Lithium's crowded trade

Demand for lithium, the key metal in electric vehicle (EV) batteries, is strong. Supply is stronger.

The result is predictable, and has been predicted for the past 18 months; a falling lithium price and the start of a process which will separate survivors from casualties.

In time, demand for EVs could rise to overpower lithium supply as governments mandate a wholesale switch to low pollution transport systems and battery-storage of grid power similar to policies proposed by Opposition Leader, Bill Shorten.

But getting to a nirvana where renewable energy totally displaces fossil fuels, and batteries store enough energy to power a national economy will take decades, and might never be reached.

For investors, the switch from old-power to new-power systems represents a significant opportunity and a big challenge. The road ahead will not be smooth.

Events, and share prices over the past few weeks are examples of the speed bumps which will test the mettle of investors with a taste for lithium, as it morphs out of its mining roots into its chemical processing future.

Orocobre, an early favourite, reported a poor March quarter with production down at its operations in Argentina where lithium is harvested off a dry salt lake. This is one of two lithium extraction processes. The other, preferred in Australia, is conventional hard-rock mining.

The end result of salt-lake harvesting, using the sun to dry lithium salts or crushing rock to liberate lithium, is much the same. The goal is the production of lithium chemicals, such as lithium carbonate or lithium hydroxide, to sell to battery makers in Asia.

The Orocobre result, production down 19 per cent quarter-on-quarter, and gross profit margin down 20 per cent, delivered a jolt to the company’s share price which lost an immediate 7 per cent. This takes Orocobre's fall over the past three weeks to 11.5 per cent.

Other lithium producers have fallen further as a wave of excess lithium washes over an EV market that is suffering from growing pains.

Galaxy Resources, which mines hard-rock lithium in Australia, has suffered a share price fall of 18 per cent over the past month, as has Pilbara Minerals.

The common problem for lithium producers, and explorers for the ultra-light metal with unusual properties such as burning on contact with water, is a glut of supply. This glut has a double-barreled cause; slower-than-expected demand and higher-than-expected production.

China, the ultimate commodity sink-hole, is a starting point to understanding the demand issue, with a spectacular surge in the production of EVs that has seen 486 manufacturers of electric vehicles registered with the government, triple the number of two years ago.

All the EV makers want lithium batteries now, but most will fail, a process already starting as the Chinese Government cuts consumer subsidies, crimping EV demand.

The Chinese EV experience mirrors that in part of Europe where EV demand is highly 'subsidy-dependent' with consumers lured into electric cars by a government hand-out and without fully considering the EV issues yet to be resolved, including range anxiety (how far can you go on a full battery), a shortage of charging points, and the time taken for a charge.

Those problems, which make buying an EV today somewhat of an adventure for most people, will be overcome — over time.

But it is important for investors with an appetite for lithium to understand the connection between producing a relatively simple metal and the end market, with a critical step being the production of intermediate, or finished, battery-grade material rather than simply digging and delivering.

Most of Australia’s early lithium players have recognised that shipping out unprocessed ore (spodumene) grading 1 per cent to 2 per cent lithium quickly became a profitless pursuit which is why they moved up to 'concentrating' he ore to 6 per cent lithium – though that too is being superseded by a shift up to producing semi-finished lithium carbonate or lithium hydroxide.

Orocobre, and other miners, are moving into chemicals as quickly as possible with Orocobre’s shift via the joint venture Nahara lithium hydroxide plant in Japan.

Macquarie Bank, in a comment on last week’s Orocobre quarterly, described the company as “the lithium canary”, a reference to the use of canaries by coal miners to detect trouble in the form of carbon monoxide which quickly killed the canary, warning the miners to get out.

What Macquarie meant is that the issues confronting Orocobre are the same being faced by all lithium producers, it’s just an early warning indicator of what’s to come.

Prices explain a lot. Lithium carbonate, which had soared in price to around $US20,000 a tonne three years ago, was sold by Orocobre in the March quarter for an average price of $US9451/t, down, 11 per cent on the $US10,587/t achieved in the December quarter – and even further down than the $13,533 in the March quarter last year.

The price of carbonate is expected to continue falling, into a range of $US8200/t-to-$US8400/t.

“The oversupply in the lithium market that we have been forecasting for some time is finally becoming a reality,” Macquarie said.

The flip from lithium being a 'seller’s market' with producers in charge and able to demand super-high prices, to a 'buyer’s market' with battery makers able to demand quality improvements and price reductions, has made production costs the key to picking lithium winners.

No one doubts that demand is strong, and will get stronger. But the simple truth about lithium is that it is not a metal in short supply. Dry salt lakes of the Andes mountains in South America are a huge source of material, as are the thick and rich orebodies being discovered and developed in WA.

Kidman Resources

Unlike most Australian explorers, Kidman recognised early that lithium is less of a mining business and more of a chemical processing business.

The company could easily have gone down the pure mining route after it discovered the Mt Holland lithium orebody while looking for gold near Hyden in the south of WA.

But rather than trying to enter the chemicals business on its own, Kidman sold a 50 per cent stake in its discovery to one of the world’s leading lithium producers, Sociedad Química y Minera de Chile (or SQM as it is more widely known).

A controversial company because of its historic connections to the military dictatorship of Augusto Pinochet, SQM has shaken off its past, improved its relationship with the current government of Chile, and claimed a role as a global lithium leader.

The difference between being just another lithium miner and a partner in a business that plans to build a lithium chemicals business in WA can be seen in recent share price movements.

While the miners have been falling, Kidman has moved up, rising by 15 per cent from $1.17 to $1.35 over the past month thanks to choosing the correct way to travel a crowded road to a lithium future.