Resourcing the new energy economy
Exploring this critical moment in the new energy market, and the forces of change ahead
The new energy economy is in a paradoxical time. On the one hand, it will result in booming demand and supply shortages, and on the other, the current market is fraught with supply surpluses and low prices that have not yet found their floors.
This paradox has also created a level of skepticism about demand forecasts. Current oversupply is driven from a mix of producers and investors rushing into the market in 2016 and 2017 based on demand expectations that did not pan out; lessons that can inform - or over-inform - current investment strategies.
Covid-19 has done little to clarify the situation on the ground. It has driven fossil fuel demand down, further limited any real investment interest in coal and reminded people that clean air is possible and good. It has created a moment in time where an accelerated shift to renewable energy is believable. It has also dampened electric vehicle (EV) demand that was supposed to be a lead indicator of the energy revolution.
Paradox aside, the new energy economy is inevitable and transformative: The mitigation of climate change, creation of economic wealth, replacement of a massive fossil-fuel infrastructure and a change in the way we live and breathe. The new energy economy requires investment to precede obvious demand signals while it takes time to bring new mines and capacity online, so even the best investment strategy will be informed by early but incomplete signals.
This report explores this critical moment in time when the market, impacted by Covid-19 and the resultant recession, is heading for an inflection point - when signals will come from different parts of the market: Some real, some PR and some just noise.
Therefore, the goal is neither exuberance nor skepticism, but to provide a pragmatic view of the next two years to give you context on how to make sense of market and price signals.
The current reality
Optimism for the long-term future of the electrification market grew with the disruptive success of Tesla and price spikes in 2015. From 2015-17, forecasts argued for exponential growth and government subsidies de-risked investments, which led to new and expanded production coming online. It was, in hindsight, well-meaning exuberance. It also resulted in oversupply and downward pressure on prices that heightened when China reduced new energy vehicle (NEV) subsidies in June 2019. The paradox is that the same materials that were expected to fuel and benefit from the new energy economy continue to face downward pricing pressure.
The trailing 24 months show a steady decline in prices. Lithium surpluses over the past 12 months alone have caused prices to drop by 41% for lithium carbonate and by 32% for lithium hydroxide monohydrate.
The low prices and weakened demand have put the brakes on new supply, alongside cutbacks of existing supply - meaning the market is beginning to rebalance while excess inventory gets used up. View our current lithium prices here.
Cobalt remains volatile. Cobalt fell from near 10-year highs in April 2018 to pre-Covid lows in July 2019; prices are slightly above those lows, at $14 per lb. It has been a rocky road: Cobalt hydroxide prices rose in May due to supply disruptions caused by a lockdown in South Africa aimed at containing the spread of the Covid-19 virus, but prices took a hit in early June when interest in spot buying thinned. They have remained under pressure during the third quarter of 2020 due to weak downstream demand.
The near-term future for cobalt is also mixed: While cobalt has clearer demand, it has the counter-pressure of companies seeking low- or no-cobalt batteries to avoid the relatively high costs of cobalt and the brand issues associated with child labor in select artisanal mines. We expect prices to remain volatile amid real supply-demand issues and broader concerns about the concentration of cobalt in the Democratic Republic of the Congo (DRC).
While most nickel is used for stainless steel (only 5% of nickel goes into EVs) and lithium iron phosphate (LFP) batteries are gaining share, nickel remains a priority material for batteries while companies explore new chemistries. Even though stainless steel demand has been steady, there has been some volatility over the past couple of years: Nickel prices rose in October 2019 amid concerns about supply stemming from an Indonesian ore ban, but took a hit as Tesla decided to use LFP batteries in its Model 3 in China. (View current LME nickel prices.)
A composite view - what does it all mean
Market prices underscore the likely skepticism about the timing and magnitude of the new energy revolution. Two challenges arise that confront conservative investment strategies: Since it takes five years to bring capacity online, supply will have to anticipate demand - even when signals are not obvious. Waiting for clear and obvious signals could mean market participants or investors lose the ability to gain a strategic stake in an inevitable energy revolution.
