The Lithium Revolution – Profiting from Supply Mismatch

Profiting with revolutions

In 2017, the financial markets were shadowed by two major highlights: the cryptocurrency revolution and the Trump’s revolution. On one hand, investors were presented with the opportunity to gain quick money due to the media attention that was captivating the public’s optimism among (specially) Bitcoins. On the other hand, the more pragmatic and ordinary investors were delighted by the stock price increases amongst the North American stock indexes, thanks to the “Reaganomics inspired” fiscal policies implemented by Donald Trump. The last couple quarters of the year were then flooded by investment opportunities, specially originated in the financial sector, created by revolutionary changes that grabbed the media’s attention and pushed up the prices of stocks and commodities. But why is the media not captivating so well investors to the greatest revolution of them all? The Green Revolution… Or, more specifically, the lithium revolution. After all, the Green Revolution came to stay.

It was in 1991 that Sony Corporation introduced us the mass commercialization of the lithium-ion battery, which has been present in our everyday life up to this moment, and now more than ever. Before then, lithium was a metal in decline since its only usage was for war purposes that were weakening with the pacification of the Cold War, and surplus stocks were being sold by the U.S. Department of Energy at the same time that many more mines were shutting down its operations. But, turning back to the present day, we live in the post-Sony era where any final good that can be electronically changed will be electronically changed, so it should make sense to turn our head to this commodity that is now about to invade the automotive industry for the next decades.

Revolutionizing the Automotive Industry

It makes no sense to approach the lithium theme without mentioning its largest demand source. The automotive revolution, mostly created by Tesla Motors Inc. (currently with a Market Cap higher than Ford), has been guiding the equilibrium point of electric cars to a whole new level, with supply and demand meeting at higher stakes on a yearly basis. The growing stock of passenger cars conjugated with the increasing benefits for electric car owners with zero emissions is being seen as an opportunity for several brands to change their consumer target.

By 2016, more than 2 million electric cars were circulating on the road, comparing to roughly 100 thousand 5 years earlier. In the same year, China became the country with the largest electric car stock, holding approximately one third of the total global stock, contributing for the high demand of all electrical (EV) and plug-in hybrid vehicles (PHEV). European countries such as Norway and the Netherlands are increasing exponentially the market share of electronic cars within national boarders, mostly due to heavy government incentives and fiscal benefits.

The number of available recharging points for EVs (electric vehicles) is also forecasted to outnumber the amount of petrol stations in several European countries, as Nissan studies suggest, and the politic, legal and social forces are in favor of a zero emissions automotive industry. Until now, we have an exponentially growing world demand for lithium, favorable government laws and social willingness to adopt EVs.

 

So, how important is Lithium in the automotive industry?

Overall, the main applications for lithium are not for electric cars yet, despite of the optimistic forecasts that several world organizations are creating for the near future. Some of the most industrialized usages for lithium are directed for the production of glass and ceramics, lubricants, pharmaceutics, aluminum, nuclear technology, astronautics, etc.

In fact, the Lithium related costs are the main new variable that was incorporated in the mass production of electric cars, and the price of raw Lithium has been bullish since the EVs production started growing exponentially in the past recent years. However, although the amount of vehicles running on batteries is gradually increasing and the lithium prices are in a bullish trend, there is a reason for which batteries prices are still going down. Lithium-ion cells are essentially useful to store the energy needed to keep electric cars running without the assistance of further fuel forms, but lithium prices only represent around 10% of the battery production costs, and the economies of scale are allowing auto manufacturers to buy Lithium packs at discount prices. This is a special commodity in the sense that it is essential to keep the automotive industry going, but the bargain power of Lithium suppliers might become quite limited over time.

How is Lithium and its market priced?

The consensus on this matter is still to exist, so it should be appropriate to evaluate only the theoretical fundamentals. There is no technical analysis able to support statistical forecasts on price movements and the public information on Lithium is still very dark.  This time, in order to understand the possible path of the commodity, we shall not look anymore to the unstoppable demand but to the supply side instead.

Turning our heads to the lithium oligopoly, there are currently four big players that control about 85% of the global lithium supply, according to Macquire: SQM (Chile), FMC Corp (USA), Albemarle Copr (USA), and Talison (Australia). Since the necessary time to build new lithium mining projects is very demanding, the growth rate of the demand side has been significantly higher than the growth rate of supply, and several studies suggest that the previous companies are not producing at their maximum capacity so far. Despite the overcapacity, new plants are still being built (both for the extraction and the innovation sake), meaning that there is a very high probability that the market will be oversupplied and the least efficient companies are going out of it. Nonetheless, safely saying that the demand is accurately forecasted to go up in the long run, one could ask how to gain exposure to the lithium market now, since the commodity is not available to negotiation in any trade exchange.The first thing to know is that this is an abundant resource and there are lithium reserves across the 5 populated continents. It is important to note that one of the biggest problems when it comes to pricing lithium is that most of the trades occur in the OTC market, with only a few players – a very limited amount of producers and their exclusive customers. Therefore, the absence of exchange trading and the very limited spot market combined with the complexity of lithium supply that can be shaped and used in numerous forms, makes the complexity of pricing the commodity higher than usual. The incomplete information on this matter allows us to rely solely on publicly known trade volumes as well as values, which severely limits the accuracy of precise numbers.

How do investors seek exposure to this asset class?

The most direct way of exposing to the precious metal is by buying lithium suppliers’ stocks, which are the most correlated financial assets to lithium prices movements, overall. Unless the investor wants to bet on the success of a single company, there is the more affordable and diversified alternative of investing in ETFs, and thus track the prices of the physical commodity. When it comes to ETFs, the most famous one for the exposure in Lithium is the Global X Lithium & Battery ETF, which offers exposure to the whole supply chain of Lithium starting from the main producers such as the four big companies stated above, passing through logistics companies and ending up in the final consumer that incorporates Lithium in the production processes, such as Tesla Motors.

The more risk averse investors have always the option of investing in synthetic ETFs that undertake long positions in lithium related assets at the same time that hold Treasury securities providing safe fixed incomes. Safe to say that different investment vehicles may have very different profiting outcomes, as well as tax implications. Regarding lithium, the best available alternatives to gain exposure are related to equity investment, which are poor in what comes to controlling for volatility and hedging against unfavorable equity markets conditions. Thus, one of the main reasons to seek precious metals – to avoid equity markets risks – is not applicable to this commodity. Nevertheless, regardless of the instrument vehicles chosen by lithium investors, it can be said with confidence that the world demand will keep increasing and, respecting to the short term, the growth rate of supply will be much lower than the demand one.

 

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