A powerful noble once sought the wisdom of a zen sage. The nobleman asked the sage: 'Tell me one sentence that will make the happiest man sad and the saddest man happy'. The sage replied in only four words: 'this too shall pass'.
As it is in zen, so it is with commodities. Booms come; busts follow and booms are born again. This is, after all, a cyclical business – something investors forget, remember and then forget again.
Amid today’s commodity price bust, lithium prices have leapt euphorically, almost tripling in two years. Once used to treat mania and depression, lithium is now the source of both afflictions as speculators, traders, the greedy and the hopeful all scramble to take positions in the twilight of the Great Boom.
Buying lithium involves three bets on the future
Higher demand does not equal higher profits
The lithium boom will end
Like all booms, optimism is grounded in reality. Lithium ion batteries are currently the favoured power source for a range of electronic gadgets, from mobile phones to electric cars. Many suggest that lithium will power batteries used by households to store and discharge renewable power.
As Goldman Sachs has famously declared: lithium is the new oil. The believers now have their narrative and we now have a boom. As prices have risen, lithium producers – there are two on the ASX – have rocketed and a host of wannabe producers have bloomed.
In April this year there were 35 lithium hopefuls on the ASX; today there are over 60 and their ranks swell each day. Recently, Dakota Minerals surged 200% in one day as it announced it was forgoing a hunt for gold and copper to focus on lithium exploration.
Yet all these producers are chasing a tiny market; just 180,000 tonnes of lithium worth about US$1bn was traded last year. The iron ore trade, by contrast, generates over 3bn tonnes of output and the copper market is worth over US$85bn. In each case, and in contrast to lithium, many buyers and sellers transact in a liquid spot market.
Ah, say the bulls, but demand is soaring. That it is, but even the most bullish forecasts suggest that demand will rise to just over 500,000 tonnes of lithium carbonate per year by 2025. In percentage terms that is a mighty increase but in absolute terms it is tiny. The world must add a mere 400,000 tonnes to meet the rosiest forecasts.
Four dominant existing producers have already outlined ambitious growth plans and are joined by a handful of new producers and hundreds of explorers. Among this ravenous lot, 400,000 tonnes won’t be hard to find. Iron ore miners, by contrast, increased output from 900m tonnes in 1999 to over 3bn tonnes last year.
The iron ore industry mined and moved an additional 2bn tonnes of material to accommodate Chinese demand, an infinitely harder task than that confronting the lithium industry.
The bull case
Talk to a lithium bull and you'll hear two words repeatedly: electric cars.
It is a worthy point. Lithium accounts for just 5% of the material in car batteries and less than 10% of their cost. It is worth noting, however, that lithium content rises exponentially with battery size. A large, high density bus battery is therefore more lithium intensive than car or mobile phone batteries.
This is the great hope of the bulls: there's already a lithium battery in every mobile; putting one in every car, bus and truck will massively and permanently increase demand.
Those expectations are hardly secret. If supply is so plentiful, why have producers not yet responded with more output?
The great barrier to more output is not economics; current prices are more than adequate to compensate producers. Nor is it scarcity; lithium is fairly common and is easy to find. There are enough lithium reserves today to cover almost 600 years of production, the highest replacement ratio for any commodity. The equivalent number for iron ore is just 30 years.
They will come
The lag between demand and supply is due to complexity. Lithium is hard to process and must be produced to exacting standards for specific buyers. Japanese buyers, for example, are set up to process brine output, but Chinese importers prefer lithium derived from hard rock spodumene.
In Australia, producers are generally conventional miners who dig up ore and process it to extract lithium carbonate. Processing is the hard part of lithium production and it is this part that has been lagging.
Orocobre’s lithium brine in Argentina has been delayed for years and Galaxy’s spodumene mine is only now meeting targets after years of false starts. It does take time to open a mine but, once underway, production is easier to expand. An avalanche of new supply is on the way.
Albemarle, the world’s largest lithium producer, currently produces 30,000 tonnes and has immediate plans to mine 50,000 tonnes. It has outlined ambitions to increase output tenfold and has the reserves to do it.
Three bets, not one
Buying lithium today, at historically high prices, means not only buying into the notion that ‘lithium is the new oil’, but also accepting a series of assumptions that end with higher prices and higher profits for producers.
That means we must accept that electric cars will succeed, that lithium-based batteries will power them and that the commodity producers will profit in that value chain. None of these is inevitable.
Electric cars are progressing and sales are growing but they represent just a fraction of the market and have yet to overcome concerns about range and refueling; lithium must compete with other materials for primacy in battery production; and the higher prices go, the more likely it is that a substitute will take market share.
Even if everything does work out and electric cars, home batteries and lithium-sourced storage all eventuate, we must consider whether miners would capture any value in that chain.
Bricks, for example, are vital in the construction of housing. Over the past century, population growth has exploded and housing is ubiquitous but that hasn't made brick manufacturers profit bonanzas. Better extraction techniques, substitute materials and competition have reduced prices, not enhanced them.
The point here is that commodity producers rarely capture above-average returns. There are a few that do: iron ore, where 80% of the seaborn market is dominated by three producers; and niobium, where one producer captures 90% of industry profits are rare examples.
Individual mines with a cost or geological advantage can do very well but a step change in demand – even if it is sustainable – is not likely to lead to a step change in profits.
Lithium is neither iron ore or niobium. It is easy to find, widely available and doesn’t need infrastructure for haulage. Commodity booms start for various reasons but they all end the same way. This too shall pass.