Material Matters: Oil; Lithium; Uranium

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Oil prices set to reverse; EV demand to drive lithium rebound; demand for uranium to exceed supply.

-Oil prices reaching overbought levels
-Growing EV demand to turn lithium around
-Increased demand meeting struggling supply growth in uranium

By Greg Peel

Oil’s Pending Sell-Off

In June and July, the bullish case for oil was reasonably robust, notes Longview Economics. Sentiment, for example, was bearish, which is a contrarian buy signal, net long positioning had fallen to low levels, the price had formed a “triple bottom”, and the fundamental outlook was improving/turning bullish.

Fast-forward to now, and much of that has fully reversed. The price is up 35% since June, optimism amongst strategists is widespread, measured sentiment readings are now bullish, net long positioning has risen to its highest level since early 2022, and oil prices are technically overbought (from oversold earlier in the northern summer).

Add the oil market having not priced in a US/global recession and Longview can foresee a reversal of the reversal.

The evidence suggests a US recession should begin within the next 6-9 months, which if correct, would result in a phase of rising global oil inventories and oil price weakness. The historical correlation between oil prices and inventory is reasonably tight, notes Longview. The key question, therefore, is: How deep will the recession be? And how high would inventories go?

Not all recessions are associated with large builds in oil inventory, Longview points out. Those associated with the 2001 and 2008 recessions, for example, were relatively small. They were much larger during the “shocks” of 2014, when the Saudis did not respond to strong shale oil supply as expected, and the 2020 pandemic.

In that respect, while a recession would tip the global supply balance into surplus, Longview would anticipate a relatively modest rise in oil inventories, given that: (a) OPEC has already cut production; (b) US production growth is slowing both cyclically and structurally; (c) the production outlook from other major producers is relatively poor and; (d) usually in recessions, the fall in oil demand is driven by the manufacturing sector.

That sector has already been in recession for the past 11 months, as measured by the global manufacturing PMI. Its retrenching process is therefore relatively advanced, Longview notes. Demand from households, though, is typically resilient in recessions.

While oil prices will likely see a sell-off on concerns about recession, a large supply and demand mismatch is unlikely on this occasion, Longview believes. The size and duration of the increase in global oil inventories should therefore be relatively small, which should limit the size of the oil price correction.

Lithium Upside

Expectations for a rebound in the lithium price are growing.

While the lithium sector continues to exhibit significant volatility, notes Wilsons, the structural outlook for lithium remains positive. Critically, the structural outlook for lithium remains intact, which should support attractive long-term lithium prices and, by extension, significant cash generation from lithium producers.

Therefore, current weakness in the lithium sector should be seen as an attractive buying opportunity for investors.

The lithium carbonate equivalent spot price hit an all-time high of about US$80/kg in November 2022, before falling back to its current price of around US$25/kg. The fall in price has primarily been driven by cyclical concerns around the pace of China’s EV uptake, Wilsons suggests, and the potential for oversupply as new projects come online.

China has experienced cyclical softness in demand for EVs this year, driven by a subdued consumer backdrop, which has been exacerbated by inventory destocking by battery cell manufacturers, which Wilsons believes is nearly over.  Despite the immediate challenges in China, the long-term structural demand story for EVs remains strong.

China’s recent renewal of a tax break extension for EV purchases to 2025 should help to steady sector growth over the medium-term, while the headline data look increasingly positive after China recorded a record month of EV sales in August, with sales increasing more than 35% year on year, signaling to Wilsons the worst is over for the sector.

The prospect of further fiscal support aimed at stimulating Chinese household demand also presents a potential catalyst for the EV sector and the lithium price over the coming months.

Wilsons suggests it is difficult to see a scenario where overall supply can keep up with the scale of expected demand this decade, with industry heavyweight Albemarle estimating some 100 new projects will be needed by 2030 to support demand.

Increases to growth and sustaining capital expenditure combined with longer build timelines across the sector, could put upward pressure on the lithium cost curve, which is likely to support higher commodity prices, all else equal, the broker notes.

Wilsons is long Mineral Resources ((MIN)) and Allkem ((AKE)).

Uranium Upside

Uranium equities are up some 16% in the last month on the back of positive price momentum with the spot price currently sitting at US$70/lb — a 12-year high. In Canaccord Genuity’s view, the market remains in a structural deficit, and with secondary supplies on the decline and inventory levels near recent lows, the broker remains fundamentally bullish on the sector.

Canaccord’s base case demand scenario has total nuclear capacity growing at a compound annual growth rate of around 3.6% through 2030 and 3.2% through 2035. This equates to a 30% increase in annual uranium demand through 2030 and 46% through 2035.

This growth is principally driven by new reactor builds in China and India, but is also supported by plant life extensions in the West. Conservatively, Canaccord’s forecasts do not, at this point, include the deployment of small modular reactors.

Higher prices have led to growth in mine supply, but the broker still foresees risks to bringing new supply online at targeted rates given ongoing supply chain issues and labour constraints. Greenfield projects remain imperative for the market to reach balance, many of which still face permitting, technical, and funding risks.

Industry consultant UxC has reported some 121mlbs have been put under long-term contracts year to date, which compares to a total of 114mlbs in 2022 — the highest level in ten years. History suggests contracting begets more contracting.

Speculative funds have been quiet in 2023 compared to 2022, but the Sprott Physical Uranium Trust has recently returned to the market.

All of the above leads Canaccord to increase its long term uranium price forecast to US$75/lb from US$65/lb. Among Australian-listed miners, the broker prefers Paladin Energy ((PDN)) and Lotus Resources ((LOT)).

See also today's Broker Call *Extra* for Canaccord's views on other ASX-listed uranium exposures: 
https://www.fnarena.com/index.php/2023/09/27/australian-broker-call-extra-edition-sep-27-2023/

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