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Game Over For Lithium?

Commodities | Jun 02 2022

This story features PILBARA MINERALS LIMITED, and other companies. For more info SHARE ANALYSIS: PLS

Brokers have swiftly come to the conclusion lithium prices will soon peak and pull back substantially, though the outlook is a little more complex.

-Calls for lithium spot prices to peak
-Global EV demand growth remains critical
-Chinese lockdowns cloud the outlook
-Inflation may lead to demand destruction

By Greg Peel

“Chinese electric vehicle maker BYD Co Ltd is in talks to buy six lithium mines in Africa with total resources of lithium oxide at 2.5% grade estimated at more than 25 million tonnes, Shanghai government-backed media The Paper reported on Tuesday, citing sources”. Reuters reported the news but “has not verified this story and does not vouch for its accuracy”.

That was just one piece of news that rattled Australia’s listed lithium miners yesterday, leading to share price falls across the sector of -8-22%.

Another was Bloomberg reporting that Argentine customs will set a reference price of US$53,000/t for lithium carbonate exports, with prices currently around US$57,000/t.

Citi analysts responded to this news by suggesting this is essentially a mechanism for customs to request the integrity of contract pricing where there is a large variance. Given this is not a floor or ceiling price, nor will it change the prevailing royalty regimes, Citi does not expect any fiscal impacts for its lithium miner coverage.

As Shaw and Partners notes, there is no “benchmark” price for lithium. Prices are published by several providers of spodumene and a number of lithium chemicals. These prices are provided in various currencies and are based on product quality and despatch or delivery location.

Lithium markets are opaque, but Shaw expects there will be a move towards a standard convention within two to three years.

That said, lithium spot prices have declined from a high of around US$69,000/t in April to US$57,000/t currently, largely due to lockdowns in China leading to a drop in EV production (including at Tesla’s gigafactory in Shanghai). But as Shanghai begins to reopen this month, presumably lithium prices will rebound?

Not necessarily. Exacerbating yesterday’s plunge for lithium miner stocks was specifically a report out from Goldman Sachs, but Goldman is not the only broker to warn of trouble ahead.

Some History

It’s not hard to understand why lithium prices have surged during 2022. Macquarie has provided some hard data this week, revealing global EV light vehicle sales rose 65% year on year over January-April, while total light vehicle sales fell -11%. The fall in total sales cannot be blamed on the global chip shortage, as this is affecting both EV and internal combustion engine (ICE) vehicles.

Citi notes EV sales are expected to be underpinned over the coming years by rising economies of both scope (increasing range between charging) and scale (falling manufacturing costs), as well as global government support. EVs and related infrastructure will be one of the first sectors to be stimulated in a downturn, Citi suggests.

In fact, demand for lithium is expected to double every three years over the coming decade, placing “phenomenal” pressure on the supply side and keeping prices elevated in order to stimulate investment in mine capacity. Citi notes that by comparison, copper demand doubles every 25-30 years and aluminium demand every 15-20 years.

Parabolic price surges for the “hot” exotic metal du jour have not been uncommon in the twenty-first century. The Kyoto Protocol signed in 1997 was a trigger for a speculative uranium price spike in the noughties that soon ended in tears (before Fukushima). The use of rare earths in everything from smart phone screens to wind turbines prompted a premature spike in rare earth prices soon after as well as a spike in sales of periodic tables. Only now are rare earths coming back from the subsequent bust.

Nor is this lithium’s first experience of a price spike. When a bloke called Elon Musk first proved the commercial viability of EVs in a market dominated by ICE vehicles, speculators took notice. China then followed with government subsidies on EV sales, and in 2016-17 lithium prices took off.

Prematurely. A collapse followed when it became obvious the world was not yet ready to drive large-scale lithium demand. Since then we’ve seen governments across the globe pledging net-zero emissions timelines, and also timelines for the regulated end of ICE production, particularly in Europe. Automakers have responded by setting their own, earlier, timelines.

And global EV take-up is only accelerating.

End of the Beginning

“The battery metals bull market has peaked,” declared Goldman Sachs in a report published late last week. Yesterday, Credit Suisse followed up with its own sector update, with similar underlying conclusions. The timing was exquisite, coming alongside the China-Africa and Argentine news.

Pilbara Minerals ((PLS)) fell -22.0%, Liontown Resources ((LTR)) -19.1%, Allkem ((AKE)) -15.4% and IGO ((IGO)) -11.7 (after Western Areas ((WSA)) shareholders approved IGO’s merger proposal) and Mineral Resources ((MIN)) fell -8.2%.

Battery equipment and services company Novonix ((NVX)) fell -12.7%.

Battery metals – cobalt, lithium and nickel – will power the green industrial revolution, facing a wave of demand comparable to that of copper and iron ore during China’s rapid growth in the 2000s. With climate change top of mind, investors are fully aware that battery metals will play a crucial role in the 21st century global economy, just as bulk and base metals did before them. Yet despite this exponential demand profile, we see the battery metals bull market as over for now.”  

