Raw Materials

Raw Materials: Types, Sourcing, and Financial Implications

In today’s global economy, raw materials play an essential role, forming the foundation of almost every industrial sector. From the steel in skyscrapers to the silicon in smartphones, raw materials are the building blocks of manufacturing and production. For finance companies, understanding the intricacies of raw materials is crucial, as these resources greatly influence market dynamics, supply chains, and investment opportunities. In this article, we explore the types of raw materials, their economic and financial impact, and the growing need for sustainable sourcing.

What are Raw Materials?

Raw materials are substances or components used in the primary production or manufacturing of goods. These materials are typically unprocessed and come from natural sources such as minerals, plants, and animals. They are essential for many industries, from automotive and construction to electronics and pharmaceuticals.

For instance, iron ore is a critical raw material used to produce steel, which is utilized to construct buildings and infrastructure. Similarly, crude oil is processed into gasoline, plastics, and chemicals used in various products.

Examples of raw materials include:

• Metals such as steel, copper, aluminium, and gold
• Energy resources like oil, natural gas, and coal
• Agricultural products such as corn, wheat, and cotton
• Natural fibres like wool and cotton

Types of Raw Materials

Direct Raw Materials

Direct raw materials form an integral part of the final product. These materials are directly traceable to the produced goods, and their costs are included in the production cost. Examples of direct raw materials include steel used to manufacture cars, wood in furniture production, and cotton in textile manufacturing.

For instance, a furniture company would count the wood used to build chairs as a direct raw material, as it becomes part of the final product.

Indirect Raw Materials

Indirect raw materials, on the other hand, are not part of the final product but are essential in the production process. These include machines’ lubricants, factory cleaning agents, and adhesives for assembling parts. While they do not end up in the finished product, they are crucial for ensuring smooth production processes.

For example, in car manufacturing, while the steel used for the vehicle’s body is a direct raw material, the lubricants and adhesives used during the production process are considered indirect raw materials.

The Importance of Raw Materials in Global Supply Chains

The global economy depends heavily on the availability and movement of raw materials. These resources are often sourced from various regions worldwide, creating intricate supply chains that span continents. The mining, extraction, and transportation of raw materials require substantial investment and logistics, making supply chains vulnerable to disruptions.

A prime example is the global semiconductor shortage in 2020-2021. Raw materials like silicon are critical for manufacturing semiconductors, and disruptions in their supply chain had widespread effects on industries ranging from automotive to consumer electronics.

Challenges in Raw Material Procurement

Sourcing raw materials is challenging. The availability of these resources can be affected by geopolitical tensions, environmental regulations, and market volatility. For example, conflicts in resource-rich regions can limit the supply of essential materials, leading to price fluctuations. Additionally, stricter environmental policies in some countries can lead to supply shortages or increased costs for companies relying on raw materials extracted from those regions.

The Ukraine crisis is a modern example of how geopolitical events can disrupt raw material supply chains. Ukraine and Russia are significant suppliers of key materials such as oil, gas, and wheat, and the ongoing conflict has caused sharp price increases and supply disruptions across global markets.

Critical Raw Materials

Specific raw materials are considered ‘critical’ due to their economic importance and the risk of supply shortages. Critical raw materials are essential for producing high-tech products such as electric vehicles, renewable energy technologies, and advanced electronics.

Examples of critical raw materials include:

• Lithium: Used in batteries for electric vehicles (EVs)
• Cobalt: Essential for high-performance alloys and rechargeable batteries
• Rare earth elements: Crucial for the production of magnets, electronics, and wind turbines

These materials’ scarcity and geopolitical concentration make them highly volatile, presenting risks and opportunities for investors. For instance, most of the world’s lithium is sourced from Australia, Chile, and China, and fluctuations in supply or political stability in these regions can have far-reaching effects on global industries.

Economic Impact of Raw Materials

The availability and cost of raw materials directly impact the global economy. When raw material prices rise, so do the costs of goods and services, contributing to inflation. Industries reliant on raw materials, such as construction, automotive, and electronics, are susceptible to these price changes.

For example, steel, aluminium, and rubber are crucial raw materials in the automotive industry. Fluctuations in the prices of these materials can affect the overall cost of production, leading to price increases for consumers. Similarly, the availability of rare earth elements impacts the production of smartphones and other electronics, influencing global market trends.

Inflation and Raw Materials

Raw materials are essential inputs for industries worldwide, from agriculture to manufacturing. Any disruption in their availability or price fluctuations can lead to widespread economic consequences, one of the most significant being inflation. The relationship between raw materials and inflation is direct: when raw material prices rise, the cost of production increases, which in turn can lead to higher prices for consumers.

