Two years ago battery minerals, and in particular, lithium, were all the rage. Orocobre and Galaxy Resources were up ~5x and ~37x respectively in a few years, and it seemed every few weeks a new company was hitting the ASX with a deposit containing lithium, graphite, cobalt, nickel, or some other niche commodity exposed to batteries. Fast forward to today, and the story couldn’t be more different. The producers have seen huge falls in share prices, and the earlier stage projects have either disappeared or gone quiet. However, the fact remains that batteries and the commodities they contain will be an essential part of our economy in future. So, does this crash present a buying opportunity?

To find out, we reached out to three experts in the space to get their opinions on the current state of the market. In this Collection, Darko Kuzmanovic from Janus Henderson Investors discusses the lithium market; Tim Serjeant from Eley Griffiths Group discusses the nickel market; and Julian Babarczy from Regal Funds Management discusses the battery minerals space more broadly.

What went wrong with the EV boom?

Julian Babarczy, Portfolio Manager, Regal Funds Management

The great battery minerals boom of prior years has unquestioningly turned into somewhat of a bust, with the share prices of virtually everything exposed to the key commodities of graphite, cobalt and lithium (and to a lesser extent nickel), having fallen 50-95% over the prior 12-18 months. This is a remarkable turn of events for a batch of commodities and related stocks that were expected to experience unprecedented growth on the back of the all exciting Electric Vehicle (“EV”) thematic. So, what went wrong?

In a word, timing. It is hard to doubt that demand for EV commodities will come, but what the market got wrong was both the timing of the demand pickup (probably 1-2 years later than expected) and the timing of the supply response (probably 1-2 years faster than expected).

On the demand side, there has been no real change in commitment from governments globally as to their desire to replace internal combustion engines with EV’s. China (the key driver of demand so far) has remained steadfast in its commitment to EV penetration, but the (expected) reduction to its subsidy regime has clearly confused and spooked the market and also led to overcapacity in the supply chain for some of the lower quality battery chemistries, which were aggressively destocked and led to a lack of apparent demand.

Faced with a de-stocking event in China (which was part policy and part market demand driven), new supply has continued to come. To use an adage though, the low hanging fruit has likely been taken. Supply response from here will be much more muted (as a % of total market size). This is because current commodity pricing is so low, and there is little to no incentive to bring on new projects (incentive only rests with existing projects that need to expand to reduce unit costs). These project expansions will likely satisfy demand for the next 6-12 months, but then what?

Standing back and looking at the big picture, many of the battery commodity markets need to expand by around 2-5x over the next 6 years to meet likely demand growth (virtually all forecasters are saying this). This demand won’t be able to be met by existing project expansions alone, it will require the addition of a number of large green fields projects, and quickly (investment decisions need to be made now to meet the demand window). This would suggest that commodity prices for battery commodities, while depressed now, could likely stage a big comeback sometime over the next 1-5 years. With consensus now so aggressively negative, the likelihood of a price spike sooner rather than later is increasing.

Short term issues, but long term opportunity

Darko Kuzmanovic, Portfolio Manager, Janus Henderson Investors

Battery raw materials have been on a rollercoaster ride over the last two years, shifting from euphoria to what seems like despair. Over that period lithium product prices have fallen 40-60%, while lithium producers have seen their share price decline between 50-80%. Several factors drove this reversal:

1: Chinese EV subsidy changes

China is a key driver of electric vehicle (EV) demand and development and this year it revised its policies by phasing out subsidies for EVs with a driving range of less than 250km and slashing subsidies for EVs with greater driving ranges.

The reduction in EV subsidies caused confusion and delays in battery production. EV sales in China were up 80% year on year in 2018 and are currently up 60% in 2019 YTD. Adding a further dampening effect is the uncertainty of the trade disputes with the US and the slowing global economy.

2: Growing lithium supply

The more significant impact on lithium pricing has been the increase in supply from new Western Australia hard rock projects (Altura, Pilbara and Mt Marion) and from modular expansions by traditional brine producers such as Albemarle and SQM.

Additional brine production from China also entered the market. Although lithium demand is growing rapidly (15-20% CAGR), it is still a small and developing market, with SQM estimating consumption of just 269 kt of Lithium Carbonate Equivalent (LCE) in 2018. By my estimates, the aggregated capacity entering the market in 2018-2019 was around 100 kt p.a. LCE.

Prior to 2018, the dominant supply source of lithium was from brine operations, but the speed at which new hard rock projects entered the market will see them be the dominant source in the future. For prices to stabilise this supply has to be accommodated by the market.

3: Converter capacity

Compounding things has been the emerging bottleneck of Chinese spodumene converter capacity (manufacturers which convert spodumene to LCE), with producers taking longer to build and ramp up capacity resulting in building spodumene inventory.

This has seen converters push back on offtake agreements to delay purchases until inventory is cleared. This knock-on effect has pressured spodumene prices (down more than 50% for most contracts) resulting in revenue (and cashflow) deferrals and tight working capital.

The share prices of Altura, Alita, Pilbara and Galaxy have declined significantly as some of these companies have had to raise equity to increase working capital in this uncertain time.

Despite these short-term issues, the general medium and long-term lithium ion battery outlook remains positive. Demand is expected to grow at 15-20% CAGR well past 2025, with Albemarle and SQM estimating lithium market demand to be around 820-1,000kt LCE, a significant increase from 2018 levels. The investment plans of the supply chain seem to support this view:

• Global automakers have highlighted investment plans totalling more than $300bn in new EV models, new manufacturing facilities and the refurbishment of existing facilities.
• EV penetration is estimated to reach 12-15% of global vehicles by 2025, with a shift to higher energy density (higher KWh) batteries for long range EVs. The inflection point for the acceleration of new/mass produced EVs is thought to be 2021.
• Global battery capacity plans now total over 2 GWh (according to Benchmark Minerals). While this will take time to build and ramp up, that capacity represents demand of around 1.5-2.0 Mt LCE.

