One of the interesting presentations was Benchmark's observation...

One of the interesting presentations was Benchmark's observation and outlook for the lithium industry. At the risk of boring you with a long post, I copy it here (now that it is outside the paywall). I acknowledge that it is Benchmark's work.

LITHIUM’S PRICE PARADOX

30thJuly 2019LithiumBenchmark Mineral Intelligence

The introduction of new supply has seen agradual correction in the lithium market over the past 18 months, but despitethe majority of new chemical projects being slow to deliver, share prices andinvestor sentiment remain tied to short-term price trends rather thanunderlying market fundamentals. With capital markets failing to confront thegrowing prospect of major supply deficits as the electric vehicle (EV)revolution gathers pace, Benchmark Minerals addresses a deceptive narrativethat has engulfed the market and asks how the industry can create a morereflective price mechanism.

The unsustainability of lithium’s record highprice spike was exposed in early-2018 as the industry began to feel the effectsof the race to new production which had occurred in Australia’s spodumenesector. By mid-2018, with four new hard rockoperations set for production, spodumene had overtaken brine as the leadingsource of chemical feedstock production. The number of active mines had climbedfrom 1 in 2016 to 9 by the end of 2018.

The false narrative which emerged from theseexpansions and spilled over into 2019 was that the industry was awash withbattery-grade lithium chemicals, sufficient to support rapid electrificationover coming years. While the supply response has addressed therelatively minor growth of today, it is still far from meeting the needs oftomorrow’s EV expansions.

A correction in pricing – although it shouldbe mentioned that lithium chemical prices finished H1 2019 at 50% higher thanat the end of 2015, on average – has unsurprisingly seen leading producersreport weaker financials than when the market was at its peak. More worryingly, however, this has causedinvestor sentiment to turn, sending share prices into a nosedive for many andcreating a growing shortfall of capital to fund the next generation of lithiumexpansions.

Spectators that flocked to the market in 2016on the promise of an EV super-cycle have left before the warm up, let alone themain event.

While a downturn in prices has reflected anecessary correction towards near-term market fundamentals, it fails torepresent the increasing possibility of another major deficit in the market bythe early-2020s, creating a deceptive narrative in both share prices andsurrounding markets.

NEW SUPPLY REALITIES

According to Benchmark Minerals’latest Q1 lithium forecast update, lithium chemical production is set to growfrom around 285kt in 2018 to 350kt in 2019. While this represents major growth in anindustry which was only 160kt back in 2015, it still lags far behind theexpansion targets laid out at the peak of the market.

Since 2016, a total of 5 new lithium chemical(conversion) plants have come into production. Another 3 have expandedproduction capacity to meet market growth.

Of these expansions, only three have come intoproduction on schedule and at full capacity – Ganfeng’s Xinyu and Ningdu plantsand Livent’s three-stage, 9kta lithium hydroxide expansion.

Outside of the tier one producers in China,new capacities have either been delayed or put on hold as market conditionsturned. To date, General Lithium and Jiangte Motor are the only non-tier 1Chinese producers to execute major (>10ktpa) new capacity, and these wereboth delayed by several months.

More major expansions outside of China are inthe pipeline for later this year, but as is often the case, timelines for theramp up of these projects have been vague, with majors building in a buffer forexpected delays. These delays and misleading timelines add tothe myth of oversupply. If all expansions had been taken at face-value at theheight of the market, we would see almost an additional 500,000 tonnes oflithium chemical capacity by 2020. In reality this figure will be less than 40%of this number.

What’s more, the type and quality of this newproduction capacity only perpetuates the smoke and mirrors state the industryhas floated in for the past four years.

As with any new lithium chemical production,only a proportion of this material will likely be sold into the battery sectorfrom the outset. Even leading producers have problems meeting specs in theinitial stages of production. Even more pressing, however, is the type oflithium production these plants are targeting.

Of the additional 65,000 tonnes of lithiumchemical production that is expected to reach the market in 2019, over 75% isbeing targeted at lithium hydroxide. Rapidly changing cathode chemistryrequirements means the growth outlook for carbonate vs hydroxide continues toshift, as do the competitiveness of various supply chains to support thesechemical expansions.

DISPELLING COST CURVE MYTHS

A symptom of the emergence of new spodumeneresources has been the question of which feedstock is the most economic sourceof lithium chemical production. For a generation the low-cost benefits ofbrine extraction, coupled with an industry dominated by lithium carbonate, sawSouth American projects cement themselves firmly at the low-end of the industrycost curve.