Major forces of change
The question is not if the market will turn, but when and how fast.
Market and investment scenarios are processing all sorts of signals, from the economic reopening to strategic moves that current or would-be competitors make, to technological breakthroughs that transfer pressure from one material supply to another.
We have identified 8 major forces that, individually or together, will influence the shape and pace of the market over the next two years.
1. Preparing for resource competition
Despite the skepticism, market participants are already putting in place strategies to gain early market advantage and hedge against likely supply shortages. These strategies give a sense of market dynamics and can provide a blueprint for future investments and actions.
Expand recycling to grow supply: Recycling - akin to the scrap market - lessens the pressure on supply, can create environmental benefits and creates new revenue opportunities. As more batteries come to the end of their useful life, companies like Umicore and Neometals are building recycling capabilities to prepare for high-growth demand and the need for recycled materials.
New lithium mining and extraction methods: Lithium is expected to be core to most battery configurations. Even against the backdrop of falling prices, companies are exploring new extraction techniques to improve yield from 30% to 70% and some governments are considering urban mining to grow demand and enable localized supply chains. This is creating further near-term separation of supply and demand; but expect companies to continue to press for supply as it takes time to put capacity online once demand takes off.
Extend upstream into the supply chain: Automakers, in a limited fashion today, are buying into lithium operations to ensure they get financed against the backdrop of declining prices. Even though cobalt prices are relatively flat through 2021, automakers are also getting directly involved in cobalt procurement rather than letting the battery companies do it for them, ensuring they have direct leverage on the supply chain.
Put in place off-take contracts: A key strategy centers on a level of cooperation: Off-take contracts that help overcome the uncertainty in the current climate. For example, cobalt buyers are locking in four to five-year contracts to ensure their allocation from miners. Alternatively, buyers benefit from assured supply while producers ensure liquidity while demand finds it footing.
In October 2020 during our first virtual lithium event we will hear directly from producers, evaluate latest technologies and analyze the outlook for these markets with recognized industry leaders.
2. Changing chemistry
Companies are already seeking to get in front of pending tightening supply. Innovation in battery chemistry is expected: Whether to have an environmentally and socially clean supply chain, drive costs below $100 per kilowatt hour (kWh), increase EV range, de-risk the supply chain or simply out-innovate the market.
There are common threads such as shifting to low- or no-cobalt batteries. We expect companies to move to an 8-1-1 configuration: First reducing the amount of cobalt by moving from NCM 111 (one-part nickel, one-part cobalt, one-part manganese) to NCM 532, then NCM 622 and ultimately to NCM 8-1-1.
There are also alternative pursuits: LFP, sodium ion batteries (using low cobalt or cobalt free) solid-state batteries, graphene-based batteries and even zinc-air batteries. Most are still in the early phase of research and it is not clear which chemistries will win. It places further uncertainty on those building strategies to deliver on or capitalize on the new energy economy, with questions about which materials will become newly critical and which will become less critical.
3. Pent-up energy
Even noting that the overall market is set to go through an inflection point from oversupply to supply concern, three materials stand out due to the stark contrast between current value and expected value. Lithium, nickel and cobalt are all expected to go into hyper-growth and hyper-valuation, but each of them is starting from a declined state.
- Lithium demand is expected to more than triple, to 940,000 tonnes from 300,000 tonnes in the next five years. However, over the past 12 months alone lithium carbonate prices have dropped by 41% and lithium hydroxide monohydrate by 32%.
- Nickel demand from batteries is expected to grow by over 150% in the next five years, to 400,000 tonnes from 150,000 tonnes, but prices have declined 27% since the 2019 highs (they are flat with where they were a year ago).
- Cobalt demand is expected to increase by 55% in the next five years, but prices have declined by 19% from this year’s high and are also flat compared with levels recorded a year ago.
The pent-up energy is palpable and hyper-valuation favors those able to time the investment, but it all comes down to understanding signals and timing the market.
