The CAPEX Challenge Is Key to Industrial Competitiveness

Want critical minerals and reindustrialization? Offer low-cost loans

The decline of the steel, aluminum, and other metal industries in the United States and Europe have long been symbolic of the general decay of Western industrial power. Yet recriminations over lost industrial capacity revolve around grand ideas of trade, overregulation, or state planning at the expense of a simpler focus on what actually makes metallurgical plants profitable.

Today, outlets like Bloomberg or the Financial Times regularly rattle off steel and aluminum as among the many strategic markets that Chinese producers now dominate. The widely-discussed new Draghi Report on EU competitiveness highlighted these two energy-intensive industries as examples of sectors where European disadvantages are deepening. Meanwhile, President Trump has famously centered steel, aluminum, and copper in his vision of American reindustrialization, seeking to revitalize U.S. metals production with the help of broad blanket tariffs on imports.

At conferences or in op-eds, western policymakers, think tankers, and business leaders ascribe the lack of new metallurgical plants in their countries and declining metal output to various causes. High labor costs remain a common explanation for manufacturing declines, but in the metallurgical sector labor makes up a tiny fraction of production costs. Other popular diagnoses for the West’s failure include heavy Chinese state subsidies, mercantilist export incentives, differences in energy input and feedstock costs, the succession of newer more efficient production plants, and disparities in environmental, social, and safety standards. These factors all play significant roles in explaining shifts in metal markets since the end of the Cold War, but a crucial reason underlying the lack of new smelter projects in advanced economies remains their high upfront capital costs.

Specifically, the interest repayments on loaned capital required to finance facility design, construction, and startup often weigh heavily on the operating cash flow of new projects, alongside energy and raw material costs. The results of this dynamic speak for themselves. The higher the capital expenditure (CAPEX) per ton of annual metal output, the smaller the share of global production of that metal by advanced economies other than Russia or China (Figure 1).

This observation highlights one of the most powerful industrial policy tools available to governments seeking to drive new innovation and grow market share in CAPEX-heavy sectors: low-cost debt. Public sector support through low-cost debt can correct private sector underinvestment that has otherwise shied away from the lower investment rate of return of higher-CAPEX industrial ventures. Such derisking, in turn, will go a long way towards enabling new breakthroughs that bolster both reindustrialization ambitions and technological progress.

Figure 1: Approximate capital intensity per ton for the production of different metals across various projects, plotted against the current share of global production outside of Russia and China.

Reduced CAPEX is an investment magnet

Certain commodities stand out in Figure 1 as both particularly capital-intensive and particularly dominated by Chinese producers: titanium, rare earths separation, rare earth metal refining, and battery-grade nickel and cobalt processing. This pattern illustrates the challenge that high-CAPEX production of critical metals faces in free capital markets. These processes, for instance, share a reputation for complex metallurgical flowsheets with temperamental quality control factors, with initial facilities often experiencing cost overruns and requiring lengthy ramp-up periods to reach full production capacity. And while labor may comprise only a minor sliver of operating costs, a safe and better-paid construction sector does drive upfront capital costs upwards, contributing to the CAPEX differential that Western projects face.

Capital markets naturally shy away from such activities. For the same assumed revenue flow, high initial CAPEX already reduces a project’s calculated internal rate of return. Factor in technology and schedule risks, and private investors gravitate instead to competing sectors with lower upfront capital costs and higher returns, posing a consistent, if rational, financial hurdle to critical mineral activities. In effect, high CAPEX has become the price of readmission into strategic industrial capabilities like steel heavy forging, magnesium smelting, and rare earth metal refining.

Modern financial markets typically reward shorter-term investment strategies with faster timelines to payback. Market actors thus possess few incentives to address strategic industrial base inadequacies—certainly not on the urgent timescales relevant to national needs. If countries intend to seriously address critical mineral processing gaps as a strategic vulnerability, they must either govern such industries as state industries, or intervene to offset CAPEX and financing costs to make such sectors more attractive to private market actors. In addition to the political hurdles of creating and maintaining state-run enterprises, there are potential pitfalls of centralized and nationalized production, such as suppressing the yet-high potential for disruptive innovation in critical minerals processing. As such, the policy case for incentivizing private sector redevelopment of strategic industrial capabilities clearly stands out.

When think tank scholars and policymakers warn about the perils of “picking winners” and caution against trying to match Chinese industrial policy dollar-for-dollar, they seem to expect plucky companies to magically compete head-to-head in industrial sectors where production economics are and have always been distorted. Without intervention, the “free market” equilibrium results in the present status quo where the “efficient” level of critical metals production in the United States, Canada, or France is often close to zero. Given atrophied domestic experience in developing greenfield projects, supportive debt financing is arguably necessary to re-enable competition by catalyzing new innovation, rebuilding technical knowledge, and alleviating CAPEX hurdles and production costs.