The potential shift away from lithiumcarbonate as the primary chemical used in lithium ion battery cathodes, andchanges to the Chilean royalty structure, have however put this position indoubt over recent years. The ability to produce lithium hydroxidedirectly from spodumene – rather than via lithium carbonate, as is required inthe brine process – means the cost curve for lithium hydroxide production cantake a distinctly different shape than that of carbonate. In turn, this challenges the previously heldbelief that brine is the more competitive source of production and could seespodumene prove the favoured feedstock of tomorrow’s lithium ion batteryindustry. Inherent in this hypothesis, however, isfirstly that the battery market will rapidly adopt the high-nickel,hydroxide-dependent cathode chemistries (a proposition that looks increasinglyunlikely in the near-term) and secondly, that all spodumene producers areintegrated lithium chemical suppliers.

Back in 2016 when Greenbushes was the onlyspodumene game in town, this of course was the case through Albemarle andTianqi’s ownership. Fast forward to 2019, and none of the newspodumene assets are fully owned by chemical converters, although the vastmajority of output is tied into offtake with leading chemical producers. These offtake arrangements have often beenstructured to allow for a return for spodumene producers, which in many casesare still operating at above their target cost levels. As a result, you are left with the cost offeedstock material proving prohibitive to China’s chemical converters takinghydroxide production costs below brine alternatives, even when bypassing thecarbonate production route. While this makes for an interestinghypothetical exchange, it is largely irrelevant in the longer-term context ofthe demand side story.

The question in the lithium market is nolonger whether spodumene or brine resources will be developed – both are neededto take us anywhere near the growth estimates of the next 2-3 years. The newquestion is what other channels of supply will be developed to take us close tothe demand forecasts for 2025 and beyond.

A QUESTION OF TIMING

The timing of the surge in lithium ion batteryproduction continues to play a role in limiting the development of new lithiumresources. While the development of a new mine can take3-4 years when the money is in place, the development of new integratedbattery-grade chemical conversion capacity is even longer. This makes the coming 12-18 months even morecritical in addressing the bottlenecks lined up for 2023 and beyond.

Money needs to start flowing into the lithiummarket quickly, or the road to electrification will be stunted by lithiumsupply, in even the most conservative of forecasts.

In Benchmark Minerals’ models,lithium supply has to increase at a 19% CAGR over the next 6 years to meet 2025demand. Even at the height of the market, the industry only managed to grow by11% per year, on average, from 2015-2018. And even when this money does arrive and newprojects are established, qualification of new material sources is not going tohappen overnight.

No new material is going to find its way intoa Chevrolet Bolt, Tesla Model 3, or any other model charged with leading thecause of wide-spread electrification, without a significant lead time ofcontract negotiations, testing and qualifications.

With all of this in mind, the financing of newprojects needs to happen now, a process which the current industry pricingenvironment is prohibiting. It is prohibitive both in the literal, marketdynamic sense, but also in the process of price transparency allowing investorsto efficiently allocate capital. And the risk surrounding price transparencythreatens to get worse before it gets better.

Despite the positive potential for theintroduction of derivative contracts into the market, the negative risks ofderivate contracts with no liquidity could be far greater. As has been seen inthe world of cobalt, a derivative contract can often add more confusion thanclarity.

Providing greater visibility on pricing hasbeen central to Benchmark Minerals’ business from day one. Working withthe supply chain to develop an accurate and reflective price assessmentmechanism that is useful to the industry, first and foremost. The development of other financial instrumentsin the market can only be effective if tied to an accepted industry price. BenchmarkMinerals provides that price and the next stages for market evolution willbe the integration of these prices as formal benchmarks in contracts. It is only when this integration occurs that atrue spot market can emerge, and more visibility will give investors theconfidence to address a growing problem for the entire battery supply chain.

As of June 2019, the Benchmark Minerals Lithiumion Battery Megafactory Assessment stood just shy of 2 TWh capacity by 2028. Toput that in context, that would equate to 1.5m tonnes lithium demand just fromthese operations if they were to reach full capacity, compared to total lithiumion battery demand of 150,000 tonnes LCE in 2018. These new facilities will not all reach themarket on time and at their expected capacity levels, but regardless this willsee a step change in consumption rates. For those consumption rates to be met, thelithium market must overcome the disparity between the short and long-termrealities in lithium pricing.