4. The next infrastructure
The expected proliferation of wind turbines, solar panels and farms, EVs and the litany of Internet of Things (IoT) devices will require a robust, efficient infrastructure - an infrastructure far different from that in place today. For example:
- The new energy grid, driven by decentralized solar, wind and other resources that enable predictable energy capacity independent of whether the wind is blowing or the sun is shining, can be fueled by existing batteries, like lithium-ion batteries (LIB), but the large-scale deployment depends on achieving economics of scale in EVs.
- The growth and extent of EV charging stations will depend on a trade-off between battery weight and the required footprint of charging stations. A country that tends to favor EVs with larger battery packs will require fewer charging stations, while a country that opts for EVs with smaller battery packs will require a more prolific charging station footprint.
Governments have subsidized the new energy economy, and given the need to stimulate economic activity - and jobs - and compete in a global economy, governments will further finance and propel the new energy economy forward. State Grid Corp of China has said it will increase the number of EV charging stations by 10 times in 2020, pledging 2.7 billion yuan ($385.8 million) of investment. The United Kingdom announced a major infrastructure build-out, and the United States’ infrastructure bill likely waits and depends on the upcoming elections. Either way, further investment will speed the development and accelerate growth of the market.
5. Energy in context
The energy markets have been hit hard by recessionary forces driven by the Covid-19 pandemic, nation-state economic competition and growing skepticism about the future of coal. Fossil fuel demand plummeted, creating an oddly inverted market where futures prices went negative. As demand plummeted, citizens awoke to cities and towns with less pollution and smog - some could see mountains for the first time in decades.
Ethanol has been volatile due to three primary causes: Exports have been affected by trade war and protectionist measures from regions such as the European Union, legislation that underpins biofuel policies have been under attack by fossil fuel interests and overall demand has been hit due to Covid-19 and the small but notable increase in EVs.
The inevitability of switching to sustainable energy seemed closer. The challenge is that the infrastructure is not in place to deliver predictable energy independent of weather and technology and not yet available to deliver affordable energy at scale, crossing the important $100 per kWh threshold. When these markers are hit, we expect a more rapid, common-sense substitution of energy resources.
6. Environmental and social concerns go commercial
A central value of EV and green energy is environmental benefit, but the reality is that green energy production is relatively dirty and carries the carbon footprint of shipping and transportation across the global supply chains. Copper, lithium and nickel production require significant energy and are prone to release toxic compounds into the air. On top of that are concerns about sustainable mining. Social concerns surround some artisanal cobalt mines in the DRC due to child labor and inadequate health and safety measures. Finally, producers have indicated significant concern about submarine tilings used for nickel waste, meaning either investment could get pulled back or more expensive waste processing methods might be needed that would reduce already pressured margins.
These issues have existed - and had been broadly tolerated - for a while. But this is beginning to change. Investment strategies such as Blackstone’s ESG brand pressure to address socially responsible products and a general desire to lift environment standards are putting commercial weight behind the goal of cleaning up clean energy. Infinity Lithium has secured funding from the EU to fund the first phase of a pilot lithium mine and plant in Spain to create localized supply chains.
The full impact of these changes are not clear and are not due strictly to environmental concerns. We expect to see changes in terms of where and who mines, and therefore, the structure of the supply chains for the materials fueling the new energy economy.
7. The commercialization of upstream
It has not always been true that there is a direct correlation between those who have strategic resources and those who profit from those resources. Those lessons are increasingly being applied to the new energy economy, with countries like Indonesia, the DRC and Zambia putting in place commercial and tax strategies to keep the resource wealth local.
This is less about protectionist policies; these are more economic development policies. We expect this to suppress margins from global producers while they either pay higher taxes or participate in shared-ownership structures with governments and local industry players. The larger impact is likely the influence on the structure and behavior of critical supply chains, while resource-rich countries seek to build production industries around mining value. For example, Indonesia has turned itself into a nickel player by banning nickel ore exports, and as a result nickel pig iron and stainless steel plants have been built up in Indonesia, along with huge industrial parks such as Morowali.
