Commodities | Jun 01 2023
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Recent broker research and corporate activity suggest a bullish outlook for lithium.
-Lithium pricing stabilises, amid ongoing corporate activity
-South American concerns around government policies
-Stronger EV sales boost lithium inventories in China
-Brokers positive on lithium fundamentals and pricing
-Macquarie sees upside for all ASX lithium stocks under coverage
By Mark Woodruff
The volume and range of Australian stockbroker research on the Lithium sector continues to expand.
Analysts are jetting off to China and South America to further investigate existing recommendations, while new research on stocks with African exposure is already yielding results for investors.
Meanwhile, lithium prices are beginning to stabilise on improving fundamentals with the spot price bouncing after experiencing a -70% sell-off that played out over five months.
Mind you, investors may do well to ignore short term volatility.
UBS recently spoke with Tianqi Lithium Corp, which controls just less than half of lithium production worldwide, and management noted the ability to predict prices for lithium is hampered by relatively low volumes in the overall market.
Moreover, Canaccord recently hosted a panel discussion in the US among various lithium companies, who noted customers/offtakers were less concerned by recent price volatility than one would assume, and were equally focused on long-term supply and ESG considerations.
Wilsons is certainly ignoring short-term price gyrations and is confident the low-carbon energy transition will drive expected compounding deficits in supply over the coming decades. In turn, this is expected to underpin robust pricing over the medium-to-longer term.
Recent activity on the ASX suggests major players are also adopting a long-term view and taking advantage of recent lithium price weakness.
Soon after, Wilsons initiated coverage on the sector with research on five lithium stocks, outlining its preference for Atlantic Lithium ((A11)) in Ghana and Leo Lithium ((LLL)) in Mali as noted in: https://www.fnarena.com/index.php/2023/05/12/in-brief-lithium-retail-us-debt/
In the following two weeks, shares in Leo Lithium rallied by around 30% before receiving a further boost this week on the announcement of a strategic placement and cooperation agreement with China’s largest lithium producer, Ganfeng.
Given the accelerated nature of the energy transition, and because Chinese entities have already secured much of the available supply from existing and near-term producing regions, Wilsons suggests Europe will need to act swiftly to secure supply from the next generation of projects.
South American supply concerns around government policies
To underline the importance of Argentina in lithium markets, exports could potentially multiply by five or even seven times, despite the country already being the main source of lithium imports for the US.
Goldman Sachs formed this view when analysing the potential impact of the country becoming eligible for credits via the Inflation Reduction Act (IRA) in the US, though uncertainty remains how a bilateral agreement may come about.
However, Latin American policy risk has been a common concern around lithium supply, and Argentina has been infected by association with the perceived risks in other jurisdictions, note the analysts.
UBS remains wary of sovereign risk in Argentina, despite policy initiatives to encourage investment. The country's complex foreign exchange regulations and broader economic risks are thought to complicate the overall investment thesis.
Last week, the broker held a conference call with Chilean-based lithium producer SQM, following its recent quarterly results. Policy ambiguity was front and centre in discussion, as the company’s expansion in Chile is at risk.
In April, shares of SQM and Albemarle (the world’s top two lithium producers) fell heavily after Chile moved to take control of the country’s lithium industry, by saying contracts with the two companies would not be renewed under a new public-private partnership model.
While near-term risks to Chilean lithium supply look to have been allayed, the broker remains conservative on potential supply growth given the pathway to meaningful greenfield supply is still unclear. The region is considered to have resource potential, yet project development times of five to seven years limit how quickly it can respond to the higher lithium pricing.
By contrast, Goldman’s recent trip to Argentina improved the broker’s confidence around the policy environment. This broker felt the perceived risk is overdone, particularly for medium-term investors.
The scale of both planned expansions and new development projects on existing resources are potentially progressing ahead of market expectations, according to the broker, adding upside risk to medium-to-long-term lithium supply.
The analysts also observed Direct Lithium Extraction (DLE) is increasingly being considered for the next wave of projects across both brownfield expansions at existing operations and by emerging explorers/developers.
DLE has the potential to significantly increase the supply of lithium from brine projects (much like shale did for oil), nearly doubling lithium production on higher recoveries, accelerating production ramp-up and improving project returns, explains Goldmans.
On the other hand, UBS feels that while DLE may add incremental supply to market, it is by no means a silver bullet for deficits in coming years.
This broker expects ongoing M&A activity in the region with larger players better positioned to secure business with local service providers and the local workforce. It’s thought synergies may emerge either across geography or via shared downstream processing plants.
Macquarie’s visited Argentina at the same time as fellow brokers. The tour included visits to Allkem’s Olaroz brine lithium production facility, a site tour of Galan Lithium’s ((GLN)) Hombre Muerto West lithium brine project and Argosy Minerals’ ((AGY)) Rincon lithium brine operations.
