Introduction
1. This client alert identifies key considerations for producers, traders and end-users (including auto manufacturers and original equipment manufacturers or “OEMs” that supply devices produced using critical minerals to manufacturers of finished products, including electric cars, solar panels and wind turbines) when negotiating contracts for the sale and purchase of critical minerals.
2. The term “critical minerals” where used in this client alert refers to minerals used in the production of clean energy technologies, including cobalt, nickel, lithium, copper and rare earth elements. Other terms commonly used for this group of commodities, which are the key raw materials used in the production of batteries and other technologies associated with the energy transition, include “green minerals”, “focus minerals” and “energy transition minerals”.
3. Both OEMs and their manufacturer customers are direct and indirect buyers of increasingly large quantities of critical minerals. Contracts for the supply of critical minerals to OEMs and other manufacturers are subject to economic, regulatory, social and political factors, and this means that their negotiation can be complex and fraught with challenges not otherwise affecting commodity supply contracts. These challenges include:
a) High market demand for the critical minerals – both current demand and anticipated future demand – such that ensuring security of supply is of paramount importance to buyers.
b) Volatile market pricing as the world moves through the ongoing transition to clean energy sources, and supply and demand for critical minerals fluctuate.
c) An increasingly stringent legal and regulatory framework of ESG obligations and commitments concerning the production and provenance of critical minerals, driven by government policy in different jurisdictions.
d) ESG considerations driven by buyers’ own internal policies and commitments to their customers and investors, which may surpass obligations under applicable laws.
e) Geopolitical risks that can affect supply chains for critical minerals in sudden and unexpected ways, especially given the concentration of certain critical minerals in a small number of countries, many high-risk.
4. How these surrounding factors are increasingly affecting the terms of contracts for the supply of critical minerals to OEMs and other manufacturers that buy critical minerals is discussed below. We consider the areas where tensions arise in negotiations between the interests of sellers and buyers, and how these tensions may be resolved in practice.
The market for critical minerals
Demand for critical minerals – the only way is up?
5. Market demand for critical minerals is growing rapidly. According to the IEA, in 2023 alone demand for lithium grew by 30%, while demand for nickel and cobalt grew by up to 15%.1
6. Demand for critical minerals is predicted to continue on this steep upward trend, as the transition to cleaner sources of energy continues in order to meet global climate targets. In a scenario in which net zero emissions targets are met, the IEA forecasts that global demand for critical minerals will increase to 3.5 times current volumes by 2030, in order to meet increasing demand for electric vehicle, solar and wind power technologies, as well as the expanded electricity networks necessary to accommodate them.
Prices of critical minerals – a bumpy ride
7. Although demand may be on a seemingly ever-upwards trend, that is not always the case for prices. 2023, in particular, was a year of extraordinarily high volatility for market prices of critical minerals.
8. By the end of 2022, and based on soaring prices over the previous two years, predictions of a new commodity “super cycle” abounded. But in 2023 prices collapsed, and by the end of the year, spot prices of lithium had fallen by 75% and prices of nickel, cobalt and graphite had fallen by up to 45%. These remarkable collapses in prices were driven by short-term oversupply as the production of critical minerals ramped up to meet demand, leaving producers overstocked with critical minerals, depressing prices and tying up producers’ working capital.
9. Already in 2024, some prices have rallied, with copper prices, for example, rising 20% between February and May 2024. However, markets have shown that the path to long-term higher demand can be a bumpy ride in the shorter term.
Impact on contract negotiation and terms
10. In contractual terms, a world of scarcity – or at least predicted scarcity in the long term – means that OEMs and other buyers are concerned to ensure long-term continuity of supply of the minerals that are of existential importance to their business.
11. The need for buyers to ensure continuity of supply has led to increasing investment by the major consumers/users of critical minerals in the sources of production, both in the private and state sectors. Equity and other investments in producers have proliferated in order to lock in buyers’ offtake rights. The longer-term expectations around demand for critical minerals are also leading to new entrants in the market, seeking to stockpile critical minerals as vehicles for long-term investors willing to take on commodity price exposure.
12. But where buyers need to source critical minerals by entering into supply contracts with producers, the market dynamics are manifesting themselves in a number of ways contractually.
