Updated: Feb 10, 2020

Reports of lithium's death have been greatly exaggerated. The rise and fall of many minerals and metals is an inevitable part of the mining cycle and should always be expected by investors. Typically, miners over-produce in response to market demand and then run for cover when the market turns. However, has lithium’s recent plunge been overdone? David Gillam is on the case.

Aside from the intractable supply and demand matrix, we mustn’t ignore the fallible human element that drives many of these boom and bust cycles. Shortages are wildly celebrated by the investment community, creating a vainglorious hype that translates into fear amongst commodity buyers and a concomitant euphoria and over confidence by miners and stock market punters.

From Euphoria to a Loss of Confidence The Australian lithium market has not been immune to these oscillating cycles. Market sentiment back in 2017 could best be described as a super cycle. Against this backdrop, I reported a forthcoming oversupply back in early 2018 much to the dismay of some investors. It wasn’t a difficult call because reality had lost touch with the market. You only needed to look at how many EVs just one of the new West Australian mines could support to see the writing on the wall. Oversupply was ridiculed by some and over-exaggerated by others.

The ultimate question is, “What really happened to the WA lithium producers and is it just another metal hyped into market submission, or the beginning of a new and vibrant industry for Western Australia?”

I believe a few basic mistakes were made by some lithium miners and, in some way, they contributed to their own downfall. In an effort to excite investors and attract capital we saw some producers touting massive expansion to feed a new energy market that had only just begun to mature. Talk by some of Stage 2 and even Stage 3 before their Stage 1 was producing at nameplate metastasised the often-exaggerated oversupply story.

A Tough Road to Quality Production The next mistake was a typical hype-driven over-estimation of pricing and under-estimation of the difficulties of pumping out a consistent quality and blend of spodumene concentrate. In fact, Tianqi was the only hard rock miner with true processing credentials and the difficulty of reaching nameplate production while producing a quality product soon became obvious. While Australian investors ridiculed the Chinese for reneging on binding agreements, perhaps the battle over the quality and quantity should not be ignored.

During 2019 we have seen miners continue to undergo expensive and major upgrades to their plants in order to reach nameplate while maintaining a high quality and consistent blend. Understanding where each miner is in the upgrade process is difficult. What we look for is a lack of stockpiles and the signing of new customers that actually process spodumene concentrate, (SC), today rather than in years to come.

A40 didn't concentrate enough at their Bald Hill mine

The good news is that quality issues should be largely addressed by the end of 2019, and for the first time we should see a high-quality product with a consistent blend. It’s all come at a higher cost to investors. However, they can take some comfort in the fact that the next round of new producers will face similar issues when we begin the next cycle upwards. In fact, the lack of finance and investor support for lithium will cause new mines to stall and should see existing producers advance expansions when the next up cycle appears, perhaps as early as 2020.

For example, Altura Mining has recently signed new offtake agreements. James Brown of Altura explained his mine’s focus on quality in order to win new clients: “We have been extensively marketing the Altura Lithium product at a very early stage of the project life. I believe all of the new concentrate producers faced similar challenges…We were selling product from the initial feedstock from the commissioning of our plants. The risk is that the need to supply the market rapidly to establish a position in the supply chain did not provide a lot of room for variances to product specifications.

“The Altura team produced high quality product from the first day which allowed us to get confirmation of the amenability for processing of the product from existing and potentially new customers very early in the life cycle.”

Identifying Winners and Losers To suggest that every miner will come through the current downturn unscathed would be a dangerous call. We have already seen one high cost producer (ASX:A40) cease production and investors may be wise to consider two factors moving forward.

The first is to evaluate whether miners have reached the quality level required or have the capital to see them through the process. There is no simple SC6 story and we have seen many investors fall into that trap. Miners need to produce a quality blend of grade, low iron and mica content, grain size and moisture content. Analysing who has the goods is extremely difficult. As an example, we often see investors excited by high grades of 3 or 4%. The reality is that, apart from Greenbushes which is a relative freak of nature, past results show these high grades may be high in lepidolite which is a major issue for processors.

With quality finally hitting the mark, we need to also consider strip ratios, recovery rates and hitting nameplate while maintaining quality. That has proven to be a big ask for all hard rock lithium producers.

We can look towards South American brine as the other source of Lithium. While the story is different, there are also similarities. We see that the reality has also been one of exaggerated supply, weather events and water issues through to dealing with environmental groups, local communities and governments. I don’t recall any of the South American operations meeting expansion projections: a fact ignored by those that choose to exaggerate the oversupply story.

