Lithium today is starting to look a lot like iron ore of 20 years ago, a comparison which includes the potential for miners of the battery metal to become tomorrow’s yield stars.
While it has never been wise to treat any natural resource company as a reliable dividend generator because of the potential for extreme moves in commodity prices, there can be exceptions at times when prices stay higher for longer.
In the case of iron ore, which has enjoyed long-lasting record prices thanks to China’s industrial revolution, Australian miners such as Fortescue Metals Group and BHP have become important sources of dividends for many investors.
Lithium is riding the equivalent of the China boom, only bigger, in the form of the global energy transition which has sparked a rapid increase in demand, especially from electric vehicle (EV) makers at a time of a significant shortfall in supply.
The result is a lithium price which has punched through the ceiling. While there are multiple ways of trading the metal it is in its form as a concentrated ore (spodumene) that the spectacular price rise can be best measured – and in which also lies a warning about commodity risk.
Over past two years the price of spodumene, which generally contains 6 per cent lithium, has rocketed up by 900 per cent from around $US400 a tonne in 2020 to recent trades booked at $US4000/t with the potential to keep rising. Credit Suisse, an investment bank, sees a future possible price of $US7000/t.
Given that most Australian producers of spodumene concentrate operate on a cost base of less than $US500/t it’s obvious that profit margins are spectacular.
In its processed form as lithium carbonate or lithium hydroxide, the numbers are even more impressive with a tonne of carbonate selling in China for up to $78,000, a remarkable 1047 per cent higher than the $6800/t of 18 months ago.
As fabulous as the price rise has been, there are some investors who might remember the first flush of the lithium boom in 2017. Prices soared briefly before crashing under the weight of oversupply, bankrupting some high-cost lithium miners such as Altura which was forced to sell its operations to near-neighbour in the north of WA, Pilbara Minerals.
Out of the wreckage of a three-year lithium-price downturn, Pilbara has emerged as a sector leader with its soon-to-retire chief executive, Ken Brinsden, confident that the lithium recovery will stick because demand is comfortably outstripping supply.
Brinsden’s conviction that this time it will be different for lithium even prompted a remarkable prediction that EV makers have so botched their lithium purchasing arrangements that they will “have keep paying through the nose” for some time.
That comment was matched for bravado by analysts at the investment bank J.P. Morgan who said that lithium had entered a period of “perpetual deficit” which would force EV makers to pay high prices for years and for miners to be forced to start digging low grade ore to try and meet demand.
“Our supply and demand modelling predicts a perpetual deficit market where low grade mine supply will need to be induced,” J.P. Morgan said.
Driving everything in lithium is the global rush into EVs which is being actively encouraged by governments offering subsidies to car buyers, along with incentives to switch from internal combustion engines by banning them from the centre of major cities.
Supercharging the EV stampede is the sharp increase in the price of oil triggered by the war in Ukraine and sanctions on Russian oil and gas.
Ian Hansen, managing director of Wesfarmers Chemicals which is developing the Covalent lithium project in WA with SQM of Chile, said in an interview published last week by Westpac Institutional Bank that three million EVs were produced worldwide in 2020, rising to 17 million in 2025 and then up to between 35 and 40 million in 2030.
It’s the mix of EV production and the higher oil price which prompted Mineral Securities and its U.S. partner, Albemarle Corporation, to bring forward the start of production at their mothballed Wodgina mine, which is close to Pilbara’s operations in WA.
Wodgina was a victim of the earlier lithium crash, constructed during the first flush of high lithium prices only to be completed at the end of October 2019 and mothballed on the day of its official opening.
A production start was scheduled for September but has been brough forward to next month to catch the record prices for lithium.
Profits being booked by lithium producers are astronomical. Pilbara Minerals, according to Macquarie Bank, will flip from a loss last financial year of $51.4 million to a profit this year of $668 million, rising next financial year to $1.16 billion.
