Where the fundies have lithium all wrong

Lithium is without question the hottest sector on the ASX at the moment, with projects of varying quality and scale littered up and down the market cap spectrum.

While our read of the available and relevant data is that consensus is underestimating overall lithium demand and overstating probable supply, we appreciate and expect that others may not share our view of the future.

Regardless of how positive you are on the sector in the macro, we think the valuation disparity between hard-rock spodumene projects, and their lithium brine counterparts, is completely unjustified and presents a material opportunity for investors.

We’d argue this discount is rooted in a false narrative that labels direct-lithium extraction (DLE) as an ‘unproven technology’ or ‘commercially unviable’ and as a result, quickly and incorrectly sees lithium brine projects disregarded by generalist portfolio managers and analysts across the market.

Let’s explore the data and see if we can convince you that the fundies have lithium brines all wrong.

How is DLE different?

In the most simple of terms, hard-rock spodumene (LiAlSi₂O₆) is dug up from the earth in rock form, floated, heated and roasted in sulfuric acid at 250°C.  It's then leached, mixed with sodium carbonate, then lime, more water and heated again.

Lithium brines (as cooking enthusiasts would understand) are a salty reservoir of water below the surface of the earth.  This water contains lithium, but also other elements (potassium, magnesium, calcium etc.) and historically, these brines have been pumped to the surface into 'evaporation ponds'.  

These ponds are shallow and large to maximise the surface area exposed to the sun.  Over a period of time (many months to a couple of years) the salty water is (you guessed it) evaporated and the salts precipitated.  Large quantities of reagents are added during the process to remove all the impurities and as concentrations of lithium increase, the water is moved from pond to pond, and eventually, only lithium chloride is left in the final pond. Further reagents are then added and the chloride becomes a lithium carbonate.  You need a lot of land, waste a lot of water and are somewhat at the mercy of Mother Nature (rain, temperature, sunshine.) 

Direct lithium extraction (DLE) takes the same sort of brine and uses a resin material that is really good at extracting the lithium from all the other elements in the salty water.  That's an important distinction - DLE takes the lithium out.  Evaporation takes 'everything else' out - which is far less efficient. 

There are a number of types of DLE at various stages of scientific and commercial efficacy.  In the interests of wordcount, we will focus on the 2 types of DLE most prevalent in listed companies today: 

1.  Sorption:  An aluminate material “adsorbs” the lithium from the brine, leaving everything else in it. The solution is then 'desorbed' i.e. the lithium chloride ions are removed into a concentrated solution, and the sorbent is then ready to be used again. This process is driven by salinity and heat, no reagents are required and has been used commercially for decades.
2. Ion Exchange:  Positive lithium ions are loaded into an exchange material that swaps its positive ions for the lithium ions, and then unloaded into a solution. This loading/unloading process is driven by large quantities of acid and base needed for each loading and unloading.

It's an important distinction as Sorption DLE has been around since the 1970s when Dow Chemicals (now NYSE: DD) developed a lithium sorbent for its Smackover (Southern Arkansas, US) brines used to recover bromine, which is used in flame retardants, ag chemicals and pharmaceuticals. 

In 1995 US-listed Livent (NASDAQ: LTHM) adopted sorption-style DLE commercially at its Salar Hombre Muertos, producing up to c. 80ktpa (Livent is currently the 3rd largest lithium producer in the world).  As lithium demand rose in the 2010s, Chinese brine operators Lanke, Zangge Mining and Jintai have commercially used DLE to produce up to 20ktpa LCE. 

Over the next 2-3 years, projects in Argentina from Rio Tinto (ASX: RIO) and Eramet/Tsingshan, Californian projects from Berkshire Hathaway (NASDAQ: BRK/A), Terralithium (Private) and Energy Source Minerals (Private), are scheduled for maiden production, all utilising sorption-style DLE.

Ion Exchange, on the other hand, has yet to be proven commercially possible and viable.  Companies such as Lilac Solutions (Private), Lake Resources (ASX: LKE), E3 Metals Corp and Standard Lithium (NYSE: SLI) are all in various stages of pilot and/or demonstration.  Experts tell us (because let's face it, we aren't specialty chemicals gurus) the primary challenges are that the large quantities of acid and base required can be (potentially prohibitively) expensive and some Ion Exchange materials are vulnerable to degradation in these acidic conditions.

The investment opportunity 

If you think the above makes sense, the opportunity below should be blindingly obvious.  

