Ojo del Mar in Argentina Andes is a salt desert in the Jujuy Province (source: Galyna Andrushko)
By Chris Berry (@cberry1):
There is a famous phrase in resource investing:
“When the ducks are quacking, you feed them.”
The “ducks”, of course are the investment community and the “feeders” here are the companies with shares for sale.
In 2016, the ducks quacked loud and continually for lithium, and rightfully so. The price of lithium chemicals rose dramatically and almost all publicly traded lithium juniors rose as well with some well into the triple digits. Other than zinc or iron ore, lithium was a star performer in 2016.
As I said in June, managing risk and profit taking in the face of lithium’s impressive strength and secular bull market seemed to be the prudent strategy. My warning turned out to be accurate as many of the high flyers in the lithium space ran out of steam.
Source: Bloomberg as of 12/29/2016; Returns in currency of primary exchange.
While I’ve always considered forecasting a fool’s errand, this note offer some thoughts on how those of us involved in the lithium supply chain should approach the sector as tight lithium markets appear to be a foregone conclusion for the next couple of years.
2017 will be the year when execution outranks exploration in lithium value creation. With dozens of lithium juniors claiming promising discoveries, finding lithium is no longer the optimal path to wealth creation. Instead, producing battery grade material at scale for a voracious downstream appetite is. This is the segment of the market that has the most to prove – those companies with de-risked projects and well-defined economics –with most long-term upside.
Based on my analysis, to bring a new lithium mine on-stream will cost approximately $400M USD (about $16,000 per tonne of LCE). In 2016, approximately $400M USD was raised globally in the sector to advance projects. Given my projections of needing one new lithium mine to come on-stream every year between now and 2025 to meet anticipated demand, the supply response is already lagging, requiring accelerated investment in the lithium sector. The lithium market will remain tighter for much longer with every month without a major financing deal.
This means companies such as Lithium Americas (LAC:TSX), Nemaska Lithium (NMX:TSX), and Galaxy Lithium (GXY:ASX) must become to avoid excessive dilution to equity holders and take advantage of the current robust pricing environment in the lithium space. I think you’ll see at least one major lithium financing deal announced in the first six months of 2016. Therefore, capital deployment and capital efficiency are the true keys to wealth creation in lithium going forward.
This execution risk extends to major producers as well who could certainly just maintain their operations and continue to generate cash flow from their lithium businesses. However, Albemarle’s (ALB:NYSE) expansion at La Negra, FMC’s (FMC:NYSE) expansion of hydroxide capacity and SQM’s (SQM:NYSE) doubling of capacity allow them to capture both market share and additional margin subject to successful execution of their strategies – a wise investment given this bull market and the oligopolistic market structure.
Given some of the stretched valuations of development-stage companies, I expect the voracious appetite of Chinese companies to extend to the project level rather than M&A surrounding entire companies. The thesis of wise capital allocation doesn’t stop at Chinese shores, though Chinese companies have overpaid for assets in the past.
Regarding lithium pricing, it’s important to think in terms of probabilities. The opaque nature of the lithium business requires this as multiple products are priced and sold to multiple customers. Guessing whether or not lithium prices will rise or fall in a binary manner in 2017 isn’t enough for your analysis. Understanding the probability of a given trajectory is what is important. I find it highly unlikely that lithium pricing will repeat its 2016 performance in 2017. I would agree with Joe Lowry that mid-teens pricing for both battery grade lithium carbonate and hydroxide are a reality in 2017 with a longer term average LCE price of $10,000 to $12,000 per tonne as this becomes the new break even.
As pricing remains robust, this will continue to re-define overall lithium mine economics. While hard rock operational expenses will not be able to match those of brine op exes, the potential for margin expansion across both types of projects means a détente of sorts between the two types of projects.
Part of the reason hard rock development stories in Australia had so much success in 2016 had to do not only with their proximity to China, but more importantly Chinese converters’ urgent need for feedstock. Recent spodumene pricing as high as $900 per tonne is an obvious sign that product will be had, no matter what the cost. The faster feedstock gets to market, the better (especially for investors). GXY and NMT have proven this.
The higher prices for lithium feedstock and chemicals have also reduced the need for extraction technology to lower costs. While I still believe that the lowest cost producer in a given industry will always ultimately win, the obvious need for additional lithium supply dictates that there is room for additional producers along with the expanded capacity coming from existing producers. It appears that “conventional” lithium production will be a resurgent theme in 2017.
While the lithium market overall will expand, this will also cloud the investment picture as marginal projects will be able to secure financing to live to fight another day. This is an unfortunate reality in the small cap resource sector. Your own due diligence here is crucial as most of these “lottery tickets” will end up in tears. Remember the $1 billion that was raised during the last lithium bull market in 2009?
There are, as always, threats to this thesis and they include: battery costs at the cell and pack level slowing their decline; currency fluctuations playing havoc with economic studies; capital sitting on the sidelines due to stretched valuations; another commodity becoming the “story of 2017” and so the ducks stop quacking.
