Commodities | Jun 20 2017
Brokers have recently broadened coverage of the lithium sector and modified price assumptions as demand for the material continues unabated. Yet the road from production to end-use is not straightforward.
-Australia's spodumene suppliers likely to fill near-term deficit in the market
-Pressure on lithium pricing suspected later in 2017
-Production problems and technical issues mean supply may not be consistent
By Eva Brocklehurst
Lithium is mineral on everyone's lips these days, along with graphite and cobalt. Brokers have recently pushed through modified price assumptions and industry outlooks, as demand for the materials, which are critical to the revolution in electric vehicles and big storage batteries, continues unchecked. However, producing the material and converting it to a form suitable for end use is not straightforward.
Macquarie upgrades its expectations for lithium and cobalt prices in the longer term and delves into the implications for several Australian stocks. While maintaining its estimates and Neutral rating for key lithium producer, Orocobre ((ORE)), Macquarie upgrades Pilbara Minerals ((PLS)) and Galaxy Resources ((GXY)) to Outperform and Altura Mining ((AJM)) to Neutral.
The broker does not expect Pilbara's Pilgangoora concentrate project to be in full production until FY19, although earnings are expected to start flowing in FY18. Earnings estimates for Galaxy are unchanged because of the contract nature of its sales. Galaxy recently recommissioned its Mt Cattlin mine in Western Australia, which is expected to produce around 160,000t of spodumene (hard rock) in 2017/18.
Citi assumes coverage of Pilbara Minerals with a Buy/High Risk recommendation and Galaxy Resources with Neutral/High Risk. By 2023, the broker estimates each will contribute around 11% of global supply of lithium. Macquarie prefers hard rock projects over brine developments and in this analysis increases the discount applied to Galaxy's Sal De Vida project, which results in a -8% reduction to the target price.
The broker also reverts to an equity share valuation for Neometals ((NMT)), given the failed sale of its 13.8% stake in the Mt Marion lithium project, 43.1% owned by Mineral Resources ((MIN)). The broker maintains its Outperform recommendations for graphite producers Syrah Resources ((SYR)) and Magnis Resources ((MNS)).
UBS also recently initiated coverage on Galaxy, Orocobre and Syrah Resources and believes Syrah offers a unique proposition in being both the largest and most advanced new entrant to the flake graphite market. The broker notes Orocobre's execution at Olaroz has not been without incident and future expansions are unlikely to be without delays.
Despite the operating risks in Orocobre's lithium brine processing, UBS highlights the stock is one of the few new entrants with a producing asset, which could mean it benefits from an interim shortfall in supply more readily than earlier-stage peers.
In the meantime, with a shortfall of hard rock supply, Galaxy should also benefit from spodumene concentrate prices. Nevertheless, with a number of new competitor projects under construction the broker envisages the heightened lithium concentrate price is likely to be short lived.
The basis for Macquarie's upgrade to lithium and cobalt price forecasts is a belief that increased electric vehicle production in China, based on the recently-announced credit system, will continue to drive demand in the medium term. The broker is more cautious about policy translating immediately to Chinese consumer uptake but, in conjunction with a slower ramping up of new projects, envisages a supply deficit extending into the early 2020s.
Australia's spodumene sector is the most likely source to fill the deficit, in the broker's opinion. Chilean brine production is trending sideways and there is little in the way of expansion in the near term.
Meanwhile, ramping up of new supply at Australia's Mt Marion and Mt Cattlin have been slower than anticipated, as technical difficulties at the mines and the issues surrounding integrating new concentrate feed into existing conversion capacity continue. These are expected to be overcome in time.
Macquarie believes lithium pricing has the potential, when fed through Chinese conversion facilities, to push the top end of the cost curve higher. As Australian lithium output is almost doubling this year the broker expects pressure on pricing into the second half and estimates December quarter prices at around US$8000/t versus the US$10,900/t witnessed in the current quarter.
Cobalt continues to surprise to the upside in terms of pricing and the broker raises its forecasts for this year by 20% to US$25/lb and 2018 forecasts by 11% to US$20/lb. The broker also raises its long-term price by 32% to reflect the lack of high-quality projects that are needed to balance the market.
Citi describes the lithium market as a wrestle between strong demand growth and a building wave of supply from existing and new producers. Spodumene projects have lower capital expenditure and shorter lead time to production and are expected to capture an increasing share of the market in the near term. But longer term these projects are at risk from the lower-cost brine projects.
The broker expects increased supply to cool lithium prices towards a long-term rate of US$7500/t for lithium carbonate and US$550/t for spodumene. The emergence of DSO (direct shipping ore), the broker suspects, is opportunistic, as at current prices it is economically viable to ship unprocessed ore to China from Australia. The broker believes this is not a structural market threat, as the economics do not work at its long-term price forecasts over a five-year period.
Citi is cautious and suspects the wave of supply that the spike in lithium prices encouraged has the potential to overwhelm demand growth, even if it continues to surprise to the upside. While delivery on projects may disappoint relative to expectations, the performance of Galaxy and Pilbara will be critical for absolute and relative performance.
Deutsche Bank believes it will take time for the DSO product to work its way through the Chinese supply chain and may not affect pricing until the December quarter. The broker currently forecasts Chinese battery grade prices of US$17,000/t for lithium hydroxide and US$15,000/t for lithium carbonate by the year, around -25% below spot pricing.
Canaccord Genuity has noticed a recent sell-off among several ASX-listed lithium companies amid fears of an oversupply from DSO. The broker believes these fears are significantly overstated. There are significant economic and technical reasons as to why the material is unlikely to present a meaningful, or sustainable, supply.
The broker, not one of the eight monitored daily on the FNArena database, reiterates its Buy calls for both Galaxy and Orocobre, maintaining a Speculative Buy rating for Altura.
What is DSO?
The concept of lithium DSO is based on the mining and crushing of lithium-bearing pegmatite ore before transporting it to China. The material is then concentrated before being delivered to mineral converter plants and made into either lithium carbonate or lithium hydroxide.
Canaccord Genuity estimates the production cost for lithium carbonate from DSO sources is around US$14,300/t, affording less attractive margins for converter plants based on current pricing. Hence, the broker envisages little incentive for converters to resort to DSO-sourced concentrate as an alternative feedstock despite its apparent availability.
Moreover, the broker suspects a considerable bottleneck will occur, given a lack of adequate converter capacity to handle large volumes of concentrate produced from DSO. Other key considerations include the disposal and storage of large volumes of waste material produced from the concentration process.
See also, Wodgina Boosts Mineral Resources' Lithium Stakes on June 13, 2017.
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