Assuming that only China is engaging in robust financing support for strategic industries is also committing a strategic oversimplification. Some wealthy Gulf States—a closely-watched emerging hub for mineral processing and heavy industry—provides similar concessional finance, grants and land grants for metallurgical projects, including subsidized natural gas and electricity in Qatar and Saudi Arabia. Many of the Gulf states offer “repayment holidays” for their strategic debt, eliminating a recipient’s obligation to pay interest while their facility is still under construction. Qatar, for instance, offers a 3-year grace period. Put simply, such debt service leniency does excellent things for a project’s internal rate of return.

Even without such repayment schedule tweaks, however, the calculus of low-cost debt is still transformative. Take the case of a new aluminum smelter in Europe or the United States. A capital cost of $8,000/ton of refining capacity and a 10% cost of capital impose $800/ton on the smelter’s cash flow dedicated solely towards paying investors. This may match—or even exceed—the $780/ton spent on electricity (assuming an electricity cost of $60 per megawatt-hour and electricity inputs of 13 MWh/ton of aluminum) and would exceed the roughly $640 of alumina feedstock required to smelt one ton of aluminum. Taken together, interest payments, power, and alumina come out to $2220/ton in total costs. Assuming an optimistic aluminum price of $2500/ton, this leaves a razor thin profit margin before even accounting for costs of labor, carbon anodes, and other site charges. In this case, halving the cost of capital would more than double the plant’s expected operating profit, better fortifying it against aluminum price volatility and making the project infinitely more attractive to private investors.

Figure 2: A simplified high-level annual cash flow for an aluminum smelter assuming a sales price of $2500 per ton of aluminum product, showing how debt repayment weighs upon operating profit margins. This project achieves positive net revenue after 12 years of operation at 5% cost of capital but takes 29 years at 10%.

A CAPEX fare across the valley of death

High CAPEX also creates a prohibitive environment for industrial innovation. Most startups already struggle to cross a technological “valley of death” that stands between a promising idea or prototype and a mature product ready for commercial deployment. But capital intensity and technical complexity intensify this gauntlet of hurdles to an even more imposing degree for chemical and metallurgical startups. To enable project finance, very expensive pilot and demonstration facilities are often necessary to generate de-risking operational data that benchtop experimentation and computer simulation cannot reproduce.

Other, less capital-intensive sectors enjoy the luxury of moving from idea to product without as much of a CAPEX hurdle. A software or services startup can ship a beta app while a consumer goods entrepreneur might make a prototype. Meanwhile, an early-stage chemical or metallurgical firm constructs a facility half the size of a football field that easily surpasses tens of millions of dollars in upfront CAPEX.

The allure of economies of scale further complicates the industrial “valley of death” and discourages industrial innovation. A company looking to build its first-of-a-kind (FOAK) commercial plant can choose between a small plant or a large plant, navigating tradeoffs between ambition and risk tolerance. The problem with a small, lower-risk plant is that—while it could operate profitably—it is likely to generate lower rates of return. Metallurgical plants and heavy industry benefit from economies of scale, with bigger plants enjoying bigger profit margins. As such, companies are tempted to take on “more than they can chew” and build larger plants that boost rates of return and help justify private investment. This is myopic, as a successful small first plant, even if it only produces 5% returns, substantially eliminates the risk associated with larger plants and thus unlocks many opportunities to build gargantuan plants with enormous margins.

Unfortunately, project financiers typically only care about the investment case in front of them, not hypothetical future opportunities. The practical result is that most developers end up needing to propose billion dollar facilities to advertise attractive rates of return, and then fail to secure financing as the project is judged too large and too risky.

With this in mind, policymakers should essentially think of low-cost, Treasury-rate loans as a necessary component of industrial research and development, just as powerful for this purpose as government grants or tax credits. A policy environment offering sufficiently favorable debt for a project’s CAPEX to enable profitable deployment of a FOAK 2,000 ton-per-year facility instead of a FOAK 200,000 ton-per-year facility is synonymous with a policy environment that can catalyze an enormous surge in industrial metal innovation.