Long-term contracts
13. Firstly, buyers are seeking longer-term contracts for the supply of critical minerals. Long-term commodity supply contracts bring their own challenges and considerations, including, for example:
a) How to balance a commercial desire to have flexibility around commercial terms (volumes, premiums, etc.) whilst ensuring that contracts are sufficiently certain to be legally binding.
b) How to allow the parties to review and reopen pricing structures that may fall out of step with market pricing as it evolves.
c) How to address unforeseen events that impact supply, such as changes in law and force majeure risks.
Please see our previous alert, “Long-term supply (and offtake) agreements: some recent themes”2, for a fuller consideration of these issues.
Contractual remedies for non-delivery
14. Buyers may seek to impose contractual remedies to protect their security of supply, which from a commercial perspective is the “lifeblood“ of their business operations. In a market where future sources of supply are predicted to be scarce, damages assessed by reference to the prevailing market price may not protect the buyer’s exposure where supply falls through – the buyer may struggle in practice to source the commodities it needs in the quantities it needs. Against that background, buyers may push for remedies that verge on the onerous, including liquidated damages set at high monetary levels or wide-ranging indemnities for losses resulting from the seller’s failure to supply, including in respect of the knock-on consequences for the buyer’s business. The buyer’s expectations of remedies for the seller’s failure to deliver critical minerals may go beyond those that a producer or other supplier of commodities would expect when selling on its standard terms, which will typically include exclusions of “indirect” and “consequential” losses as standard.
Liability caps
15. Suppliers’ exposure to their customers for failure to deliver can be managed through appropriate liability caps, including by limiting the supplier’s liabilities in the aggregate over the life of the contract. Appropriately drafted liability caps can help parties to model their potential “worst case scenarios” in liability terms, and thereby ensure that the financial rewards of the contract are set at commercially appropriate levels.
Price reopener provisions
16. The potential for both price volatility and development in how critical minerals are priced has driven the use of price reopener clauses in critical minerals supply contracts, providing a mechanism to renegotiate prices based on predefined triggers, including in response to significant changes in market conditions, such as commodity price fluctuations or the development of new pricing indexes. Price reopener clauses can thereby allow contracting parties to commit to long-term contracts with greater confidence.
Environmental, social and governance (ESG) considerations
17. ESG considerations are of critical importance to OEMs, manufacturers and other buyers of critical minerals. The development of ESG requirements is moving hand in hand with the energy transition, as are the market and reputational considerations around ESG. The ESG priorities of buyers are driven by a mixture of mandatory legal and regulatory obligations and the voluntary policies of buyers that have developed to meet the expectations – and ESG policies – of customers, investors and other stakeholders (and notably, in the case of OEMs, auto manufacturers).
18. Buyers will maintain a range of policies covering a broad sweep of ESG-related matters including environmental impact, carbon footprint, biodiversity protection, human and labour rights, community impact, supply chain transparency, and conflict minerals.
19. It is common for buyers to require that suppliers adhere to the buyers’ and/or their customers’ ESG policies when supplying critical minerals, and even to indemnify them for the consequences of not doing so. Some auto manufacturers will require their supplier OEMs to ensure that commodity suppliers enter into tripartite agreements, such that the supplier can give direct assurances regarding ESG considerations to the auto manufacturer. Buyers and their customers will also expect audit rights to verify the suppliers’ compliance with their ESG commitments.
20. The policies of suppliers and buyers may well overlap on many ESG issues, but giving contractually binding promises that ESG standards will be adhered to can be challenging from the perspective of suppliers, especially in the context of long-term agreements. ESG policies will vary over time, and suppliers will be reluctant to give binding promises to meet the changing and future expectations of buyers or their stakeholders. Further, indemnifying a buyer for the consequences of not meeting ESG commitments opens the supplier to a wide range of potential liabilities. Consequently, suppliers will prefer to limit voluntary ESG-related commitments to dialogue and collaboration toward common ESG-related goals. Agreements may also provide “no fault” exit rights for one or both parties where ESG policies cannot be aligned, after a period of negotiation.
