Poised to Outperform

How much could battery materials prices rise in a recovery? It’s more than you think.

With prices for most battery raw materials banging around at bargain basement levels but a significant demand recovery just around the corner, we decided to investigate just how much prices could actually increase in a demand recovery?

And our analysis is bad news for battery producers and consumers because it’s more than you would think.

If you look at battery raw material price forecasts by investment banks, there’s quite a variation. Some players are now starting to build in a price recovery in lithium chemicals within the next two years; others (Morgan Stanley being the leader of this pack) suggest that oversupply will last longer.

But what happens if oversupply doesn’t last? What happens if we move into a strong demand market with a shortage of new supply? Prices will rise and they will rise significantly.

We’re pinning our colours to the mast. We believe that insufficient capital is being allocated now for raw material supply additions from 2022-23 and that the Covid-19 event will accelerate demand for EVs in such a way that supply/demand gaps will start to open in key raw materials by that time.

That means that there will likely be a price reaction. But how much of one?

Many commentators would suggest that we’re in virgin territory here. There’s never been an event like the battery event. But, we would suggest, there has: the China fixed asset investment event of the 2000s can provide a useful guide as to what could happen in a demand recovery when there is insufficient investment in supply.

Recapping the China Event

There are some quite distinct similarities between the China demand event for metals in the early-noughties and the event the battery materials sector is undergoing now:

· At the time of the China event, prices for most metals had been declining in real terms for some time;

· Mining as a sector was out of vogue and struggled to attract new investment;

· The magnitude of the demand event was under-appreciated by the market for some time, even after it started;

· The potential longevity of the event was also under-appreciated;

· The ease and rapidity of adding new supply was over-estimated by the market, while the cost of new capacity was underestimated.

These are all factors that chime with what we are seeing in today’s battery materials markets.

Complexities of Adding New Supply

A recurring factor with those that are bearish on the battery raw materials event is an underestimation of the complexities of bringing new supply into the market.

This is particularly emphatic in lithium where Morgan Stanley (the cheerleader for the bear case) continues to treat lithium chemicals as a commodity product when it is absolutely clear to those involved in the industry that they are becoming more and more specialised.

In all battery materials start-ups of the past two years, it has taken considerably longer for assets to reach capacity and reach spec than was initially estimated. In some cases, it has taken over 12 months longer. Syrah Resources (ASX:SYR; graphite), Pilbara Minerals (ASX:PLS), Nemaska Lithium and Orocobre (ASX:ORE) are just some of the examples of battery materials projects where start-up has taken longer than expected (or hasn’t happened at all in the case of Nemaska) and targeted capacity has proved hard to reach. In the more commodity end of the business (i.e. nickel), you can point to just about any High Pressure Acid Leach project as failing to reach its production target and going over budget and, even in nickel sulphides, a number of projects have experienced delays.

The other key issue, of course, is capital availability. To get the next stage of hard rock lithium projects into production would cost a minimum of US$3bn by our estimates. It would be US$1bn for graphite, US$1bn for manganese and probably US$3-7bn for nickel/cobalt. That’s over US$12bn and the combined market capitalisation of the battery raw materials sector at the moment is considerably less than 50% of that!

Price Increases Due to Demand Event

The China Fixed Asset Investment event saw some pretty significant commodity price increases during the early-2000s, particularly in the years 2002-07. Following the Global Financial Crisis there was a second wave of the China event, but we’ve focused our analysis on the first five years, which are most relevant to what we’re going to see in the near-term in battery materials, in our view.

If we compare prices for the five key infrastructure-related metals, we can see a very substantial uplift from the prices prevailing in 2002, when the China demand event started to attract global attention, and 2007, just ahead of the GFC.

It’s easy to see that prices went up by multiples over that period, and if we extend into 2008, steel prices rose to US$1450/t, resulting in a more than doubling from 2002 price levels.

Only aluminium, where China was adding substantial amounts of domestic capacity, lagged in the price appreciation stakes.

While metal prices rose across the board, there is one vital aspect of the above table which is even more pronounced if we include the key steel additive markets of molybdenum and vanadium in our analysis.

That is namely that the price appreciation for smaller market sizes is greater than for large markets.

This is a key consideration when looking at battery raw materials which are, compared to base metals, all tiny markets.

Inverse Correlation of Price Rises to Market Size

If you compare different sizes of metals markets with peak price increases during the China event, then there is a very clear inverse correlation between market size and the percentage price increases.

In short, smaller markets see greater price appreciation.

For vanadium and molybdenum which had market sizes of less than 100Kt at the start of the China event, prices increased by 8-12 times.

There are also material differences for these metals in how prices were negotiated. Apart from steel, all the base metals were exchange-traded metals. The smaller markets were contract markets between buyers and sellers: very similar to what we see in battery materials today.

Battery Materials are Smaller Markets

So, let’s look at battery materials market sizes. Lithium is probably the biggest market size with c.320Ktpa of lithium carbonate equivalent. Manganese (HPEMM) is probably the smallest, with less than 50Ktpa of demand.

All of those are well below the market size of nickel in the early-2000s. Refined nickel had a market size of about one million tonnes at the time and we saw the LME price rise more than five times from its 2002 levels.

We’ve separated nickel sulphate from nickel in the table above because they are two very different materials. While nickel nominally has a market size of 2.4Mt, a large proportion of this (71%) is for stainless steel, which has totally different inputs and demand structure. Inputs for nickel pig iron are generally unsuitable for battery manufacture meaning that a two-tier nickel market is likely to develop, going forward.

Realistically, we expect nickel sulphate prices to trade differently from LME nickel prices over time.

'Battery raw materials prices increasing by at least four times from current levels'

Price Impact: Quadruple Increase is Possible

Based on the price behaviour that we saw in 2002-07, we believe it is not impossible to see battery raw materials prices increasing by at least four times from current levels.

This would be not just a significant increase, but a massive increase compared to what any forecaster currently has in their models.

Our analysis of consensus metal price forecast assumptions suggests that long-term prices for the bulk of EV battery raw materials are currently c.50% higher than current prices (nickel long-term prices are lower than that).

What would happen to investment banks’ price targets if analysts fed in prices four times higher than current levels?

They wouldn’t just go up. They’d go stratospheric.

And that’s the issue we’re dealing with here, because the market is not factoring in significant price increases in their models and, while they don’t, the likelihood of a situation where significant price increases occurs becomes more and more likely.