The average spodumene project (i.e. not yet in production) in what I'll call a tier-1 jurisdiction (think US, Canada, Australia, Europe, Argentina etc.) is trading at an enterprise value-to-resource (EV/Resource, AUD, mt) $454/mt of resources on an ex-Liontown (ASX: LTR) and ex-Piedmont (ASX: PLL) basis. 

The reason we exclude LTR trading on $1,068/mt is due to the takeover premium. The reason for PLL's exclusion (trading on $1,410/mt) is they are essentially in production via their favourable deal with Sayona Mining (ASX: SYA), with fixed-price offtake from the NAL Mine which recently got into production. 

However, if we apply the same rules to brine projects and the numbers are significantly different.  Brine projects average at $82 of enterprise value, per metric tonne of resource (excluding a huge outlier Argosy, AGY on $2,171/mt).  You can buy a brine project at a more than 80% discount to its average hard-rock peer.   

This discount in our mind is a significant market inefficiency.  

The thesis is pretty simple. If you agree that sorption-style Direct-Lithium Extraction is not some 'new unproven technology' but in fact, something that's been commercially operating for decades,  then a metric tonne of a lithium-carbonate equivalent resource should be priced by the market (relatively) equally and therefore, the discount currently being applied to Brine Projects, relative to Spodumene, is an opportunity. 

If we take this a step further and begin considering DLE's potential to operate at lower running costs, reduce (or some cases, remove entirely) carbon emissions, water and land usage, as well as increase lithium recoveries, there's even a case to be made for a premium to traditional brine (evaporation ponds) and hard rock miners.

Our preferred stocks

While we have a keen interest in lithium, our standard resource-company investment criteria and philosophy remain the basis of how we deploy our capital regardless of the underlying commodity. 

We want to invest in globally significant resource discoveries (scale), in tier-1 jurisdictions, which we can reasonably expect to operate in the bottom quartile of the cost curve.  We want those projects and companies to be managed by aligned, proven individuals.  Often, these sorts of projects attract the capital, strategic interest and talent required to get into production without destroying shareholder value. 

While popular with retail investors, and gaining traction with European institutions, Vulcan Energy Resources (ASX: VUL) continues to fly under the radar of most local institutional investors.  We think its rocket-like share price run in FY21  (from 40c to $16) and the seemingly implausible "Zero Carbon Lithium" product are to blame for the company trading at half the valuation of its nearest brine-project-peer. 

Located in Germany, Vulcan's Zero Carbon Lithium project is the largest lithium resource in Europe.  The company intends to use the geothermal energy stored in the hot brine, to power their lithium extraction (sorption DLE) process.  They are to my knowledge, the only ASX-listed company to have an EV automaker (Stellantis NV, NASDAQ: STLA) as a major shareholder (7%).  The only person holding more stock than Stellantis is the Executive Chair (who was long-time CEO until this week) and co-founder, Dr Francis Wedin (9.9%). 

While retail investors seem to get excited about offtake agreements with Stellantis, Renault, LG, Umicore and VW, most fund managers I talk to point out the 'execution risk' associated with drilling 3-5km into the earth's crust to extract a fluid under pressure.  

I find this difficult to understand given the same fund managers have no issue investing in an onshore oil and gas field like the Cooper Basin (Australia, over 3km deep where ASX: STO, ASX: BPT and ASX: COE  operate) or the Permian Basin (US, up to 8km deep where NYSE: CVX, NYSE: XOM and just about every other O&G major operates).   In fact, the Upper Rhine Valley has been producing oil, gas and geothermal energy since 1980, with over 1000 oil and gas wells and 24 deep geothermal wells drilled.  Vulcan itself already has wells producing renewable energy. 

Vulcan's project is far more akin to an onshore oil and gas project than a spodumene mine in WA or a salt flat in Argentina. Financing the $1.9bn capex bill (another common fund manager concern) seems to also be more like the oil and gas industry, with German specialty chemicals company Nobian (subject to final terms) farming in on the upstream lithium hydroxide plant.  

With a lot of recent interest from oil and gas majors looking to move in on the new energy sector, we think it's likely that Vulcan does a similar farm-in deal on the downstream brine extraction and geothermal plant in the near future.  

Additional funding support in the form of environmental grants (similar to those seen in the US, with the 'inflation reduction act'), green bonds and/or bank debt are also reasonable expectations given the company's environmental credentials and long-term engagement with relevant agencies - I'm not sure the highly dilutive cap raise the market seems to be pricing ever eventuates.

(Thanks to Ben Richards for his assistance with the background research for this article.)