21. That said, compliance covenants in respect of ESG-related requirements are becoming more common, particularly in the EU . As ESG-related compliance is increasingly subject to legislated obligations, companies (including in some cases non-EU companies that do business in the EU) are required to maintain ESG-related policies and to report on compliance. Relevant legislation includes:
a) The EU Corporate Sustainability Due Diligence Directive (CSDDD), which requires companies to identify, prevent, mitigate and remediate adverse human rights and environmental impacts in their operations and supply chains.3
b) The EU Corporate Sustainability Reporting Directive (CSRD), which requires companies (including non-EU companies with significant operations in the EU) to report on social, environmental and governance impacts, and how these factors affect financial performance.4
Geopolitical risks
22. National governments are scrambling to ensure security of supply chains for critical minerals. China currently dominates the world’s production and processing of rare earth elements, leading to other governments introducing measures and strategies to protect sources of supply under the banner of national interest.
23. Protectionist measures can take many forms among the “consumer” countries, whether direct intervention in supply chain ownership, as recently seen in Australia,5 or the imposition of tariffs on the importation of Chinese products and commodities, as seen in the U.S.
24. The U.S. Department of Energy recently released final interpretive guidance on the definition of so-called “foreign entities of concern” (FEOCs) under the Bipartisan Infrastructure Law (BIL).6 The BIL is aimed at limiting the participation of FEOCs in U.S. domestic battery supply chains, and defines FEOCs (in broad terms) as entities that are more than 25% controlled by any of the governments of China, Russia, North Korea and Iran. From 2025, any electric vehicles with a battery containing critical minerals extracted, processed or recycled by a FEOC will be ineligible to receive certain existing U.S. tax credits for clean vehicles.7 The measure is intended to support the processing and manufacture of battery materials in the U.S. and among U.S. allies.
25) For their part, producer countries are also taking protectionist measures. Governments of developing nations where many of the global deposits are located are seeking to incentivise international mining companies to invest in their economies and infrastructure in order to capture larger parts of the supply chain. Namibia, for example, has banned the export of certain unrefined critical minerals with the effect that minerals must be refined locally.8
26) Arguably, no commodities sector currently has as much potential for geopolitical risks as the critical minerals sector. The impact of such geopolitical risks on contracts will be further exacerbated by the concentration of many critical minerals in few countries.
27. Well-drafted supply contracts will seek to anticipate the risks of government intervention in markets, and include mechanisms to address the consequences of such intervention, not only where this prevents performance but also where it renders performance uneconomic for one of the parties.
Conclusions
28. Critical minerals supply contracts present complexities that do not affect “typical” commodity supply contracts. The increase in sustainable demand for critical minerals from OEMs has been shown to give rise to additional complications in the negotiation of long-term contracts. OEMs are operating in a commercial, regulatory, social and geopolitical environment that motivates them to seek contractual commitments around continuity of supply and compliance with ESG-related standards (as demanded by customers in the retail market among others), which go beyond those that a commodity producer would traditionally have been asked to give. These challenges are only set to increase, both as demand for critical minerals continues to rise and as the ESG-related expectations placed on suppliers continue to grow and, increasingly, become codified into laws and regulations. To complicate matters, producers of critical minerals increasingly face counterparties that may not be familiar with (a) their products and (b) the terms on which minerals and commodities have traditionally been traded or sold. This “clash in cultures” is a factor which appears to create an additional layer of complexity that increasingly needs to be managed when negotiating long-term deals.
- IEA Global Critical Minerals Outlook 2024, available at iea.org.
- Long-term supply (and off-take) agreements: some recent themes
- For further details of the EU CSDDD, see our client alert, “The EU Corporate Sustainability Due Diligence Directive passes final hurdle”.
- For further details of the EU CSRD, see our client alert, “EU CSRD: sustainability reporting requirements extended and scope broadened to include non-EU groups and their EU subsidiaries”.
- See, e.g., “Australia orders Chinese-linked funds to sell rare-earth stakes in ‘national interest’”, Financial Times, 3 June 2024.
- DOE releases Final Interpretive Guidance on the Definition of Foreign Entity of Concern”, 3 May 2024, energy.gov.
- Specifically, the Section 30D Clean Vehicle Credit for electric vehicles under the Inflation Reduction Act 2020.
- “Namibia bans export of unprocessed critical minerals”, Reuters, 8 June 2023.
In-depth 2024-135
