, for example, is now under threat, given that Russia is the world’s third-biggest producer of the industrial metal. In fact, the price of one ton of nickel hit a record high of $100,000 at one point this week – five times higher than at the start of the year. And when you consider that EV batteries are typically 80% nickel, you quickly start to see how a high nickel price could be set to increase the cost of EVs.
It’s not just nickel. EV batteries have one major disadvantage compared to conventional internal combustion engines: they’re heavier, which reduces vehicles’ ranges. One way to fix that problem is to replace weighty steel parts in the vehicle with aluminum – a lightweight but strong metal. But Russia is also the world’s third-biggest producer of aluminum, which explains why the metal’s price hit a record high this week too.
Let’s go back to the beginning: first-level thinking says surging oil prices will cause prices at the gas pump to rise, which should incentivize more people to make the switch to EVs. But second-level thinkers will recognize that EVs’ charging costs have also gone up by as much, if not more. Throw in soaring nickel and aluminum prices, and higher upfront and total ownership costs could end up denting demand instead.
That’s not good news for EV makers. US electric truckmaker Rivian has even gone as far as to try to up the price of its pre-ordered vehicles to offset rising costs, and it faced heavy backlash as a result. And sure, manufacturers could choose to keep their prices stable to avoid increasing customers’ upfront costs, but only at the expense of higher costs themselves. That would lead to lower profit margins – again, not a great outcome.
Now, does that mean you should sell out of your EV stocks or short Tesla? Not necessarily: as always, things are more complicated than they seem. There are cost savings that come from other parts of the battery that could offset some of the impacts of rising commodity prices, and climate-conscious governments might step in with new EV subsidies to offset rising costs and stay on track toward their green targets.
What’s more, EV firms might already have seen this coming. Some EV makers may have hedged some of their commodity exposure for this year, or locked in price agreements directly with miners. And interestingly, Tesla is changing the battery cell chemistry that it uses in its non-long-range vehicles to one that doesn’t require any nickel – a move that could help increase its cost advantage over other manufacturers.
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