Goldman wasn’t mucking around.

The 2016-17 lithium price spike proved too early a jump on the battery demand call. But in the interim the supply-side response to the assumed trajectory of EV sales has been swift.

“A surge in investor capital into supply investment tied to the long term EV demand story, essentially trading a spot driven commodity as a forward-looking equity, Goldman suggests. “That fundamental mispricing has in turn generated an outsized supply response well ahead of the demand trend in focus”.

With the lithium spot price currently around US$60,000/t, Goldman is forecasting a 2022 average price of US$53,982/t and a 2023 price of US$16,372/t.

Over 2022-25, the broker forecasts global lithium supply to grow by 33% year on year. Chinese lithium project expansions are expected to multiply rapidly, in particular integrated hard rock projects, just as ex-China spodumene supply continues to strengthen.

Shaw points out that 95% of global lithium supply comes from the world’s top four producers – Australia, Chile, China and Argentina. Hard rock spodumene deposits are considered the most commercially viable, and Western Australian miners account for more than 50% of the current lithium supply.

No wonder our producers were so hard hit yesterday. But one important point should be noted – the cost of production of lithium, as Citi points out, is only US$5,000-10,000/t.

Consensus View

Like Goldman, Citi’s base case is for prices to moderate further from extreme levels, but, unlike Goldman, remain “higher for longer” – averaging US$35,000/t through 2025 – supported by solid growth in electric vehicle sales on the back of improving economies of scale and scope in battery and vehicle production.

Macquarie agrees there are growing signs of a major correction in prices for lithium, nickel and cobalt after the boom of the past year, reflecting mainly the Chinese slowdown. For cobalt and lithium, this could be temporary, the broker suggests, once China bounces back, while nickel prices could continue to fall due to rising Indonesian supply.

Credit Suisse now sees a balanced lithium market in 2023-24, and believes surpluses threaten from 2025, which is a major change from previous deficit forecasts. The broker previously considered the deficit was intractable, but notes the world has changed with inflation, war and lockdowns souring the demand outlook, whilst the pace of supply response to spiking prices has been more rapid than anticipated.

Credit Suisse also highlights demand destruction as battery costs climb 30-40% (driving a shift in demand from battery EVs to plug-in hybrid EVs), lockdowns delaying production, and inflation eating into consumer discretionary budgets – including for EVs.

The broker thus suggests lithium prices may peak in the next few months: Received prices may climb further in coming months to close the gap with spot (given longer term supply contracts), but should then roll over. The March quarter of 2023 may signal the biggest price drop if the Chinese EV subsidy ceases as planned.

“We see scope for the market to become oversupplied from 2025, so prices may slide to deter potential oversupply. Of course, much depends on the demand outlook.”

Demand for lithium has grown at around a 20% compound annual growth rate through 2017-22. Shaw and Partners forecasts the same rate of demand growth to persist through to 2030, expecting EVs to represent 50% of global new car sales by that time.

Which stock?

Credit Suisse has today downgraded Allkem to Neutral from Outperform, to leave five Buy and four Hold equivalent ratings among FNArena database brokers. However, most broker updates go back to April, so ratings, and a consensus target of $15.80, suggesting 37% upside, may soon be subject to review – a la Goldman Sachs and Credit Suisse.

Credit Suisse has also downgraded Pilbara Minerals to Neutral from Outperform, while Macquarie has today left its rating at Outperform. The two other brokers covering each have Buy ratings as at end-April, for a consensus target of $3.71 suggesting 60% upside.

Only two database brokers cover Liontown Resources. Macquarie has today retained an Outperform rating while Ord Minnett initiated coverage in May with Hold. Their average target is $1.90, suggesting 61% upside.

Macquarie's research update today stipulates the broker anticipates Liontown might have a binding supply agreement with Tesla this month after the company extended its termination date for the binding offtake until June 6th.

Valuation becomes more clouded in the case of Mineral Resources, which also produces iron ore and also operates a Crushing Mining Services division that provides a level of defensiveness. Credit Suisse and Morgan Stanley have today reiterated Outperform and Overweight ratings respectively, and all five covering brokers (not counting Ord Minnett, on restriction) have Buy-equivalent ratings. The consensus target is $69.75, suggesting 21% upside.

It’s a similar situation with IGO, which is primarily a nickel producer, and more so now since Western Areas ((WSA)) shareholders yesterday approved a merger proposal.

Credit Suisse has today retained an Outperform rating on IGO, and two other brokers updating in May also have Buy-equivalent ratings. Ord Minnett bucks the trend with a Lighten rating, while Macquarie is on restriction. Consensus target is $12.82, suggesting 11% upside.

In a final word we might note the market panicked last year when the iron ore price plunged swiftly from a record high around US$220/t down as far as under US$90/t, before stabilising currently around US$130/t. Given Australia’s big iron ore miners have such low costs of production, they were able in the last reporting season to hand out record dividend payments.

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