8. Post-government investment
Governments have played a central role in financing the new energy economy, but commercial investment outside the automotive sector has lagged. That will change once demand takes shape and converts potential to reality.
Oil and gas companies have targeted investments, but nothing to match the size of their balance sheets and their critical need to become energy companies of the future versus fossil fuel cash cows. Technology and industry conglomerates that will build out the technology-heavy energy infrastructure of the future are pushing forward, but still lack the big bang investment.
We expect to see significant investment that will expand and accelerate research and development, and create new players hungry for resources and committed to avoiding unpredictable supply chains.
The next two years
The new energy economy is out there somewhere, but the path from where we are today to the market that is clearly going to take flight is uncertain. The challenge is that the market dynamics are not clean:
- Market players and investors might be wary due to 2016 and 2017 over-exuberance and resultant oversupply and price erosion.
- The Chinese government’s 10-year planning horizon - and clear desire to be a dominant player in the market - sits in stark contrast to commercial annual or quarterly reporting horizons.
- As it takes five years to stand up capacity, investments need to precede clear demand signals - signals that have misled investors in the past.
- Being early is costly; being late can be devastating.
Current and future market participants and investors need to become immersed in the internal - and changing - fundamentals of the market and be aware of price signals in the evolving market. This can mean different tactics for different industries.
Although the future market fundamentals are promising for producers, the challenges lie in this interim period when producers will be looking at several signals:
- Focusing on price thresholds: The lithium price needs to be +/- $12 per kg and the nickel price around $18,000 per tonne to encourage investment in those markets.
- Focusing on cobalt: Participants in the cobalt market have been focused on a lack of demand, but with Glencore’s Mutanda mine closed for the next two years due to increased royalties levied by the DRC government there are questions over whether it will reopen. In addition, all the talk about moving to a no- or low-cobalt future discourages potential producers from entering this market. Taken together, these two forces could result in a serious shortage in the not too distant future.
Most automakers have found themselves at a disadvantage when dealing with battery makers who want to pass off price increases in raw materials, in part because hedging systems do not exist for lithium and cobalt at capacity. Once EV demand picks up and drives prices higher, automakers will need to address cost risk by either absorbing unnecessary costs or passing costs onto consumers in a highly competitive market.
Consumer electronics will be caught in the inevitable competition for resources, and any misreading of the market that results in material supply shortages or price increases can create unnecessary and avoidable competitive risks.
Energy and utility
The pressure comes from two fronts, the growth of clean energy and the continued pressure on fossil fuels. Demand for energy storage systems (ESS) is expected to grow by more than five-fold to 75 gigawatt hours (GWh) in 2025 from 14 GWh currently, which will place acute supply and price pressure on a market already reeling from fossil fuel margin pressures. Similarly, mounting negative pressure on fossil fuels will likely force energy companies to take a larger stake in the new energy economy, which is not yet supported by hedging systems that are part and parcel of the fossil fuel market.
Those advising, building or operating the systems that will build tomorrow’s products that are dependent on raw materials will be challenged to know the market as well as the clients they serve, especially with design, performance or financials relying on a deep knowledge of the market.
The path forward
The new energy economy - and the specific references to the battery materials that will resource that economy - sits pragmatically between exuberance and skepticism. Exuberance in that any and all forecasts point to an explosion of demand that will both place acute pressure on supply and drive prices up. Skepticism in that this story sounds familiar, and ended in today’s market of oversupply and price depression.
Being early to market has known risks, but being late to market can carry greater consequences. All told, a more pragmatic, informed approach is needed, especially in the next two years when market and price signals will be mixed and strategies to recover from Covid-19 collide with those to invent for tomorrow.
This is ultimately a question of when will inflection truly begin, how fast will it accelerate from there, and what strategies and investments will pay off? Those answers increasingly will be found in the market and price signals that will shape this market.