Increase Demand for Metals

Source : McKinsey & Company

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Procurement of raw and processed materials

The main supply chain risks that are likely to affect raw materials are supply shortages and geographical-sourcing dependency.

These risks will be particularly severe for rare-earth materials. Neodymium and praseodymium, for example, are key components of the permanent magnets used in wind power and electric vehicles (EVs) and will see a surge in demand in the coming years. Substitution options are limited, which may create risks in the future because the industry is highly dependent on China’s refining capacity. Recycling will therefore be a key focus area, but based on expected capacity growth plans, we neverth less predict an undersupply of 50 to 60 percent in 2030, leading to significant price spikes.

Other raw materials will also be affected. For example, the energy transition and electrification will significantly increase demand for metals such as nickel, lithium, cobalt, aluminum, and copper. Demand is already rising, which has driven price increases (Exhibit 3). We expect that opportunities for increasing supply, recycling, and substitution will maintain a relative equilibrium between supply and demand for aluminum, copper, and cobalt, but we expect to see supply shortages of class 1 nickel and lithium in 2025.

Vulnerabilities in the heat pump supply chain

Heat pumps can be used to electrify both space and water heating in the residential- and commercial-buildings sector, where they replace gas and oil boilers. They can also be used to electrify industrial processes such as in the chemicals, pulp and paper, and food and beverage industries.

Historically, heat pumps have been significantly more expensive than alternatives in terms of total cost of ownership. At 2019 fuel prices, for example, the cost of heating an average German residential dwelling was about 50 percent higher with air-to-water heat pumps than with a condensing gas boiler. However, rising commodity prices and direct subsidies are rendering these pumps increasingly cost competitive. In addition, carbon taxes and policies will further encourage the installation of heat pumps, which are both a short-term lever to reduce European dependency on Russian oil and gas and a key longer-term decarbonization lever.

As a result, the European Commission has set a target to double the rate of deployment of heat pumps over the next five years. An analysis of heat pump supply chains, however, reveals a number of potential vulnerabilities:

Procurement of raw and processed material. Steel and copper are among the key raw materials for the creation of heat pumps. While steel production will likely not face bottlenecks in supply, increased demand for green steel and increasing energy prices might significantly drive up steel prices. There will also likely be a near-term undersupply of copper. Demand will increase as a result of grid expansion, increasing renewable energy, and the adoption of electric vehicles (EVs), while supply will be limited by aging mining assets and weak project pipelines.

Component manufacturing. While components such as fans and valves are highly commoditized, and therefore no sourcing constraints are expected, inverters and electrical components may fall victim to the semiconductor bottleneck.

Components assembly. Increased use can increase the output of existing assembly lines, but there are high barriers to entry for new players in the heat pump market; complex systems and licensing requirements in certain cases result in a lead time of up to 12 months to open new plants.

Construction and labor. While increasing worker shifts can provide some labor scale-up flexibility, labor shortages might slow down the uptake of heat pumps. To meet governmental targets, for example, the United Kingdom will need to add 5,000 to 7,000 heat pump installers per year from 2025 until 2035.

Furthermore, the ability to retrofit heat pumps into existing buildings is restricted by space limitations in urban housing and bureaucratic hurdles, such as the need for owner communities’ approval and preservation orders.

Enabling strong heat pump uptake may therefore require businesses and other relevant stakeholders to consider the following actions:

Advocate for supportive policies (including subsidies and carbon taxes), launch awareness campaigns to increase local demand, and engage in large-scale skilling and reskilling efforts for technicians.
Make corporate commitments in commercial real estate to accelerate the adoption of heat pumps in stakeholders’ building portfolios.
Create innovative designs to enable the retrofitting of buildings and allow for heat pump installation in small urban apartments.
Scale up assembly-line production capacity with a focus on automated-manufacturing practices.

Stakeholders can act to minimize supply chain risks – and seize the opportunities

Businesses and other relevant stakeholders could take a range of mitigation actions to guard against supply chain risks. These actions are not just about mitigating risk, however: building supply chain resilience can also be an opportunity and a catalyst for collaboration and partnerships, as well as a driver of innovation—for example, to replace materials and increase productivity.

Potential actions for businesses

The right next steps will vary by the type and the specifics of individual businesses, but the following resilience-boosting actions can be beneficial to businesses along the supply chain:

Diversify and localize supply chains for critical raw materials and components across multiple suppliers and geographies.
Explore opportunities for cross-industry pooled procurement of raw materials.
Invest in recycling, innovation, and research around substitutes for critical materials.
Explore opportunities for vertical integration to secure critical raw materials and decrease price volatility, either through alliances and partnerships or through targeted acquisitions.
Optimize procurement strategies by targeting long-term supply agreements or developing streaming agreements with advance lump-sum payments for future production.
Send clear demand signals via long-term target and volume commitments, such as by announcing target developments in offshore wind to drive the upgrade of vessels.
Attract and retain workers from the European Union and beyond by conducting early outreach in schools and offering targeted reskilling programs.
Reduce labor demand through automation and digitalization.

Potential actions for other stakeholders

Other stakeholders could consider the following actions:

Scale up regional supply chains to a critical minimum; for example, use incentives (including both taxes and subsidies) or insert sustainability and local content criteria into tenders and policies.
Encourage innovation, including around substitutes for critical and scarce raw materials.
Harmonize regulations and streamline permitting processes.
Introduce intra-European Union alliances to source strategic raw materials, including rare-earth materials.
Increase OEM recycling of raw materials such as aluminum, lithium, and cobalt by creating financial incentives and setting standards regarding higher levels of reuse.
Communicate and commit on growth plans to build the confidence that will allow businesses to make proactive investments.
Invest in labor programs for blue-collar energy transition jobs focused on metallurgy and RES manufacturing capabilities. Programs could include skilling and reskilling while also facilitating international and cross-sector utilization.
Attract and retain workers from the European Union and beyond—for example, by facilitating migration, activating passive workforce segments, and ensuring a predictable and steady project pipeline.

The supply chains for crucial energy transition and electrification technologies are only as strong as their weakest links. Therefore, businesses and other relevant stakeholders may benefit from plotting out and mitigating potential risks along every step of the supply chain. This is a significant endeavor, but it is also a real opportunity for innovation and collaboration among stakeholders. Those that can build resilient, future-ready supply chains will be well positioned to reap significant benefits as the energy transition continues to gather momentum.

ABOUT THE AUTHOR(S)

Stathia Bampinioti is a consultant in McKinsey’s Athens office; Harald Bauer is a senior partner in the Frankfurt office, where Friederike Liebach is a consultant; Nadia Christakou is an associate partner in the Geneva office, where Luigi Gigliotti is an associate partner; Lorenzo Moavero Milanesi is a partner in the Milan office; Humayun Tai is a senior partner in the New York office; and Raffael Winter is a partner in the Düsseldorf office, where Emil Hosius is a consultant.

This article represents views from McKinsey’s Advanced Industries and Electric Power & Natural Gas Practices and McKinsey’s initiatives on orderly energy transition and industrial electrification.

The authors wish to thank Marcelo Azevedo, Patricia Bingoto, Stefan Burghardt, Greg Callaway, Tommaso Cavina, Spencer Dowling, Tamara Gruenewald, Alessandro Gentile, Magda Handousa, Blake Houghton, Jake Langmead-Jones, Simon Norambuena, Philipp Pfingstag, Hamid Samandari, Eivind Samseth, Namit Sharma, Erlend Spets, Paolo Spranzi, Fabian Stockhausen, Christer Tryggestad, Antonio Volpin, Alexander Weiss, and Jakub Zivansky for their contributions to this article.