FOCUS: Lithium’s volatile evolution prompts companies to rethink how best to trade
The dramatic shift in the dynamics of the lithium market over the past four years has changed business practices and increased demand for price transparency.
Fueled by anticipated growth in the global battery market and the consequent price swings and supply responses in China, the epicenter of the lithium market, this volatility has at different times disadvantaged one side of the market or the other.
Buyers and sellers have historically chosen to lock in fixed prices on long-term contracts, which “has risks for buyer and seller”, Daniel Jimenez, partner at mining consultancy iLimarkets and former vice president of sales at Chilean lithium producer SQM, told Fastmarkets.
Now though, companies are seeking greater exposure to the spot market, concerned that they will miss out when a price swing works in their favor if they are locked into long-term fixed-price contracts. Many have therefore been changing the way that they conduct business across the supply chain.
(Governments, interested in ensuring maximal returns on their natural resources of lithium, also incidentally support more transparent and market-based pricing, as this interview shows.)
Below, Fastmarkets outlines what is driving these changes in behavior and what it means for lithium sales and procurement.
Wild price swings
The lithium industry paid scant attention to the insubstantial spot market before the dramatic spikes of 2015. There was little reason to do so given the tiny proportion of business done on spot - lithium was largely traded on long-term contracts at a price agreed between the buyer and the seller in a steady market.
More recently, however, the rapid growth in lithium demand and the production of lithium compounds in China have fundamentally altered the market’s dynamics and turned the focus of the market onto independently assessed benchmark prices.
China dominates lithium’s upstream and downstream - it is home to more than half the world’s production of lithium ion batteries and 61% of global lithium chemical production.
Fastmarkets’ lithium prices have swung dramatically in the past four years. The carbonate 99.5% Li2CO3 min, battery grade, spot price exw domestic China almost quadrupled to $27 per kg in June 2016 from $7.70 per kg in June 2015.
The price then fell by more than half to 70,000-77,000 yuan ($10,175-11,193) per tonne on June 20, 2019 from 165,000-175,000 yuan per tonne on December 21, 2017 (see graph below).
(Fastmarkets changed the currency and unit in this price from dollars per kg to yuan per tonne in November 2017 to better capture the market in China.)
Fastmarkets has captured similar behavior in the price of battery grade lithium hydroxide monohydrate compounds.
The major swings in lithium prices were largely driven by marginal output from new producers coming online in response to higher prices caused by growing demand, mostly from the battery sector, Fastmarkets senior analyst Vicky Zhao said.
This took the lithium market from undersupply in 2015-2017 to oversupply in 2018. Fastmarkets’ research team estimated global demand in 2017 as high as 237,000 tonnes of lithium carbonate equivalent (LCE), exceeding total global supply of as much as 228,000 tonnes.
Fastmarkets pegged demand of LCE at 262,000 tonnes in 2018 but by then supply had swollen to 290,000 tonnes, predominantly because of the increase in lithium units produced by converters in China. These typically have higher operating costs than lithium chemical producers in Chile or Argentina - the other main lithium-producing nations.
In 2019, Fastmarkets expects supply of lithium to be as high as 355,000 tonnes of LCE, outstripping demand of 300,000 tonnes and causing the global surplus to grow.
This marginal production at the higher end of the cost curve is the first to come under pressure when prices fall.
While high-cost producers may sell material close to or below production costs to generate cashflow for short periods, this is unsustainable in the long term, Zhao said: producers at the high end of the cost curve may have to halt output.
Earlier this year North American Lithium suspended its lithium spodumene production because of lower prices demanded by spodumene converters in China.
Lithium spodumene is used in the production of lithium carbonate and hydroxide in China. Lower prices for these compounds in China have pressured spodumene prices lower over the past year, causing some defaults on contracts at the end of 2018.
The lithium spodumene 5-6% LiO2 min, cif China price fell by 34% to $585-650 per tonne on June 26 from $900-970 per tonne on June 27 last year.
Changes to strategy
The response of prices to both demand outstripping supply initially and now, conversely, to supply temporarily outstripping demand, has changed how many participants buy or sell in this volatile market.