Allkem, created last year through the merger of Galaxy Resources and Orocobre, is tipped by Citi, another investment bank, to lift its performance from a loss last year of $US20.9 million to a core net profit this year of $US344 million, rising to $US457 million next year.
Citi said in a research note on Allkem after the company’s investor day meeting in Sydney that the company’s customers “want product as quickly as Allkem can produce it”.
What the banks also see is a classic management tug-of-war developing as the desire to continue investing capital in expanding production to satisfy customers is likely to be met by demands from shareholders for a slice of the pie, either through dividends or share buybacks.
The size of the problem, if too much cash can be called a problem, can be seen in bank estimates, with Macquarie calculating that Allkem will end the current financial year with net cash of $487 million, rising to $1.1 billion next year.
Interestingly, Macquarie has yet to make a provision in its calculations which are out to 2025 for Allkem to pay a dividend by which time the company is expected to be sitting on a cash pile totalling $2.6 billion.
Growth projects, new mines in Australia and more brine ponds in South America, will be the focus of Allkem, with UBS noting that the company was aiming to be the world’s third biggest lithium producer with a 10 per cent share of the global market.
Other banks are starting to recognise the potential of Allkem and Pilbara to do something with the cash other than expand to try and plug the perpetual deficit seen by J.P. Morgan.
Bell Potter and Credit Suisse believe Allkem will be first of the current crop of lithium producers to start paying dividends, with Bell Potter tipping a payout in the 2023 financial year of 15c a share, rising to 40c in 2024.
Credit Suisse sees a payout of US91.69c in 2023, slipping to US84.39c in 2024 as rising supply sparks a lithium price slide.
These are early days in the latest lithium boom with the three-year bear market which followed the price collapse of 2018 is still fresh in minds of some investors, as is the well-worn record of other commodity booms and busts.
The start of Wodgina will introduce an extra 250,000t of lithium into the market from next month with another 250,000t from September.
Wesfarmers and SQM are about to start construction of their lithium project in WA and other potential new producers, including Liontown and Core Lithium are planning to move quickly into production – and that’s just in Australia, with other countries rushing to enter the business, including Canada, while in the U.S. Tesla founder Elon Musk says he might have to go mining for lithium because the price of the metal is “insane”.
There is no guarantee that lithium will be different to other commodities with the recent sharp price increase followed by a long-term decline, though the theory that lithium could be travelling on the same trajectory as iron ore is backed by the powerful force of energy transition.
Australian lithium producers are particularly well-placed because all production in this country is based on well-managed hard-rock mining with minimal environmental disturbance whereas most South American lithium is from brine ponds which suck water out of aquifers, leading to clashes with government and environmentalists.
Last week the government of Chile said it was prosecuting a number of mining companies for extracting more water than permitted from the super-dry Atacama desert and its dry salt lakes with BHP and Antofagasta two copper miners being sued along with Albemarle, a lithium producer.
Citi, in its latest research note on Allkem said management was conscious of high lithium prices “not being here forever” but it expected the company to have amassed a “war chest of more than $US1 billion in the 2023 financial year”.
Over the last 12 months Allkem’s share price has risen by $7.62, or 139 per cent, to $13.09. Credit Suisse sees a future price of $15.30. Citi sees $15.50. Macquarie sees $16.90 and Bell Potter has pushed its target price out to $18.05.
Pilbara Minerals, which is planning to invest in a “mid-stream” chemical processing project to broaden its offering, last week saw Credit Suisse boost it price target for the stock from $3.20 to $3.90 though the bank’s rating was neutral as it is already trading at $3.20. Macquarie reckons Pilbara is heading up to $4.30.
Optimists are confident that the lithium price will remain elevated for years and producers will become high yield investments as they churn out dividends.
Pessimists doubt that any commodity which is relatively easy to find and extract will achieve J.P. Morgan’s state of perpetual deficit, especially if car makers like Tesla go lithium mining in their own name to drive down the price of a key input.
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