Raw Material Shortages and Inflation

When shortages occur in critical raw materials, the impact is felt across various industries. For instance, in the food production sector, agricultural raw materials like wheat, corn, and soybeans are fundamental for producing everyday food products. If these crops experience shortages due to poor harvests, climate change, or geopolitical disruptions, the prices of the raw materials increase. As food manufacturers pay more for these inputs, they pass those costs onto consumers, resulting in higher prices.

A good example of this ripple effect is seen in the energy sector. Fuel costs rise when crude oil prices increase due to shortages or geopolitical tensions. This affects transportation and logistics and the cost of manufacturing products that rely on petroleum-based materials, such as plastics. As the price of fuel and plastic components rises, the increased cost is reflected in the prices of goods ranging from household items to automobiles.

How Do Raw Materials Contribute to Inflation?

Inflation, measured by the Consumer Price Index (CPI), reflects the overall rise in prices of goods and services over time. When raw material costs increase, production costs rise. Companies raise the prices of their finished products to maintain profitability, which contributes directly to inflation.

For example, prices for these materials can soar during high demand for commodities like copper, steel, and oil. Manufacturers relying on these inputs, such as those in the automotive or electronics sectors, must absorb the higher costs. As a result, the final prices of cars or electronic devices go up, driving inflation.

Sustainability in Raw Materials Sourcing

With growing environmental concerns, industries are shifting towards more sustainable raw material sourcing practices. Sustainable sourcing involves obtaining raw materials that reduce environmental impact and promote resource conservation.

For example, industries are increasingly considering recycled materials as substitutes for virgin raw materials. In the steel industry, recycling scrap metal helps reduce the need for raw iron ore and decreases energy consumption.

Innovation in Raw Materials Sourcing

Technological advancements are crucial in sustainable raw material sourcing. Innovations such as blockchain technology are improving transparency and traceability in supply chains, helping companies track the origin and environmental impact of their raw materials.

Moreover, the concept of the circular economy, which aims to reduce waste by reusing and recycling materials, is gaining traction in various industries. By focusing on resource reuse, companies can reduce their reliance on finite raw materials and mitigate the risks associated with supply shortages.

Raw Materials Accounting and Valuation

Managing raw materials efficiently is crucial for manufacturing companies to maintain financial stability. Raw materials are recorded as inventory on a company’s balance sheet, and their value is vital for financial reporting and tax purposes.

Accounting for Direct and Indirect Raw Materials

Direct raw materials are classified as current assets and expensed as part of the cost of goods sold (COGS) once used in production. Indirect raw materials, on the other hand, are considered long-term assets and are expensed over time through depreciation.

For example, in a furniture manufacturing company, the wood used in production would be recorded as a direct raw material. In contrast, the lubricants used in the machinery would be considered an indirect raw material. The correct accounting treatment of these materials is essential for accurate financial reporting and tax compliance.

Investment Opportunities and Risks in Raw Materials

The raw materials sector offers numerous investment opportunities but is also fraught with risks. Investors can gain exposure to raw materials through commodity markets, mining companies, or raw material-focused ETFs. However, price volatility, geopolitical risks, and environmental concerns can pose significant challenges.

Hedging Against Raw Material Price Volatility

Companies and investors often use hedging strategies, such as futures contracts and long-term supplier agreements, to manage the risks of raw material price fluctuations. These strategies help stabilise costs and reduce the financial impact of raw material price increases.

For example, a car manufacturer reliant on steel may enter into a futures contract to lock in the price of steel for a specific period, protecting itself from sudden price hikes.

Opportunities in the Raw Materials Sector

Despite the inherent risks, the raw materials sector presents significant opportunities, especially in industries undergoing transformative changes, such as renewable energy and electric vehicles (EVs). As global economies shift toward decarbonisation and adopting cleaner technologies, the demand for certain raw materials has surged, creating profitable avenues for investors and companies.

Growing Demand for Critical Materials in Emerging Sectors

The increasing demand for lithium, cobalt, and rare earth elements is one of the most significant growth drivers in the raw materials sector. These critical materials are essential components in batteries for electric vehicles, energy storage systems, and renewable energy technologies such as wind turbines and solar panels.

Lithium

The growing EV market is the largest consumer of lithium, which is used in lithium-ion batteries. As EV adoption accelerates, driven by government mandates and consumer preferences for cleaner transport, the demand for lithium is expected to soar. Lithium mining, processing, and battery manufacturing companies will likely benefit from this surge.