The broker suggests Allkem offers unique exposure to both lithium brine in South America and spodumene production in Australia.
In what seems a bullish indicator, Macquarie anticipates upside remains for all lithium miners under its research coverage, which extends to more than a dozen stocks.
Stronger EV sales boost lithium inventories in China
For commodities in general, UBS finds the wave of positive reopening sentiment in China and rapid recovery expectations in March quarter has faded into the June quarter.
However, feedback on the ground during a recent trip to the country suggests the lithium market is stabilising.
Domestic and regional interest to secure lithium supply remains very strong, according to the broker’s contacts during the trip.
Through the first quarter of 2023, lithium chemical inventories started to lift as cathode makers' orders were trimmed and they procured lithium chemical feedstock only when required.
Inventories are now falling (thanks to stronger EV sales in April), and the recent Wuxi futures rebound to around RMB300,000 per tonne of lithium carbonate is set to provide a good price guide for the second half of 2023, in the broker’s opinion.
The fall in inventories is due to original equipment manufacturers (OEM) inventories of cars built but not sold, explains UBS. This is expected to result in increased battery orders, which in turn suggests battery OEMs will move to lift production rates and component orders, including with cathode producers.
According to locals in China, increased demand and restocking will likely reduce the overhang of lithium chemical inventories at converters, leading ultimately to increased lithium chemical production and demand for feedstock.
The big rhetorical question posed by UBS is: how long/large might this restock cycle be?
The answer depends in large part on EV sales momentum, according to the broker.
On that front, the EV sales recovery is thought to be well under way and structural demand for EVs remains very strong.
Goldman Sachs agrees and continues to see a robust mix-shift among auto companies towards EVs. The percentage of units sold is expected to climb to 28% in 2026 from 4% in 2020.
In the US, this broker expects annual EV sales will rise to 9.3m by 2032 from 0.8m in 2022, averaging 5.6m annually over the 2023-32 period.
Even if overall vehicle sales soften, anecdotal evidence points to a strong consumer preference for EVs, notes UBS, and it’s possible this category of sales will continue to grow strongly regardless.
Broker views on fundamentals and preferred ASX lithium exposures
In the first week of May, Morgan Stanley noted a potential turning point for lithium spot prices, which were rallying due to falling midstream inventories, while actual supply growth had also disappointed during 2023.
Cathode and battery cell producers in China had not fully returned to buying in the spot market, but sentiment was clearly improving, noted the broker.
Further upstream, China's carbonate producers still had one to two months of inventory on hand, according to price-reporting agency Argus.
Morgan Stanley forecast a full-year lithium market deficit for 2023 and expected the recently oversupplied lithium market will become tighter again for the remainder of 2023.
The broker contemplated some upside risk to its base-case forecast for an average China lithium carbonate price of US$25/kg for the second half of the year.
At the time, the carbonate spot price has bounced by 30% from its low of US$21/kg to US$27.5/kg and hydroxide had risen by 20% to US$30/kg.
While lithium chemicals were gaining, the spodumene concentrate price (6% Li2O) had continued its downward trajectory to US$4,050/t.
Canaccord Genuity also believed Chinese spot pricing was approaching a nadir, and observed that, while euphoria had waned, the thematic remained solid.
The broker felt recent lows of US$23,000/t for Chinese chemical pricing were unsustainable and felt optimistic for a China-led recovery in the second half of 2023.
Regarding ASX share prices, the analysts felt a line had been drawn under valuations courtesy of recent M&A activity in the sector.
On the demand side, the broker observed stronger-than-expected EV sales in 2022 as manufacturers pulled production forward in anticipation of the withdrawal of Chinese government subsidies, but believed battery factory capacity will continue to underpin demand long term, while strong EV growth year on year to the March quarter augurs well for the near term.
Turning to supply, the broker forecast supply would grow strongly as projects delayed from 2022 come online, but on balance expected supply to remain steady.
Overall, Canaccord remains long-term bullish on the sector and expect structural market deficits and elevated pricing for the medium-to-longer term.
From among producers on the ASX, the broker’s top picks are Allkem and Pilbara Minerals, while favoured developers are ioneer ((INR)), and Leo Lithium.
By mid-May Lithium prices in China were around US$28,000/t, and Citi reiterated its bullish view into year end, targeting 25-40% upside.
This broker attributed the recent rally in prices to demand from physical traders, recovering EV sales, lower inventories in the supply chain and more attractive export arbitrage.
It was only a matter of time, according to Citi, before the downstream producers started to restock, supporting higher prices. Media reports of additional policy support in China could also underpin higher EV sales, in the broker’s opinion.
Citi forecast a nominal lithium surplus this year, but a deficit remains possible as labour shortages, permitting issues and mining technicalities constrain supply growth.
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