🔋Built To Scale
🔋Built To Scale
Due to economies of scale, we are in a paradigm in which new factors dominate the price of batteries and renewables today.
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Do you shop local and support small businesses or shop deals at big retailers? Similar goods often can often be found significantly cheaper at Walmart, Target, or Amazon. These large chain companies have taken advantage of economics of scale to the extreme. As evidence by a short film, Walmart is often thought of as abusing their power to get low prices from suppliers since often they become dependent on the exposure gained though Walmart and left with little alternative for sales. We may intuit this process and take advantage of its benefits on a daily basis, the principle is clearly powerful with wide reaching impacts both positive and negative.
Regardless of the pros and cons, it is something each business experiences as it grows. Most commonly, as a company grows its input costs go down yielding greater profits as a function of output quantity. This means that a company producing 1 million dollars worth of toys has a cost of 10 cents per toy while a 10 thousand dollar toy producer may have costs of 20 cents per toy. Less commonly early on and sometimes with an matured company that keeps growing, diseconomies of scale can take hold which increase costs as quantity of output increases.
When “economies of scale” are reached, cost per unit with respect to the output goes flat, meaning constant returns for the company. The factors giving rise to this economic phenomena as companies grow are more efficient production through proven and well developed technology, access to cheaper capital/loans, reduction in logistic costs, ability for bulk orders, buying power with suppliers, increased marketing breadth, managerial expertise, ability to hedge risks/survive recession, and specialization of workers/product.
“Diseconomies of scale” are things that raise costs like opposition (windfall profits taxes, regulation, anti-trust action, lawsuits), geopolitical factors and uncertainty, scarcity of resources, bureaucracy/delays, and internal company conflict.
Costs of Li-ion batteries (LIBs), solar panels, wind turbines, etc. have maintained steady price declines until very recently. There are a number of reasons for this relating to the overarching theme of scale. For LIBs, the technology has seen improvements and is near the current theoretical limit. This is one reason for the switch in focus to other things like sulfur, silicon anode, solid-state, and other battery technologies to make another stepwise improvement in technology. Further, as more companies decide to scale up and sell batteries to the market, their overhead and production costs get lower due to more availability for machines, materials, etc. Companies may get cheaper debt or outright assistance from governments and expertise in terms of specialization and managerial experience improves as the industry grows as well.
Similar trends have caused a steep cost decrease for wind and solar over the past decade as shown clearly here. As these industries have grown, the market matches the demand allowing input costs to decrease over time.
These industries are steaming ahead and rapidly approaching economies of scale. While supply chain bottlenecks of components in all of these fields are very common today and the industries are expected to continue growing, the volumes achieved are sufficient in my opinion to say we are closer to flat constant returns to scale than the rapidly cost decreasing economies of scale on the minimum efficient scale above in the first figure. This effects multiple types of companies like resource, processing, and manufacturing companies.
Focusing on manufacturing, the main costs are materials, labor, and overhead. As economies of scale are sufficiently reached, labor and overhead costs make up less of the total cost as quantity of product produced surpasses cost of overhead equipment. Add in automation and labor costs trend down as well. What this means in real terms is that a battery manufacturing facility may have $500,000 in equipment costs to make LIB cells. At some point if they have enough buyers, the cost of materials will exceed multiple millions, dwarfing the constant labor costs and initial overhead cost assuming equipment lasts for a long time.
My point is when economies of scale are achieved in these industries, costs become dependent on raw materials which by extension are dependent on energy costs. If we look at the cost breakdown of and EV battery cell, about a quarter is manufacturing + depreciation. The bulk of the cost is materials, dominated by the cathode. This is the commonly referred to materials of lithium, nickel, cobalt, and manganese which are so important. Copper, steel, and graphite are also important for raw material prices.
For some time, the supply of battery metals was not stressed, but recently demand has been increasing each year. With a more constrained supply side, prices have risen. In addition, higher energy costs in general result in a higher cost for batteries, solar panels, and wind turbines. Fuel prices for mining, energy prices for processing facilities, and electricity prices for manufacturing which are still largely a function of fossil fuel prices are higher now than pre-2022, just at the same time that they matter more in the framework of economics of scale. Prior to these new developments, cheap energy was a tailwind for the cost reduction of renewables/batteries over the last decade, however they were dominated by the technological improvements and other benefits of increasing scale.
To be clear, material costs now represent a larger percentage of the total cost, and those material/energy inputs have increased in price. This reality in the backdrop of nearing economies of scale is the dominant factor as to why the price of renewables has increased in the last few years (and last one year for batteries).
Energy and metal prices have since had a reprieve, shown below with lithium carbonate as an example. A critic may point this out to say cheaper raw materials are returning and my analysis won’t be a factor, however it would take considerable more deflation to reach and stay at pre-2022 levels (~30% drop in WTI oil price and ~50% drop in lithium carbonate to reach 2015-2021 trend).
If cheap energy returns for the next decade, I think renewables/batteries could see a flatlined cost as a function of benefits of scale. My current long term outlook does not factor in energy prices returning to what was sustained from 2015-2021 though, but instead a price trend overall over years higher than that time frame. I’ll caveat that we could easily see lower energy prices in a recession, in which case there would be lower demand for not only energy, but likely batteries/renewables as well.
Many believe that renewable energy will usher in cheap energy and this will be a self fulfilling cycle, however the observation so far is the opposite in addition to the largest manufacturing centers using more coal than ever before. It is proving difficult to cheaply produce and replace fossil fuels on the grid and there aren’t complete solutions to diesel mining equipment or high power mineral processing facilities so important to the current energy transition goals. These factors are key to understanding the long term trajectory of metals, mining, and battery manufacturing in the future and how material and energy costs will play a bigger role going forward. Until next week,
-Grayson
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