Feature Stories | May 27 2016
This story features MINERAL RESOURCES LIMITED, and other companies. For more info SHARE ANALYSIS: MIN
This story was first published for subscribers on May 16 and is now open for general readership. Readers are also referred to a subsequent update, Supply Response In Lithium Hots Up.
– Lithium price on the move again
– Battery demand forecast to grow exponentially
– Supply response to be constrained
– Australian stocks at the forefront
By Greg Peel
“The need for a fully electric yet practical car has clearly become an urgent one ever since the oil price hit US$147/bbl and the world began to panic about its carbon footprint. The fact that oil is now back at US$45/bbl is not fooling anyone.”
One might be forgiven for assuming the above quote is only a couple of weeks old. In fact, it is from a feature story I published in FNArena in March 2009. The GFC-inspired fall in the oil price from all-time highs took us down to the mid-thirties before rebounding to the mid-forties and continuing upward again to around US$120/bbl. The US shale oil explosion has since repeated the pattern, at least to the extent the WTI price has returned to US$45/bbl. If we are ever to see US$100/bbl again, it won’t be for a very long time.
The feature in question was Lithium Reaches For The Stars and was inspired by a meeting with the then managing director of lithium early-mover Galaxy Resources (hence the title). In researching this new FNArena feature on lithium, my first port of call was this previous feature. Has anything changed since 2009?
Well for starters, 2009 was a year in which anything on the periodic table that was not a household name, like carbon or copper for example, surged exponentially in price in a speculative bubble. Rare earth minerals led the charge, but while not the least bit rare, lithium was caught in the same frenzy. The thesis behind the rare earths and lithium was the same – new technology, in the form of mobile devices, electricity generation and storage, electric vehicles (magnets and batteries) and so forth, was set to change the world.
The bubble burst late in 2009, just like the speculative uranium bubble had burst two years earlier. In March of 2009, Galaxy Resources was trading at around 35c per share. In September that year it hit $2.19. By 2015 it was at 25c.
Galaxy Resources is on the move again, given new developments in what was already new technology back in 2009. In 2009, many in the industry did not believe the fully electric car would ever be viable. The hybrid Prius, they said, was just a fad that would fade. Seven years on, Tesla has received over 400,000 pre-orders for its new, fully electric and affordably priced Model 3, due off the production line in 2018.
In 2009, it was assumed it would be electric vehicles that would drive lithium battery demand, alongside mobile devices and anything that is easier to use without a power cord, such as power tools. In 2016 it is still assumed electric vehicles will be the major driver of battery demand in the near-term, but what was not foreseen in 2009 was that by 2016, households and commercial properties would be converting to battery storage power systems, either supplemented by on-grid connection or completely off-grid.
It’s early days, but economies of scale will continue to bring such a “green” shift into the reach of more average households and businesses which at this stage have shied away from the up-front cost, despite longer term cost savings. Australia’s downstream electricity suppliers know this, which is why the likes of AGL Energy and Origin Energy are rapidly diverting their resources towards alternative power development and becoming on-sellers of battery storage units for the home and business.
What has also changed between 2009 and now is the global demand-supply outlook for lithium production. This new article will concentrate on the latest research, and highlight new Australian players in the lithium space. However I encourage readers to return to my 2009 article for a comprehensive overview of lithium – its history and potential future – as a prologue to how we got to where we are today with regard the metal. The forecasts and projections therein can be considered outdated, nevertheless, but not misguided.
The Outlook Today
While the electric vehicle (EV) had its detractors back in 2009, many in the market saw the EV as the future, as fossil-fuelled vehicles waned in popularity. It was not an oil price issue given, as noted above, the WTI price in March 2009 was US$45/bbl and is basically that in May 2016. It was “green” theme.
As is usually the case, the market got ahead of itself. Development of viable EVs took longer than anticipated, particularly affordable EVs, and in the meantime, global emission reduction negotiations among governments ended with the usual agreements to plan to think about a plan, and nothing concrete.
But despite a lack of any global cooperation, nations took it upon themselves to establish emission reduction targets. While Europe has always led the green charge, the US has now established meaningful policies and China is leading the alternative energy drive. Corporations across the globe, including in Australia, have not waited for government action. Households across the globe, including in Australia, have taken it upon themselves to “go green”, despite the cost, because they want to.
While Tesla is still trying to iron out the gremlins in its EV offerings, the fact over 400,000 punters have pre-ordered a US$30,000 EV without ever seeing one in the flesh is testament to the green-shift among the world’s population.
In 2009, notes Paragon Funds Management, lithium demand was projected to reach 200kpta by 2013. This did not eventuate. But demand has now hit 200ktpa, and is growing at double-digit rates. Having bubbled and burst, lithium prices are now bubbling again, but this time the demand-side of the equation actually exists, whereas pre-2009 it was all about speculation. Today inventories are so low, Paragon reports, all the major global lithium producers have confirmed they are fully sold out.
