Climate Change Mitigation and Changes in Commodity Relationships

Climate change (and the corresponding mitigation efforts) are impacting many parts of the economy and financial markets, a phenomenon also known as transition risks. These structural changes will impact well-known relationships between many variables. One likely impact would be to weaken the well-known strong positive correlation between Crude Oil and Copper, two commodities that are each positively correlated with economic growth, hence widely used in predictive financial models, and have an active futures market.

Crude oil and copper are traditionally both ‘growth’ commodities. Their demand and thus their prices increase when global growth picks up. A healthier economy consumes more oil, and copper is used in so many parts of the real economy that Economics has termed it “Dr Copper”, in recognition of it being a leading barometer of the real economy. This common linkage had traditionally made Crude oil and Copper prices highly correlated, both to real economic growth (and future growth prospects) and therefore to each other. This positive correlation between Crude Oil and Copper will continue through this economic cycle, and probably for a few more cycles.

However, the structural impact of climate change mitigation efforts will probably weaken this highly positive correlation between oil and copper in the future. Reducing carbon and greenhouse emissions is a key goal of climate change mitigation efforts. A well-documented way to achieve this goal is to transition from the traditional combustion engine cars to electric vehicles. And this impacts oil and copper in opposite ways. A move towards electric vehicles reduces demand for oil and increases demand for copper, since all types of electric vehicles require a substantial amount of copper. As the world moves towards environment-friendly solutions and sustainability efforts, these historically positively correlated commodities will soon be at opposite ends of the climate change mitigation spectrum.