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The Lithium Period: A Cyclical Bloodbath (linkedin.com)

The Lithium Period: A Cyclical Bloodbath

Emily Hersh

Developing lithium exploration projects

Published Feb 7, 2024

Lithium prices are down, but I think that equity markets may be ovary-acting a bit.
Since starting a lithium exploration company in 2021, the pricing dynamics in the lithium spot market have not been at the front of my mind. I vividly remember a meeting in early 2023. I laughed in a Brazilian man's face as he was trying to sell me a prospective property in Minas Gerais when he quoted the lithium spot price as US $68,000/ton. I told him that was ridiculous - and while I certainly do not regret passing on his once in a lifetime business opportunity, I do wish that I had paid more attention to the potential damage that lay in store for lithium at the hands of a brutally cyclical market.

Source: iLi Markets
Lithium prices north of US $70,000/ton for lithium carbonate were ridiculous. Today's spot prices in the range of US $13,000 are unsustainable, but closer to where long term prices will likely settle, where my best guess is somewhere between US$15,000 and US $20,000. Higher would certainly be super nice for me personally, but as a cheerful pessimist and the CEO of a lithium exploration company, I choose to navigate troubled waters rather than wallow in sadness over a rainy day ☔. The question remains as to when we may actually settle into a more predictable cycle, what path the lithium market will take to get there, and most importantly - who wins and who loses on that journey.
Why so sensitive?
I gauge which way lithium sentiment will blow by breaking down what's happening in the world into two categories: headwinds vs. tailwinds for EVs.

Source: Emily's Noisy Opinions
We went through a period where the perception of tailwinds got out of hand, and even led us to believe that the EV narrative could somehow skate through the strongly negative macroeconomic undercurrent unscathed. Central banks started raising interest rates at the end of 2021, and the extended high interest rate environment impacts all the relevant players in the lithium story. Consumers have less money to splash out on an expensive new Tesla and automakers find it more costly to invest in expensive new manufacturing lines.

Governments and OEMs have signaled rolling back commitments to phasing out ICEs - but that shouldn't have come as such a massive surprise. The targets were largely viewed as unrealistic steps in some vague "right direction". China is phasing out financial incentives for EVs, but they've already reached their stated penetration rate targets. EV sales grew 31% year on year, composed of a 27% increase in sales of BEVs and a 43% increase in sales of PHEVs (Rho Motion).

Source: Rho Motion
As governments roll back targets and consumers vent their frustration over valid concerns such as lack of charging infrastructure and high costs of repairing vehicles, it gives large automakers an "out" from EV commitments they didn't want to make in the first place. It was bad for their bottom lines to begin with, even without high interest rates and inflation gnawing away at their margins.
The headwind/tailwind factor that troubles me most is the movement away from ESG and climate-focused investment trends. Besides the fact that it marks a cultural swing in the direction of profits over people, it worries me because I viewed these commitments as more tangible and measurable than government policy guidelines. Call me a capitalist, but I view large pools of capital backing down from requirements that funding recipients measure, report, and achieve sustainability targets as prescient of a "race to the bottom" on price with little regard for environmental or human development initiatives.
Price Benchmarks: The End of Innocence
Over the past two years an extremely relevant factor determining lithium pricing has changed. In the past, the majority of lithium chemicals by volume were sold on the basis long term contract that may have had a price ceiling or floor, whereby spot prices were somewhat divorced from reality. The rise in importance and credibility of multiple price reporting agencies has shifted that dynamic. Spot prices (especially in China) used to serve as a valuable indicator for the direction prices may go in the future. Today, more and more lithium supply contracts are indexed to one or more monthly price reporting agency's published prices and settled at prices either the same month of delivery or even with a one month lag.