In the absence of a price benchmark that would enable them to manage price risk efficiently, some lithium producers have over the past three years shortened the length of their contracts. In China, short-term contracts are increasingly the norm.
“Affected by the frequent fluctuation of lithium prices since last year, most cathode producers in China choose to negotiate with lithium producers each month or even each week when they need to purchase material due to the fear of further price changes,” Liu Yiding, the general manager of Sichuan Fuhua New Energy, told Fastmarkets.
“Some cathode makers agree on a reasonable price fluctuation range when they [sign long-term contracts],” he added. “The current lithium market fluctuates a lot and concluded prices are in a wide range. There are some transaction prices lower than spot prices but, when bargaining with suppliers, we will refer to spot prices.”
Consumers of lithium compounds have also responded by managing with lower stock levels. When lithium was in short supply between the end of 2015 and the start of 2018, many locked in as much material as they could to avoid high prices.
But since the start of 2018 when the market swung to oversupply, lithium consumers have operated with lower stocks, opting to buy more on a spot basis in a downward-trending market.
Developments such as this have ensured that market participants are also looking for more transparent pricing mechanisms. Producers and consumers sometimes refer to weighted averages calculated using trade statistics when negotiating prices, especially during periods of high volatility, in an attempt to settle at a fair and independent level.
But this is not always the case. One side could be put at a disadvantage by trade statistics because they ignore aspects such as the quality of material that have an impact on the final price of lithium compounds.
Although trade statistics are still considered by some during negotiations, iLimarkets’ Jimenez argues that other options are more favorable.
“The most common pricing practice among lithium players is trade statistics, which in my opinion are the worst index because of serious contamination of data: mix of grades, off spec product, rebates (not accounted for in trade stats), transfer pricing etc. Therefore, a reliable spot price index will the closest to perfect and would certainly enable long-term and fair relationships,” he said.
Instead, other producers and consumers are seeking more exposure to the spot market, hoping to secure business at the latest price, making transparent pricing data more relevant.
(It is worth noting that while trade statistics do capture spot transactions, by their nature they also lag the market, thus reducing their utility.)
Increasingly, the price agreed in a term contract includes a floating element with a floor and a ceiling. The price rises or falls in line with changes discovered by a price reporting agency (PRA) such as Fastmarkets.
Referencing a third-party price helps smooth contract negotiations for the supply of lithium, sources said. If a buyer and seller cannot agree on a price, they will typically use a weighted average of a specific index or trade statistics.
This has led to the marginal tonnage sold in the spot market, the basis of PRA prices such as those published by Fastmarkets, gaining in relevance and support.
China’s influence in spot pricing to grow further
Some lithium producers remain uncomfortable with the concept of settling contracts basis an independent, market-based price, preferring long-term fixed prices.
But regardless of this, lithium companies must increasingly pay attention to the Chinese spot market to understand market dynamics, particularly while that market grows in size and in importance.
Spot and short-term sales also look set to gain in relevance given their increasing share of total global sales, according to Zhao.
Zhao expects global lithium production to reach 355,000 tonnes this year, including 240,000 tonnes from China.
“In 2019, more material will be traded on the spot market due to the downward trend of lithium prices and the supply surplus, especially in China, owing to weaker price expectations and weaker demand due to the decrease in new energy vehicle subsidies in China,” she said.
Of course, producers acknowledge the significance of pricing in China.
“China is currently the largest and fastest-growing lithium market. We are convinced that China will be leading the demand growth over the coming years so we need to be present,” Felipe Smith, commercial vice president Asia Pacific at SQM, told Fastmarkets.
In addition, Chinese producers are likely to look to book more sales overseas, particularly in the wider Asian region, when the arbitrage allows, because of the domestic surplus and the small premium still available in nearby export markets, Zhao said.
“The growth in the market in China, combined with the seaborne material traded on a cif China, Japan and Korea basis will therefore provide a global benchmark that is both responsive to the domestic trends in China as well as the market for material from international suppliers,” Zhao said.
In the lithium market, price volatility in China and beyond, driven by the fundamentals of demand and supply, has generated the spot-traded volumes that feed PRA’s benchmarks at the same time as it has driven the recognition of their practical application and value.