Cobalt

Cobalt is another essential material for battery production, mainly sourced from the Democratic Republic of Congo. The rise in EVs and renewable energy storage systems will continue to drive demand for cobalt, making it a valuable investment.

Rare Earth Elements

These elements, particularly neodymium and dysprosium, are crucial for manufacturing permanent magnets used in EV motors, wind turbines, and other high-tech applications. China dominates the global supply of rare earth elements, and securing alternative sources is a priority for many countries. As a result, companies involved in rare earth mining outside China are seeing increased investment and interest.

Opportunities in Sustainable Raw Material Sourcing

As sustainability becomes a key focus for businesses and investors, companies that lead in sustainable raw material sourcing are well-positioned to capitalise on the growing demand for environmentally responsible practices. Sustainable sourcing is crucial for mitigating the environmental impact of raw material extraction, reducing waste, and promoting the circular economy.

Recycling and Circular Economy

Companies focused on recycling materials such as steel, aluminium, and rare earth elements are increasingly attractive to investors. Recycling reduces the reliance on virgin raw materials and is often more energy-efficient, making it a sustainable and cost-effective solution.

ESG Considerations

Environmental, social, and governance (ESG) criteria are becoming central to investment decisions. Investors are increasingly looking for companies that adhere to high ESG standards, particularly in industries like mining, where environmental degradation and unethical practices have historically been issues. Companies that adopt sustainable mining practices, ensure fair labour conditions, and minimise their carbon footprint will likely attract more investment.

Regional Diversification and Geopolitical Opportunities

Many countries and regions aim to diversify their supply chains to reduce reliance on geopolitical hotspots dominating raw material production. This trend creates opportunities for investment in emerging markets and areas ramping up their raw material production capabilities.

• Australia is becoming a key player in lithium and rare earth mining, positioning itself as a stable alternative to other resource-rich countries. Investors are looking at Australian companies as safer bets due to the country’s stable political environment and its focus on expanding its raw material production for the green economy.
• South America, particularly Chile and Argentina, is a significant player in lithium production. Investment in mining infrastructure in these countries could see long-term gains as global demand increases for materials used in batteries and clean energy technologies.
• Africa also presents opportunities for growth in raw material sectors, especially in cobalt and copper. Countries like the Democratic Republic of Congo and Zambia are key producers, but the challenge lies in creating stable political and economic environments to attract more substantial investment.

Technology-Driven Efficiency in Raw Material Extraction

Advanced technologies like artificial intelligence, automation, and blockchain for tracking supply chains are revolutionising the raw material sector. These technologies help improve efficiency, reduce waste, and ensure transparency, particularly in high-risk areas like mining.

• Artificial intelligence (AI) optimises mining operations, reduces environmental impacts, and improves extraction techniques. Companies leveraging AI to improve operational efficiency and reduce costs will likely increase profitability.
• Blockchain technology is enhancing supply chain transparency, allowing companies and consumers to track the origins of raw materials. This is particularly important for critical materials like cobalt and rare earth elements, where ethical sourcing and environmental considerations are paramount.

FAQs

What is Raw Material vs Material?

Raw materials are substances or unprocessed components used as the initial inputs in manufacturing. These materials, such as iron ore or crude oil, are typically extracted from nature. In contrast, materials can also refer to processed substances, such as steel or plastic, used later in production. Raw materials are the starting point, while materials may include raw and processed goods used in production.

What are the Three Types of Raw Materials?

The three main types of raw materials are:

• Plant/Tree-based: Sourced from plants or trees, including vegetables, fruits, wood, latex, and resins.
• Animal-based: Derived from animals, such as leather, wool, silk, meat, and milk.
• Mining-based: Extracted from the earth, including minerals, metals, crude oil, and coal.

What are Raw Materials Also Known As?

Raw materials are also referred to as primary materials or unprocessed materials. They may be called commodities in global markets, mainly when traded in large quantities.

What are the Characteristics of Raw Materials?

Critical characteristics of raw materials include:

• Company appraisal: Ensuring the supplier is reliable and consistently delivers the materials.
• Identity: Verifying that the material is precisely what it claims to be.
• Purity: The degree to which the material is free from impurities or contaminants.
• Potency: The effectiveness or strength of the material in its intended use.
• Shelf life: The time the material remains usable before it degrades.
• Composition: The specific ingredients or makeup of the raw material.

Is Gold a Raw Material?

Yes, gold is considered a raw material. It is a natural resource extracted from the earth and used in various industries, including electronics and jewellery, and a store of value in financial markets.