Low-cost loans or investment credits are in turn complemented strongly by policy programs that reduce market uncertainty, like an active strategic reserve program or firm purchasing commitments. Ultimately, it’s all about finance, and large industrial projects face exposure to a number of external risks that deter private capital: construction cost and schedule overruns, permitting compliance, or long lead times for key components. Internal uncertainties like engineering challenges or a lengthy production ramp-up period may also weigh on investor worries. Demand-side tools like offtake agreements augment the lower barrier to entry facilitated by low-cost loans by assuring committed, patient customers, bringing projects to a lower risk threshold, and appealing to private finance.

Hard tech in high-CAPEX sectors—perhaps more aptly termed “heavy tech”—is especially costly and difficult to commercialize. To make progress in building these “heavy tech” sectors requires a favorable policy and market environment that allows new approaches to advance down the cost curve, and one of the best levers governments can wield to this end is financing support that attacks the root obstacle to the early commercialization stage of R&D directly—its high capital costs. Fundamentally, a large institution providing low-cost debt to small first-of-a-kind commercial facilities will greatly accelerate technological development in critical minerals processing and other difficult heavy industry technologies.

Fixing the CAPEX problem

The United States is already flexing powerful policy levers to spur new projects. The Office of Strategic Capital in the Department of Defense—authorized to commit up to $100 billion in loans for critical minerals projects—is forging ahead with low-interest loans and loan guarantees. The Office of Energy Dominance Financing (EDF) at the Department of Energy—formerly known as the Loans Program Office—possesses $250 billion and $89 billion in loan authority under its Section 1706 and Section 1703 programs among others, although such programs span energy as well as critical minerals priorities. The Export-Import Bank’s Make More in America Initiative can similarly support domestic critical minerals capacity under the U.S. Export-Import Bank’s (EXIM) total $135 billion in financing authority.

However, such programs require long-term certainty to effectively carry out the decade-plus project of reestablishing a resilient U.S. industrial base. Congress should start by rapidly reauthorizing EXIM this year, sending a strong signal to the world that EXIM is a durable instrument of U.S. strategic financing. The Office of Energy Dominance Financing similarly deserves continued support from Congress to maintain its capacity to support innovative critical minerals projects into the early 2030s and beyond.

More ambitious Congressional efforts could revitalize the Section 48C Qualifying Advanced Energy Project Credit, offering a new tranche of competitive investment tax credit opportunities to support industrial base projects that supply critical materials at commercial scale. But above all, policymakers should more intently appreciate the impactfulness of debt financing tools relative to other policy incentives. Recent proposals to expand per-unit production tax credits for battery critical minerals, for example, might yield greater and more lasting results if reimagined as support for low-cost loans available to the same kinds of facilities.

In any event, whether the industry in question is magnesium smelting or nuclear power plant construction, regions like the United States and Europe can no longer afford to continue procrastinating the hard work of relearning how to execute CAPEX-intensive large projects. Across such efforts, governments should maintain focus on the chief goal of debt financing and policies to slash the industrial capital cost burden—lowering the disproportionately higher risk experienced by first-of-a-kind technology deployments and first-in-a-generation domestic projects.

Governments undertaking this challenge should do so with the understanding that their efforts will grow easier over time. In essence, the public sector is covering the upfront costs of retraining the industrial sector’s muscle memory, lowering the CAPEX hurdle and non-financial risks to such a point that projects become more palatable to private finance. In some sectors, low-cost financing or investment tax credits might enable the commercialization of innovative new processes that could flip the global calculus of cost-competitive production entirely. Such industry revolutions are hardly theoretical. New metallurgical processes recently transformed the face of the global nickel market, while a new technique to leach and refine ores directly into metal is now disrupting the copper sector.

Established technologies that benefit from already-developed domestic know-how, like a common copper refining tankhouse or a scrap recycling electric arc furnace, are not the primary target demographic of such financing support. If a project can already acquire loans for the majority of their project capital costs at a 7% to 8% interest rate, then the role of low-cost government loans is minimal. Rather, the objective of government lending should be to enable recipients who might otherwise only be able to secure high interest debt to access debt at much lower cost. Those projects in greatest need of financing support are often precisely those deploying promising new technological approaches, and countries that fail to offer such financing support will concede the potential of today’s yet-theoretical techniques to the countries that do incentivize their development.

The public sector should thus prioritize supply chain gaps where strategic industries either have no choice but to learn and acquire capabilities dominated by adversarial producers, or are hoping to pioneer new paradigm-shifting technologies altogether. The long-term policy philosophy should treat reindustrialization and industrial innovation as two sides of the same coin—inseparable and requiring dedicated policy support focused squarely on the capital cost problem.

A data spreadsheet documenting the calculations and sources underlying the main figure in this article can be viewed and downloaded HERE.