Thinking in terms of probabilities, these are low probability events, but ignored at your own peril. 2017 promises to be more transactional in nature than in years past, but the lithium bull market will remain intact until ample supply can come on stream. This doesn’t appear likely until 2019 at the earliest.
Whether the ducks continue to quack in 2017 is immaterial to the long term shift in how we generate, use, and store energy - a theme I´ve discussed many times in the past. What is important is altering your strategic and tactical plan as the lithium market continues to grow and evolve in 2017 and beyond.
Chris Berry
President of House Mountain Partners LLC and Co-Editor of Disruptive Discoveries Journal
Chris Berry is a well-known writer, speaker, and analyst. He focuses much of his time on Energy Metals – those metals or minerals used in the generation or storage of energy. He is a student of the theory of Convergence emanating from the Emerging World and believes it will have profound effects across the globe in the coming years. Active on the speaking circuit throughout the world and frequently quoted in the press, Chris spent 15 years working across various roles in sales and brokerage on Wall Street before shifting focus and taking control of his financial destiny.He is also a Senior Editor at Investor Intel. He holds an MBA in Finance with an international focus from Fordham University, and a BA in International Studies from The Virginia Military Institute. Please visit www.discoveryinvesting.com and www.house-mountain.com for more information and registration for free newsletter as well as his disclaimer.
Our Thinking and What We Do
We are believers in the theory of Convergence. As the quality of life between East and West slowly merges due to advances in technology, continued urbanization, and changing demographics, opportunities across numerous industries will arise which we can take advantage of. We aim to point out the strategic opportunities in the commodity space which arise from these themes.
Throughout history, no society has sustained a higher quality of life without access to cheap commodities or materials. As global population increases, putting stresses on resource availability, efficiency and technology must come to the fore to continue to provide for a higher quality of life. The looming convergence of lifestyles between the emerging world and the developed world is a fact we must all understand and accept in order to chart a sustainable path forward for humanity.
DISCLAIMER AND INFORMATION ON FORWARD LOOKING STATEMENTS
The material herein is for informational purposes only and is not intended to, and does not constitute, the rendering of investment advice or the solicitation of an offer to buy securities. The foregoing discussion contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (The Act). In particular when used in the preceding discussion the words “plan,” confident that, believe, scheduled, expect, or intend to, and similar conditional expressions are intended to identify forward-looking statements subject to the safe harbor created by the ACT. Such statements are subject to certain risks and uncertainties and actual results could differ materially from those expressed in any of the forward looking statements. Such risks and uncertainties include, but are not limited to future events and financial performance of the company which are inherently uncertain and actual events and / or results may differ materially. In addition we may review investments that are not registered in the U.S. We cannot attest to nor certify the correctness of any information in this note. Please consult your financial advisor and perform your own due diligence before considering any companies mentioned in this informational bulletin.
The information in this report is provided solely for users’ general knowledge and is provided “as is”. We make no warranties, expressed or implied, and disclaim and negate all other warranties, including without limitation, implied warranties or conditions of merchantability, fitness for a particular purpose or non-infringement of intellectual property or other violation of rights. Further, we do not warrant or make any representations concerning the use, validity, accuracy, completeness, likely results or reliability of any claims, statements or information in this research report or otherwise relating to such materials or on any websites linked to this report.
The content in this report is not intended to be a comprehensive review of all matters and developments, and we assume no responsibility as to its completeness or accuracy. Furthermore, the information in no way should be construed or interpreted as – or as part of – an offering or solicitation of securities. No securities commission or other regulatory authority has in any way passed upon this information and no representation or warranty is made by us to that effect. Chris Berry owns no shares in any of the companies mentioned in this report.
All statements in this research report, other than statements of historical fact should be considered forward-looking statements. Some of the statements contained herein, may be forward-looking information. Words such as “may”, “will”, “should”, “could”, “anticipate”, “believe”, “expect”, “intend”, “plan”, “potential”, “continue” and similar expressions have been used to identify the forward-looking information. These statements reflect our current beliefs and are based on information currently available. Forward-looking information involves significant risks and uncertainties, certain of which are beyond our control. A number of factors could cause actual results to differ materially from the results discussed in the forward-looking information including, but not limited to, changes in general economic and market conditions, industry conditions, volatility of commodity prices, risks associated with the uncertainty of exploration results and estimates, currency fluctuations, exclusivity and ownership rights of exploration permits, dependence on regulatory approvals, the uncertainty of obtaining additional financing, environmental risks and hazards, exploration, development and operating risks and other risk factors. Although the forward-looking information contained herein is based upon what we believe to be reasonable assumptions, we cannot assure that actual results will be consistent with this forward-looking information. Investors should not place undue reliance on forward-looking information. These forward-looking statements are made as of the date hereof and we assume no obligation to update or revise them to reflect new events or circumstances, except as required by securities laws. These statements relate to future events or future performance. These statements involve known and unknown risks, uncertainties and other factors that may cause actual results or events to differ materially from those anticipated in such forward-looking statements. For a more detailed disclaimer, please click here.