Guest post by Isuru Seneviratne, Founder & Portfolio Manager, Radiant Value Management. Isuru has specialized in energy sector analysis and investing since 2004. Visit www.radiantval.com for more information on the author and firm.
“In short, we are dealing with niche, specialty chemicals and minerals rather than commodities. The biggest challenge for this handful of specialties [lithium, graphite, cobalt and nickel] is scaling the supply chain from the mine to the battery plant in time to meet demand from the auto manufacturers.”
– Simon Moores’ testimony to U.S. Senate Committee on Energy and Natural Resources, October 2017
Not a single day goes by without electric cars or autonomous vehicles on the front page of a major newspaper. The exponential growth in lithium demand is well established. However, supply dynamics of this soft silvery metal is less clear, even to analysts who cover the sector. Reputed industry research firms like SNL Metals & Mining (owned by S&P) have detailed cost curves on commodities like copper and oil, but lack such data on this niche chemical. This opens an opportunity for diligent stock picking for those able to separate the wheat from the chaff.
Demand on the Rise
An average battery-only electric vehicle (EV) consumes 10,000-times more lithium than a smartphone. Grid-scale energy storage is becoming critical, as non-dispatchable renewable electricity generation exceeds a 30% share (e.g. South Australia, Germany, California). Lithium-ion battery costs have been declining at an astounding 19% per annum since 2010, encouraging large-scale uptake. The rechargeable battery manufacturing industry is slated to multiply worldwide manufacturing capacity from ~103 GWh currently to over 273 GWh by 2021 (28% CAGR).
Overall lithium demand has grown 6-7% per annum over the last decade. Expectations to 2025 range between 9-18%, as batteries have become the biggest share of demand. EVs are 1% of car sales, and each % increase raises overall lithium demand by a third. Automakers have recently unveiled goals where 15-30% of sales are electric by 2025.
Exhibit 1: Per-tonne lithium prices have multiplied in the last decade. Source: Benchmark Mineral Intelligence
Supply has struggled to keep up with the meteoric pace of demand, driving up prices (Exhibit 1). Some recent spot transactions in China have been at $21,000/t. While investor expectations are anchored to past prices, we expect elevated prices until supply expansion overtakes demand growth. Lithium accounts for 3-8% the cost of an average battery (1-2% of overall EV cost), rendering demand price-inelastic. Lithium-ion batteries have superior energy density, rechargeability, energy efficiency and environmental impacts. For mobile applications where weight is a major consideration, lithium-based batteries can expect exponential growth ahead.
Lithium is relatively abundant. There is more lithium in Earth’s crust than lead and tin, let alone silver and gold. However, it takes many years for production to materialize. We estimate an average of 2 years from definitive feasibility study to nameplate capacity for higher-cost mined production and ~4 years for lower-cost brine projects.
Exhibit 2: Lithium prices have multiplied in the last two decades. Source: Benchmark Mineral Intelligence
As seen in Exhibit 2, the cheapest lithium comes from the ‘Lithium Triangle’ of Chile-Argentina-Bolivia, which holds 60-70% of the world’s identified reserves. Brine from sub-surface reservoirs are pumped into ponds and allowed to evaporate before chemically extracting the lithium. Chilean politics are complicating production additions by the local producer SQM. CORFO, the industrial arm of the government, recently approved U.S.-based Albemarle to double production from its brine deposit in the Atacama Desert under a much higher and progressive royalty regime (Exhibit 3). With the government taking 40% of every dollar of revenue above $10,000/t, the incentive to increase production from the country has diminished.
Bolivia, host to the largest brine deposit on the planet, is keen on indigenous development and has rejected international capital markets to expedite the process.
Argentina is set to emerge as the winner in Latin America. Presently, Argentina has two active operations: one of the oldest projects by US-based FMC Corp and the first brine project brought online in 20 years by Australian group Orocobre. Investors are just warming up to the country after the election of a business-friendly government December 2015. Since then, one major project has been sanctioned (SQM and Lithium Americas) and funded but more will emerge over the next few years. Australian group Galaxy Resources has a high quality, low-risk project ready for capital deployment. Argentinians will hold their mid-term elections in October. While no party will gain a majority, a Peronist resurgence might hurt the ruling coalition’s efforts to reform the economy.
Exhibit 3: Albemarle’s Chilean royalty scheme. Source: Albemarle announcement, Jan 2017
In 2016 more than half the world’s lithium will come from hard-rock operations in Australia with processing China. High-cost production from mines provides a price umbrella for new developments to achieve quicker payback. However, West Australia’s lithium endowment coupled with the country’s penchant for mining should help drive lithium prices down. All eyes will be on three fully funded projects in West Australia that should start producing in 2019 (two Pilgangoora projects by Pilbara Minerals and Altura Mining, plus Mineral Resources’ Wodgina). On a longer term, SQM’s plans to co-develop an integrated operation with Kidman Resources in Australia looks intriguing.
However, much of Australian production tied up by the two Chinese majors Tianqi (via Australian mine Greenbushes) and Ganfeng (via offtake with Pilbara). Cathode makers are increasingly looking to Canada’s Quebec province, where North American Lithium is ramping up production, Nemaska is raising capital for a novel hydrometallurgical process and Critical Elements is conducting advanced exploration.
In time, disruptive extraction processes (from clays, directly from brines or from oil brine) and recycling may help satiate battery growth. The race to produce lithium from clays is headed by Bacanora Minerals in Mexico and two contenders in Nevada: Lithium Americas and Global Geosciences.
At a 12% growth rate, 43 thousand tonnes (kt) per annum (kt/a) lithium carbonate-equivalent (LCE) production must come online each year. This is a formidable undertaking for an industry with a very limited base of technical knowledge. Lithium plants are chemically challenging. Unlike crude oil refining, with more than a century of global knowledge base, specialty chemicals are niche industries. Four companies currently provide three-quarters of the global lithium supply and instructional courses on lithium processing are rare and most lack depth. Rechargeable batteries elevated lithium from a mature industrial chemical into a fast-growing critical metal only recently.
Given the complexities involved, many development projects suffered delays (Orocobre in Argentina) and failures over the last decade (RB Energy/Canada Lithium in Quebec, Galaxy’s first attempt in West Australia) and many investors were left with little or nothing to show for it (Rodinia Lithium in Argentina, Simbol in Nevada). Execution concerns have slowed capital markets’ appetite to fund new lithium projects, which means lithium prices should stay elevated for a couple of years more. The supply delays have forced downstream processors (converters, cathode makers and battery manufactures) to underwrite some developments. Security of supply is becoming paramount as even some car OEMs are scrambling to secure access to supply.
Simon Moores believes the industry is going to need between $4-$5 billion of lithium investment out to 2025. While a plethora of juniors have emerged with projects all over the world, if the past is any indication of the future, the probability of success will likely remain low. The major agro/industrial chemical companies that produce lithium have appreciated 58-220% year-to-date and trade at 15-20x EBITDA multiples. While the junior developers are trading at a material discount, they require navigating technical, geopolitical, financing and governance risks.
It’s time for investors to start kicking some rocks and putting microscopes to work.
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