Lithium producer share prices – a glass half full or a glass half empty?

Lithium producers’ share prices have been under pressure all year - some investors are no doubt wondering whether that marks the end of the lithium boom.

Since Metal Bulletin Research’s forecast is for the lithium market to shift into a supply surplus this year, we have expected prices to fall so it is understandable that producers’ share prices are also suffering.

But this is merely the dawn of the electric vehicle (EV) and energy storage systems (ESS) era – the main boom in battery raw materials lies ahead.

What we are seeing is the first significant supply response following the demand shock in 2015 when China endorsed the EV revolution.

The demand shock led to a run-up in prices to an average of $21,760 per tonne in 2017 from around $9,500 per tonne in the second half of 2015 (basis MB’s assessment of spot prices ex-works China). As well as boosting lithium producers’ share prices, it also incentivized producers and processors to build and expand capacity.

While in recent years new capacity has suffered from start-up issues and production of the right grades of material have been a problem for some, the combination of significant potential profit margins and the passage of time mean many have now acquired the expertise to produce the grades required.

And, given a significant ramp-up in mine supply, more spodumene and DSO is now expected to be processed into battery-grade lithium.

The ramp-up of a handful new producers in 2018/2019 (see map below) is expected to shift the market into a supply surplus – and, unsurprisingly, prices are reacting accordingly.

While oversupply may be an issue for a year or two, the demand side of the equation is only going one way: sharply upwards.

In future, especially after 2023, demand is likely to grow exponentially on at least three counts.

First, falling battery prices are set to make EVs cheaper to own and to run than petrol/diesel vehicles. This is expected to make EVs the vehicle of choice. Second, governments will increasingly push the EV agenda; and third, cheaper batteries will mean ESS become more feasible. With more energy generated from renewable sources, the need for grid load balancing and energy storage will grow rapidly.

Compound average growth rates (CAGR) for lithium demand of 15-19% are widely expected between now and 2025, with CAGR for EVs forecast to be around 25%.

So the the big-picture medium-to-long term outlook suggests that lithium and indeed all battery raw materials have a very exciting time ahead of them. Any pullback in lithium prices and in producers’ share prices are likely to be temporary.

Glass half empty
As in any commodity cycle, price booms will be followed by price busts, reflecting supply responses that hit the market. This year has heralded the first correction within the long-term boom.

After lithium prices started to turn lower in December 2017, the share prices of produces and juniors have unsurprisingly been negatively affected.

The chart below shows the indices of various categories of producers – existing producers, those ramping up and those that are expected to start production in the early 2020s. The indices were calibrated at 100 at the start of 2017 so they show the reaction of equities both to the rising lithium prices in 2017 and to this year’s fall in price.

The more speculative end of the equity spectrum, which included the two sets of juniors – those close to entering production and those expected to be in production in the early 2020s – that did well in 2017 when lithium prices were rising.

This is because rising lithium prices meant the outlook was bright and potential profit margins for these companies were improving while prices climbed. Those producers now ramping up production have the advantage of being able to set long-term contracts using a relatively high base price while some existing producers will still have contracts based on prices from recent years.

The share prices of existing producers, which would in fact benefit immediately from price rises, rose but not to the same extent as the juniors.

 This might seem odd at first sight but it partially reflects the fact that existing producers in the index sell most of their output on long-term contracts; these long-term contract prices have lagged behind  spot prices so those producers would not have been in a position to benefit from the rising spot market.

For example, prices for large contracts cif Asia averaged around $14,000 per tonne in 2017, according to Metal Bulletin, while US dollar equivalent spot prices, ex-works China, averaged around $21,760 per tonne so the contract prices have not increased to the same degree as spot prices.

With spot prices falling, fortunes have changed. Although the outlook has deteriorated, at least those producers that are ramping up production have been and are benefiting from relatively high prices where margins are still good. Those still a few years from entering production run the risk of coming on stream when prices are lower so their shares have been hit the hardest.

Metal Bulletin’s battery-grade lithium carbonate index was calculated at 85,298 yuan ($12,492) per tonne, ex-works China on Thursday August 30, down from 159,250 yuan per tonne at the start of the year.

On a percentage basis, the index of existing producers had climbed 70% since the start of 2017. Late in August 2018, the index was still 15% higher than it was at the start of 2017 – the correction from the top has been around 32%.

The index of those producers ramping up in 2018-2019 rallied by 184% and was recently still 73% higher than at the start of the period so it has corrected by 39%. The index of those producers not expected to be in production until the early 2020s gained 165%; the index now stands 14% above its start point, meaning it has corrected by 57%.

The corrections from the highs have accelerated since June this year: At the end of May, the corrections stood at 22%, 24% and 23% respectively. The fact that other metals’ prices have fallen sharply since June – base metals prices are down by an average of 24%, tied into growing concerns about the fallout from US President Donald Trump’s trade war – suggests a significant proportion of the correction in lithium equity prices may not be solely due to the lithium market.

It seems as if the lithium producers’ share prices have also been caught up in a broad-based risk-reduction sell-off by investors.

This leads us to the glass half full…

In recent weeks and months, the lithium industry, along with the downstream companies such as processors, cathode and battery makers, as well as OEMs, have been active in securing their supply chains. This is a solid sign that industry insiders have complete confidence in the outlook for EVs and ESS.

Reports of offtake agreements, joint ventures, equity partnerships, streaming deals and asset swaps all show considerable upfront investment to secure supply. It is doubtful that downstream companies would be so keen to lock in these deals if they expected continued surpluses.

With lithium producers’ and juniors’ share prices under pressure, the spate of consolidation in the industry and along the supply curve is likely to accelerate.

This analysis comes from Battery Raw Materials Market Tracker, a weekly service providing prices, forecasts, supply and demand insights and market analysis for lithium, cobalt, nickel, graphite and manganese.

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