Undersupplied lithium markets should persist over the medium term, Paragon suggests, given the inability for any significant supply-side response globally and the usual resource project development challenges.
At the centre of surging demand lies the lithium-ion battery. While lithium batteries of the scale required to power your iPhone or cordless drill have long been inexpensive enough to render them mass-market, the cost of batteries of the scale required to form the power matrix for an EV or to store solar power sufficient to satisfy an average household’s needs were, back in 2009, simply prohibitive. The cost of an energy cell in 2010, notes Deutsche Bank, equated to US$9000 per kilowatt hour. That cost today is US$225/kWh. Deutsche believes the cost can fall to US$150/kWh by 2020 as global battery manufacturing capacity ramps up.
While household/business battery storage units are the next big thing in the world of green, the EV remains the primary driver of battery demand for now. Tesla has taken centre stage on this front, despite the fact established marques from Europe to Japan and the US (Chevrolet Volt, for example) have also been working feverishly on their own EV models. Most importantly, Deutsche Bank notes, the largest catalyst for mass-market EV take-up is China, where government subsidies are now in place for both passenger and commercial EVs.
Hybrid EVs (such as the Toyota Prius) currently dominate global EV sales, with fully electric EVs reaching only 0.6% of all global auto sales in 2015. Deutsche is forecasting EV sales sales to grow to over 16 million vehicles by 2025, of which 3 million will be fully-electric, meaning six times the 2015 number.
A key buzzword in the 2010s has been “disruptive”, referring to anything that challenges the status quo in a given industry. Amazon has proven how online retail has disrupted traditional bricks and mortar stores. Netflix has disrupted traditional “by appointment” television. Uber has disrupted the global taxi industry. And lithium-ion batteries, Morgan Stanley believes, are set to disrupt traditional sources of energy.
New markets are being created with new value chains that could significantly affect industry fundamentals, Morgan Stanley suggests. These new energy materials include raw materials to manufacture rechargeable batteries but also those needed for the infrastructure required to support greater take-up of EVs and energy storage.
Depending on type, rechargeable batteries contain not just lithium, but a number of mined materials including graphite, cobalt, nickel, zinc, manganese, aluminium and phosphorus. Of this group, only lithium, graphite and cobalt are used in any meaningful proportion, Morgan Stanley notes. Of these three, cobalt offers little in the way of direct exposure in Australia for investors. Not so lithium and graphite.
Taking another step down the path, Morgan Stanley points out copper will also be important in this new energy world, providing the conductivity in charging poles and stations.
The Demand Side
Global lithium demand was 184kt in 2015, with battery demand increasing by 45% year on year and accounting for 40% of global lithium demand. Deutsche Bank expects global lithium demand to increase to 534kt by 2025, with batteries accounting for 70%.
Deutsche is forecasting EV battery consumption to grow at a 23% compound annual rate over the next ten years.
Starting from a lower base, battery demand for energy storage will grow by a 45% compound annual rate, Deutsche believes. While lithium is not the only metal capable of storing energy, technological development, superior performance and rapidly falling costs should ensure lithium batteries will remain the battery of choice.
Paragon Funds Management cites several key positive industry developments in 2016 alone.
There are the aforementioned Tesla orders. Currently there are commitments around the globe to build twelve lithium battery mega-factories. Warren Buffet’s BYD Co, China’s largest electric car and bus manufacturer, has announced plans to diversify upstream to secure lithium supply. And the Mt Marion and Mt Catlin lithium projects in Australia (more on these later) have forward-sold or entered into binding offtake agreements for most to all of medium term production, at above-market pricing.
Lithium prices have continued to rise in 2016, Paragon notes, up over 25% to US$7500/t, which suggests the funds manager’s medium term forecast price of US$9000/t may need to be revised. Domestic spot prices in China have risen by over 70%.
The lithium market will remain in deficit in 2016, Deutsche Bank forecasts, suggesting these elevated prices can hold to the end of the year. It is this market backdrop that is now incentivising new supply projects.
The Supply Side
Global lithium output in 2015 was 171kt, a fraction of global lithium reserves of 102mt, Deutsche notes. Most major commodities have 15-100 years of global reserves based on 2015 supply, but lithium reserves are 594 times 2015 output.
This would tend to suggest it’s only a matter of time before the bottom falls out of the lithium market. Effectively unlimited supply in the face of rapidly growing demand should encourage a rush around the globe to commission lithium production projects until ultimately supply growth exceeds demand growth. But it’s not that simple.
Paragon concedes the strong rise in the lithium price will incentivise new supply, with end-users and offtakers themselves likely to pursue greenfield projects. The potential for oversupply is a key risk to Paragon’s positive view on lithium but this is dependent on likely new projects coming online on time and at design capacity.