Negative Sentiment Infection The second significant influence is an understanding that sentiment infection is a reality for all miners. We only need to see the negative market sentiment from quality or cost issues that has stained the outlook for others. You simply cannot run a lone game in a market that is driven by the revolution most of us know is coming. It remains a market swinging unsteadily between market hype and the realities of production.

It's been a rollercoaster.

Prices for spodumene concentrate could fall as low as USD 500/t for low grade material that’s problematic to process. We reckon there is plenty of that material currently available in stockpiles. However, that does not suggest that low quality material sets a benchmark price for SC. Indeed, we see a much broader price range as mines begin to hit quality standards. Around USD 600/t appears to be the low point for quality material and below that point profitability becomes problematic. In the mind of the investor, any mention of USD 500/t is going to impact all lithium miners regardless of the reality of the quality and price correlation. These are additional head winds that the industry is coping with right now.

Just because you are making the grade does not mean you will not be infected by the failings of others.

Supply Chains Yes, we did see the current oversupply of SC earlier than most. What we probably gave too little thought to, was how the supply chain could affect new miners. We can separate the supply chain into five basic groups: miners, chemical processors, cell manufacturers, battery assemblers and EV manufacturers.

The majority of raw material supply comes from Australia and South America. The Australians must look to chemical processors in China to produce the chemicals for cell production whereas South American brine producers can basically skip this step. The vast majority of cell production, (the small batteries that are massed to form an EV battery), is located in China. The construction of finished batteries is assembled from cells and, while concentrated in China, is expected to grow rapidly in elsewhere. Growth in EVs is again concentrated in China but gaining traction in other regions.

We can clearly see that the over-reliance on China is dramatic right up to, and including, cell manufacture. Subsequently, Australian producers have little choice but to focus on China in the short term in order to form a strong customer base.

With five distinct parts to the supply chain, a bottleneck at any one point may throw the whole supply chain into turmoil. As first in the chain, miners are at the mercy of bottlenecks anywhere else in the supply chain, much like being a first time buyer ensnared in a house-buying chain.

Regardless of whether it’s a processing capacity issue or a lack of EV sales, any bottleneck translates into restricted demand for the miner. Conversely, a lack of raw material supply will impact the whole EV sector and could see prices for SC climb substantially. At the first hint of lithium shortages, other supply chain groups will begin to horde material required for their massive investments.

What Happened to My Agreement? I’ve heard many complaints, perhaps unfairly, that the Chinese have reneged on binding offtakes. I personally start from the premise that there is no such thing as a binding offtake with a Chinese company. No miner is going to pursue a legal recourse if the terms of a contract are not met and, even if they did, they would almost certainly fail in a Chinese court. The buyer may simply stall shipments, sighting any number of issues from lack of quality through to an inability to send funds due to government regulations.

‘Sentiment infection is a reality for all miners.’

Forget the word binding. These offtakes are purely indicative of a regular customer. Perhaps some miners were naïve in believing the binding nature of agreements, and not over-selling their production to a wide enough customer base. The position needs to be that, if one stalls or reneges on a shipment, then another buyer can take their place. In effect, almost double-selling the resource while ensuring you meet Australian legal standards if the market turns. Airline ticketing for budget airlines double-booking seats comes to mind.

Who’s the Partner? Hard rock lithium is processed in China. Sure, I have a sneaking suspicion the Japanese are thinking of processing and Korea almost certainly will. Regardless of how investors wish miners would ship to Korea or Japan, the reality is that today the entire customer base is in China.

Once we come to terms with quality and efficiency issues, we need to take a long hard look at partners. The first question is whether they are current processors or planning to produce in future. We see agreements that sound amazing and yet, for a miner trying to get started, may be quite dangerous. The focus of investors is on each quarterly.

Production needs to be shipped now - how big the future partner is, may not pay the bills today.

For this reason, we look carefully for miners that are signing new agreements with current producers. We also look for a lack of stockpiles, meaning that material is being accepted as it’s produced rather than laying in low quality stockpiles waiting for a home. I think we have to accept the fact that no mine is going to admit to low quality output so this becomes the only story we can rely upon from the outside looking in.

