Material Matters: Lithium, Energy & Coal

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Lithium production may need to rise eight-fold to keep up with demand; LNG Prices to be on the higher side in 2021; Iron ore miners are Macquarie’s top picks

-Electric vehicles to reach 30% market penetration by 2030
-Global consensus may be too optimistic on oil supply
-Macquarie still cautious on exposure to thermal coal

Lithium: Good times ahead

Many countries have pledged to the goal of going completely carbon neutral by 2050. Undeniably an aggressive goal, going carbon-free would also require a shift towards electric vehicles (EV) and massive investments in renewable energy generation and storage.

This tilt towards renewables implies huge investments in various commodities including copper, nickel, aluminium, graphite and, of course, lithium.

According to Janus Henderson, 2021-22 is expected to be the inflection point for electric vehicle (EV) demand with EV penetration forecast to increase to 30% by 2030 from the current 3%.

Declining battery costs will go a long way in achieving this penetration level, suggests the wealth manager, making electric vehicles cost-competitive with internal combustion engine vehicles.

The mainstay of EVs and renewable power storage – lithium – which forms the core of lithium-ion batteries, will be a key beneficiary of this clean energy transition.

Janus Henderson expects demand for lithium-ion batteries to grow in parallel with growth in EV production, pegging the growth rate at 30% pa (CAGR).

This claim is backed by Tesla which, at its most recent investor day, suggested that battery capacity could increase to 3 million megawatt-hours by 2030, equivalent to 2.4-2.8m tonnes per annum of lithium carbonate equivalent (LCE).

This is massive especially when looked at in the context of lithium’s 2020 demand figures, estimated at 0.35m tonnes of LCE, with a capacity of only around 0.55m tonnes.

What does all this mean for lithium?

In a report by UBS, lithium demand is expected to shoot up over the next ten years and production may need to increase by eight times to play catch-up.

During the last lithium boom in 2014-18, the demand for the metal shot up to 20% (compounded annual growth rate) with prices more than tripling during the period.

After a -50% fall in prices post 2018, lithium is once again seeing a lift in demand, observe analysts at Janus Henderson, aided by a reduction in raw material supply.

Going ahead, the analysts feel one of the key hurdles facing lithium companies will be meeting the rapidly growing demand, especially since many companies have reduced or delayed capital investment after the recent price pullback.

A less talked about but equally important part of the clean energy transition is the growth potential offered by the stationary storage market. The demand for graphite is expected to rise by five times while the demand for cobalt and rare earths is likely to triple.

Anticipating better times ahead, the equity market has already soared ahead of the commodity price moves with producers such as Albemarle Corp, Ganfeng Lithium, Livent Corp, Pilbara Minerals ((PLS)), Mineral Resources ((MIN)) and Orocobre ((ORE)) performing strongly in 2020.

As was the case during the last lithium cycle, Janus Henderson analysts anticipate the emergence of new producers and believe the pecking order could look quite different in 12-24 months’ time.

Oil and LNG: A favourable time for more exposure 

With Asian countries like Japan lifting their LNG imports (Japan's imports rose by more than 1mt in December 2020) to cater to winter demand, spot LNG prices have surged setting new records. 

At US$32.50mmbtu, the LNG spot prices are 5-6 times the price of a typical oil-linked contract.

Gas prices have also increased in Europe and the UK and Morgans assesses this trend will continue for the rest of 2021.

As a result, Morgans has lifted its spot LNG assumptions to the March 2022 quarter from the December 2020 quarter, in line with the JKM curve, which in its view is the most suitable benchmark for Australian LNG producers.

Companies who have been nimble, turning production around quickly to take advantage of the tight market stand to benefit the most, suggests Morgans, like Origin Energy ((ORG)) and Santos ((STO)).

Macquarie prefers Woodside Petroleum ((WPL)) due to the improving prospects for the Scarborough development, and Beach Energy ((BPT)) for better free cash flow prospects over the next 2-3 years.

Morgans believes the oil market is past peak negativity with global consensus seen as too optimistic in thinking the oil supply recovery will almost match the demand forecast.

Morgans identifies factors that could slow down the pace of oil supply recovery, including the significant lack of access to capital faced by the US oil industry. This indicates producers would struggle to increase development activity in the short term if oil prices were to move materially higher.

In the medium term, Morgans analysts expect oil fundamentals to be increasingly impacted by plans to exit oil from several global supermajors which in the shorter term may see capex held back from these assets.

Pointing out that the last three months have been favourable for adding oil and gas exposures, Morgans suggests that window of opportunity remains open.

Some stocks suggested by Morgans include Santos, Beach Energy, Senex Energy ((SXY)) and Karoon Energy ((KAR)).

Coal and iron ore

Recent reports state Australian coal cargo has cleared customs in China.

While this appears positive, Macquarie’s commodity team also notes the purchase of Australian seaborne cargoes remains prohibited in China with currently 5mt of Australian coal waiting offshore.

Unsurprisingly, Macquarie analysts are wary of stocks with exposure to thermal coal and reiterate their Underperform rating on New Hope Corp ((NHC)).

Led by buoyant iron ore prices, low port stocks and positive steel margins, Macquarie is bullish on iron-ore stocks and prefers Fortescue Metals Group ((FMG)) in large caps. In smaller caps, Mineral Resources ((MIN)), Deterra Royalties ((DRR)), Champion Iron ((CIA)) and Mount Gibson Iron ((MGX)) are the top choices.

Given the current subdued pricing scenario, Macquarie is cautious on alumina exposure and reaffirms its Underperform rating on Alumina Ltd ((AWC)). South32 ((S32)) continues to be rated as Underperform.

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