History suggests, says Paragon, this is highly unlikely.
Deutsche Bank is forecasting the lithium supply market to triple over the next ten years. Even then, there would still be 185 years of global reserves available.
The current lithium supply market is dominated by four major producers – Albemarle (US), SQM (Chile), FMC (US) and Sichuan Tianqi (China) – which accounted for 83% of global supply in 2015. The rise of the lithium battery in the early noughties and subsequent surge in lithium prices in the late noughties resulted in a wave of investment in mine expansions for South American-based brine assets and increased conversion capacity in China for hard-rock lithium feedstocks, Deutsche Bank notes.
[A full explanation of the differences and pros and cons of lithium contained in brine and lithium contained in rock is included in the prior FNArena feature, linked at the beginning of this article. Suffice to say, brine lithium requires a greater capital intensity to bring to production but provides a low operating cost thereafter, whereas hard-rock lithium production is cheaper to start up but operational costs are much higher.]
Then along came the GFC, and the lithium bubble burst. By 2013 lithium prices were severely depressed. But by mid-2015, prices began to move again as the much hailed lithium battery began to become more science than science fiction.
Last week Deutsche Bank upgraded Orocobre ((ORE)) to Buy. The company owns 66.5% of the Olaroz brine project in Argentina with joint venture partner Toyota Tsusho. Having suffered early commissioning issues, the project has now reached 60% of nameplate production capacity and is expecting to reach full capacity by September.
With cash costs expected to be below US$2500/t, Olaroz should be strongly cash flow positive at a full run-rate. The project recently passed the cash breakeven mark. The next step is for Orocobre to de-risk the Olaroz phase II expansion, which will take production from 17.5ktpa to 30-40ktpa.
Since late last year, Orocobre’s share price has more than doubled, almost reaching Deutsche’s upgraded price target of $3.90. Stockbroker Morgans (as opposed to Morgan Stanley) upgraded Orocobre to Buy (Add) last month, and set a target of $3.48. This may soon be revised.
Mineral Resources ((MIN)) produces iron ore, which is why its share price was hammered in 2015 and into 2016, and why the stock for some time was one of the most shorted on the ASX. Mineral Resources shares have also now doubled from their February lows, and the shorters have been sent packing.
One reason is that Mineral Resources is primarily a mineral processor, with a bit of iron ore mining on the side. As junior iron ore miners have suffered major cash flow issues of late, Mineral Resources’ cash flow has been more reliable thanks to processing revenues. More importantly, the company will earn-in to a 43% stake in the Mt Marion lithium joint venture, located near Kalgoorlie in Western Australia.
Mt Marion is under construction, with first production expected sometime later this year. The initial target production rate is 27ktpa. Mineral Resources is building and will operate Mt Marion on behalf of joint venture partner Neometals ((NMT)) and joint venture and offtake partner, China’s Ganfeng Lithium.
Deutsche also upgraded Mineral Resources to Buy last week, joining Morgan Stanley and Ord Minnett with equivalent ratings. The average price target between the three is currently $8.77. Morgan Stanley has this week reiterated its Overweight rating.
This is not because the spot lithium carbonate price has been surging. Morgan Stanley notes the more relevant benchmark lithium concentrate price seems to be more stable. The broker has reiterated Overweight, and lifted its target price to $8.90 from a previous $6.50, because the Mt Marion project is de-risking.
Shares in General Mining ((GMM)) have rallied from 10c last October to over 60c today. That’s because General Mining will earn in to 50% of the Mt Caitlin lithium project near Ravensthorpe in Western Australia, otherwise owned by joint venture partner, the aforementioned Galaxy Resources ((GXY)).
The joint venture has now pre-sold 2016 and 2017 Mt Caitlin production to offtake partner Mitsubishi, with a 2016 price agreed at US$6000/t. This is a major de-risking event, suggests Paragon Funds Management. Thus while the shares of both General Mining and Galaxy Resources have re-rated significantly of late, the fund manager continues to hold both ahead of what is now a likely expansion to the Mt Caitlin project.
Galaxy Resources also owns 100% of the Sal de Vida brine project in Argentina, which Paragon describes as the “best and most advanced undeveloped lithium brine asset globally”. Despite Galaxy’s recent share price surge, a heavy discount for Sal de Vida is implicit in valuation, Paragon’s analysis suggests. A bankable feasibility study for the project is due shortly ahead of securing funding, both of which should prove material catalysts for the stock, the fund manager believes.
Paragon has nevertheless now taken profits on its holding of Pilbara Minerals ((PLS)). While Mt Marion and Mt Caitlin are ramping up production, Pilbara has recently raised further capital in order to advance its Pilgangoora lithium-tantalum project in Western Australia. The stock has enjoyed a similar re-rating to Australia’s other lithium-exposed names, but has reached Paragon’s base case valuation and is a long way from de-risking.
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