Enter the Dragon How China works, both as a government at a corporate level, is a fascinating story I’ve studied for decades. From one of the first real mass-produced consumer products to roll out of China to the west, (the humble trolley car jack), through to the powerhouse they now are. Whether you like China or not, you simply must accept what they have achieved over a few decades as remarkable

This economic strength comes first and foremost from the CCP. What we often see as an end result is always a rigorously thought out plan. I call it the great Chinese vacuum cleaner. Suck them in (subsidies) at any cost. Then with perfect timing, begin the process of consolidation and market control. EVs gave China the perfect weapon for the next step forward.

China had failed dismally at ICE auto exports despite all their efforts. Along came EVs and new energy as the answer to their prayers. Anyone that thinks China will lose the battle is likely to be seriously mistaken.

Form the Market with Subsidies. Sure, subsidies are disappearing…and so they should. Yes, the media uses subsidies to create fear in the market. As an example, sales will always increase prior to any subsidy change as manufacturers try to beat the end of the period. Naturally, this will equate to some decrease post-subsidy change. It’s simply common sense that is not always reported that way in the media.

Subsidies will eventually disappear, especially as foreign brands enter China. Did anyone honestly think the Chinese would pay subsidies to western companies? Those same subsidies will simply move out of sight and make their way into technical grants or cheap finance. It’s how China works and it’s clever.

Altura seems to be making the grade.

That China has a plan to dominate the world of new energy is without question. That they control the pace of development is equally without question. Through the licensing of EV vehicles, inner city access for commercial EVs and emissions rules they will dictate the growth of new energy well into the future. They will dominate the market just as they did with solar panels and nothing in the west can stop that. They may not control the EV passenger car market but you can be sure they will dominate the supply of the cells needed to drive each one. A Good News Story Against this backdrop, we believe some investors, (as distinct from traders), may be making a fundamental error of judgement. The reality of the battery metals market is that this is not a typical mining cycle at all. There is simply no correlation between a market like iron ore where new supply at a time of dwindling demand caused a crash. Nor is there any correlation with rare earths where a change in government regulations can send prices on an upward spiral only to then come crashing down.

There is one fundamental difference for the lithium market: demand growth. Battery metals remain one of the fastest growing sectors. That growth has never waned and continues to climb at unprecedented rates. Despite the current issues, existing miners have the capacity to expand to further stages as the market demand dictates. Such expansions are likely to occur before we see new mines attract the required capital to begin the long road towards production. For the Chinese who play the long game, they may do well to consider their current relationships in a market that may make a complete about face.

If you believe in new energy disruption, now might just be the perfect time to do your homework. There will be casualties along the way, consolidations, takeovers and failures. These changes will occur right through the supply chain from miners through to the hundreds of EV hopefuls. The market is poised with the temptation of a second cycle and the opportunity exists to enter at low valuations that would be unheard of a year ago.

Existing miners that get their quality, output, partnerships and finance just right, may be the new darlings of the market within a very short time. It’s not there yet, but we feel change is coming.

Light at the end of the tunnel?

It is now increasingly difficult to stay abreast of the outpouring of new energy news. News flow is three times that of a year ago and you have to wonder what the next year will bring. Just this month we see major stories like Amazon ordering 100,000 delivery vans from Rivian and CATL announcing plans for a new USD 1.4 billion EV battery plant in China. It’s simply a matter of time before the volume of news turns to reality and feeds into the demand story for lithium mines.

It is still an opaque and fragile market. Investors should be wary of disparities between production and sales. This differential may be indicative of stockpiles or simply a timing issue between miner and processsor. Any scale back of production would likely indicate that further plant improvements have become necessary.

Perhaps a comment from Altura’s CEO offers a dose of honesty and medium-term insight, accepting that challenges remain but that there might be light at the end of the tunnel:

”Although the market remains tight we believe that 2020 (especially H2) will provide some balance back into the market. The combination of downstream conversion delays in commissioning of new and expanded plants and the removal of the EV subsidies in China in May all pointed towards some pressure.

“The fact is that converters now have more choice for supply than 3-4 years ago. We firmly believe that consistency of quality and supply will underpin the new entrants to the market as long as they are able to deliver what is required when it is required. There is no doubt that Tier 1 partners are looking at long-life supply from stable operations.”

With the price of spodumene still dropping, is it a case of brinkmanship or will the market kill the golden goose? During industry downturns, consolidation and company failures spike in what some might say is the natural attrition of a market economy. Companies survive by cutting costs, lowering their prices and doing everything to maintain their key customers. The last refuge, once operations have been made as efficient as possible and stripped to the bone, is to lower quality to satisfy rock-bottom prices. You pay for what you get. However, with chemical converters requiring high quality to make battery grade, this is not an option.

So, who’s going to blink first?