There’s more to nickel than just batteries

Tim Serjeant, Portfolio Manager/Analyst, Eley Griffiths Group

The supply side equation for Nickel as it stands today presents a bullish outlook.

Nickel Pig Iron (NPI) is ~950kt of the ~2.35Mt nickel market, so call it 40% of total supply. It has been a feature of the market since 2007 (all the incremental supply) where China has featured prominently, tapping cheaper ore sources, power and capital intensity advantages to drive down the cost of production for stainless steel. Forgive the history lesson, but the context is important.

Since 2014 (and largely since 2017), Indonesia sought to participate further downstream, growing from virtually zero to almost half of all NPI produced. The 1 Jan 2020 banning of ore exports (which was originally earmarked for 2022) puts ~10% of the total nickel market or 220kt of NPI exports (going to China) notionally at risk / to come from an alternate source over the longer term.

With the ore ban pulled forward, we’ve seen a significant drawdown of inventory in the system, as measured by LME and SFE stocks to days consumption (seven-year low). 

The market has recently moved from contango to backwardation (a bullish short-term signal typically), with surging cancelled warrants triggering an unwind of carry trades, which is probably exacerbating the inventory movements via warehouses (on and off exchange) at present.

From the chart below you can also see that non-NPI supply (i.e. the other ~1.5Mt that comes from nickel sulphide, nickel matte etc) has been falling in recent years. Lower prices over the last decade have not incentivised new mine supply or exploration as the cost curve has shifted structurally lower on the proliferation of NPI.

Supply and demand balance in the nickel market

Source: INSG, Company report, Macquarie Commodity Strategy, September 2019. Note 2019-21F data is before supply disruption allowance.

Demand by comparison paints a sombre picture.

Stainless steel presently consumes ~ 1.6Mt contained nickel, accounting for ~65% of end use for nickel. Fundamentals here are unquestionably weak. Margins are tightening (higher input costs), inventory, in contrast to nickel, is elevated and protectionist barriers are rising. Indonesia (via Tsingshan) is growing strongly, but off a low base (<10% of what China produces today) and is self-sufficient for its nickel units (at lower cost). Within China, production growth rates for stainless have been strong, particularly in higher nickel intensive units like 300-series (8-9% nickel), however sustaining such rates would appear particularly challenging given prevailing weakness across end markets.

Nickel that goes into the burgeoning battery market currently equates for only ~4% (~100kt), with projections of up to 500ktpa by 2025 (15-20%), i.e. an incremental 400kt of nickel demand ( ~17% of current market) over that period, which NPI cannot supply (as it stands today). Much rides (pardon the pun) on the take up of electric vehicles (EV), and within that, the nickel intensity of battery used (e.g. NCM 532, 811 etc). It is likely to be a meaningful driver for nickel in the long term (BHP are talking mid-late 2020s for battery demand to impact the market), just not today.

Evidence further downstream highlights a cautionary tale, in line with commentary we’ve seen with other battery materials. Umicore, a global leader in cathode materials for EV batteries, is a case in point, where investment in capacity downstream is outpacing demand.

“The Energy & Surface Technologies business group is facing challenging market conditions, resulting in delays of 12 to 18 months in the development of its cathode material sales compared to the stepped-up expectations communicated in 2018. E&ST earnings in 2019 are expected to be below the record levels of 2018” - April 2019

And what about the other ~30% of the market, the non-NPI, non-battery piece? Arguably the growth of NPI > stainless steel has freed up some of this material to make nickel sulphate for the battery market. Macquarie estimate this could be ~200kt.

So, the risk for nickel prices (+68% YTD) and nickel equities we see from here into 2020 is that the restocking phase (triggered by the Indonesian ore export ban) coupled with heightened speculative interest of late unwinds; i.e. a pull-forward. The supply equation is supportive but arguably longer dated whilst demand side challenges may have been overlooked near term.

As for the medium to longer term, well, consensus numbers have nickel in the ~US$8.00 - 8.50/lb range. Rather than be nailed to a medium to long term price forecast (we know it will be wrong anyway!) I thought I’d mention a few different things we watch when analysing the nickel market;

1) Nickel has historically had a strong correlation to oil prices, as power is a big % of the unit cost economics, especially for NPI. See chart below (nickel in white, oil in yellow). The disconnect of late is noteworthy.

Source: Bloomberg

2) Nickel is often a by-product of other metal production (e.g. Norilsk is the world’s largest nickel producer, but palladium + platinum is 46% of revenue v nickel 25%) so prices of other commodities (Pd, Pt, Au, Cu, Co, Fe etc) do matter. As do exchange rates, particularly US Dollar to Russian Ruble (which is why the correlation with oil is typically very strong).

Wrapping it all up

Despite the possible bottom forming for some commodities, there’s no doubt that challenges remain in the short term for all the battery exposed minerals. 

But for the patient and diligent investor, there could be opportunities to be found. Demand for most of these commodities is set to grow exponentially in the decade ahead, but even if it rises steadily, there will no doubt be further price cycles with plenty of chances to both make and lose money. 

As pointed out by Tim Serjeant above, the only thing you can be sure about with long term price forecasts is that they’ll be wrong. But if you can be less wrong than others, there could be money to be made.

“We always overestimate the change that will occur in the next two years and underestimate the change that will occur in the next 10.” – Bill Gates

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