Should lithium producers consider hedging?

Given the current state of the lithium market, how can hedging some of your exposure to lithium prices help you ride the wave of volatility?

In this article from risk solutions director, David Becker, he outlines the factors to consider if you’re a lithium producer looking to hedge your risk.

The decision is an investor preference

Whether or not to hedge your risk is an investment question. Do you want 100% exposure to commodity volatility or the most efficient exposure with maximum risk reward?

If you choose the latter, some hedging techniques can maximize your risk-adjusted reward and simultaneously reduce the volatility of your returns.

On the other hand, if you desire 100% lithium price volatility reflected in your company’s value, hedging can be less impactful.

If you want to hedge some of your exposure to lithium prices, you might consider looking at some history of forward annual swap prices relative to the past 12 months’ swap price settlements. The forward curve will provide an estimate of where your 1-year future sales could be if you sold lithium futures contracts today. Instead of trying to forecast the price, you can gauge your forecast relative to the forward curve.

The Lithium futures price curve provides market participants with a tradeable market. The CME futures contract that tracks Fastmarkets lithium hydroxide monohydrate 56.5% LiOH.H2O min, battery grade, spot price cif China, Japan & Korea, $/kg, shows that prices are backward (another way of saying spot prices are higher than deferred prices).

The settlement of the annual lithium swap surged for the first ten months of 2022, but future prices show that lithium prices are likely to moderate.

Despite a backward futures curve, the average for the next 12 months, including November, reflects the 12-month average that is higher than the average in the prior twelve months by more than 13%.

How is the swap calculated?

The swap prices from each futures contract month equal the arithmetic average of all available price assessments published lithium hydroxide monohydrate LiOH.H2O 56.5% LiOH min, battery grade, spot price cif China, Japan & Korea, $/kg by Fastmarkets during the contract month.

A graph of historical 1-year swaps, beginning in November, shows that the futures curve is pricing in a one-year forward swap price about 13% higher than the prior year’s 1-year swap price ending in October 2022.

The upshot is that the market believes prices will decline slowly, but the average price for the coming year will be higher than last year, based on where lithium futures prices are trading now.

If you wanted to mitigate some of your lithium price volatility, the forward prices would allow you to tell your investors or banking partners that you will experience a 13% year-over-year gain in price value if you hedge now.

Your focus would then change to executing your production levels. Your hedging would create price-collateralized cash flows that can be discounted back using current interest rates to give investors a present value of your business.

The market is pricing elevated volatility

The current lithium futures swap price, at nearly $84 per pound, is well above October 2023, with futures settlements near $68 per pound. The difference between spot and one-year deferred prices is significant. The decline reflects implied volatility in the market at 84%, using a Black-Scholes model.

A historical chart of the spot swap minus the 12-month deferred swap shows that the current backwardation (deferred prices lower than spot prices) is the largest during the last five years.

The graph of the prices represents historical Fastmarkets lithium hydroxide monohydrate 56.5%.

While there is no extended record of a forward curve before the CME Fastmarkets Lithium hydroxide monohydrate 56.5%, the historical settlements show the change in the swap price settlements.

The bottom line

Whether you hedge your exposure to lithium, given investor preference, or ride the wave of lithium volatility, you should have an idea of what you could experience. Fastmarkets NewGen Long-Term and Short-Term Forecasts can provide you with a gauge of where prices might be headed.

The shape of the lithium futures curve reflects a price likely to be volatile. If you are considering hedging your lithium exposure and would like some insight on how to approach this endeavor, reach out to our risk solutions team. You can read more insights on our dedicated page for lithium analysis.

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