In the long run, greater price transparency coupled with increased financial market sophistication will allow lithium producers to be in a position to hedge against the kind of price swings that defined the last 12 months. At present, it leaves lithium producers - and companies in development looking to lock in financing - at the immediate mercy of the spot market, which I believe further exacerbates cyclicality while the physical market is still so small.
The Balancing Act of Supply vs. Demand

Source: Benchmark Mineral Intelligence
I have spent the better part of the past week having long form conversations with the people who dedicate their lives to collecting halfway decent data on lithium, batteries, EVs, OEMs, governments, and the rest of the motley band of maniacs whose behavior at the end of the day determines the lithium price. I have concluded that the ability to predict periods of oversupply or deficit are limited by the inability to predict human behavior and global events beyond limiting whether things are highly probably, probable, or possible. I do know that assumptions on the demand side have pulled closer to the base case scenario than the high case scenario, and that today's prices are lower than what is necessary to incentivize new supply.

On the supply side, I'd be remiss if I failed to touch on lepidolite converted to lithium carbonate in China. Lepidolite is a gorgeous sparkly purple rock that sheds purple glitter. It makes you feel like a mineral identification genius when you find it in the wild, because you'd have to be blind and pay zero attention to miss it.

Congratulations, you are now a lithium mineral identification genius (Source: My Office)
Lepidolite makes a lot more sense looking awesome on my shelf than it does in a battery supply chain, especially at this price point. As real analysts who are far more savvy than I have pointed out, lepidolite is expensive to turn into lithium battery chemicals, even in China. It could be the casually conspiracy theory-esque crowd is on to something with claims that China is intentionally driving prices below operating costs to acquire higher quality assets worldwide at lower prices. It isn't sustainable but it sure as [expletive] impacts investment behavior.

Lepidolite is on the far right (Source: Supply Chain Insights)

Things don't crash, they unwind
You can break the lithium raw material supply side into four simplified categories:

Exploration companies (like me): We need high prices and happy humans writing checks to fund the risky but rewarding activity of identifying and defining new potential lithium mines

Development companies: These companies are in the throes of feasibility and scoping exercises to determine how much it will cost to build new lithium production, and how much money their (typically more risk averse) investors will make if the project goes through construction and into production. They need to consider forecasted CAPEX and OPEX.

Producing companies: These companies can expand, stay the same, reduce production, or shut down. Reducing or shutting down implies a future cost and lag to restart. Their key metric is OPEX, as well as necessity to pay back debt that was incurred during construction. If prices are near or above OPEX for any considerable period of time, these players will reduce production.

Recycling companies: This one is trickier for me to consider, but as they are forecast to contribute meaningfully to supply from 2027 onwards, I am curious how pricing impacts decisions to build and operate capacity.

The analysts at Wilsons Advisory have approached the current pricing situation by developing an Incentive Curve that considers what price levels are necessary to justify the CAPEX spend for development companies along the cost curve.

In an environment where lithium carbonate prices stay low, fewer developers will be able to pull together the capital required to execute on their planned projects. Many of the North American projects have used long term lithium carbonate prices of US $24,000 - or even higher - to calculate Net Present Value (NPV) and Internal Rate of Return (IRR). When you layer the fact that interest rates of 8% are probably no longer accurate and that CAPEX estimates will likely have increased due to inflation and higher interest rates across the board, I believe the conditions to justify many of these projects will unwind.

I am curious as to whether the financial incentives in government policy initiatives such as the IRA in the United States are sufficient to move the needle on investment decisions. The three provisions of the IRA that put dollars behind lithium projects are:

30D: Clean Vehicle Tax Credit of US $7500 per vehicle that could trickle down to producers

48C: Advanced Energy Project Credit that could lop 30% off the top of CAPEX (If you take this, you can't take 45C)

45X*: Advanced Manufacturing Production Tax Credit that could take 10% of OPEX (If you take this, you can't take 48C)

The Loans Program Office of the DOE is getting involved, so that can also play a role in reaching CAPEX and NPV/IRR levels that justify investment.

Both North American and Europe have invested heavily in building upstream battery capacity and that feedstock will have to come from somewhere. Whether it comes from domestic projects that get over the line with the help of federal funding or is imported from more cost-competitive jurisdictions will play out, and really depends on just how deep the desire to create an ex-China battery supply chain truly runs.
Cycles mean pain
Unless you take the view that EVs are a passing fad, now is the right time to invest in certain parts of the lithium industry. Stock prices are hemorrhaging and hopefully analysts around the world are pulling apart the assumptions underlying feasibility and scoping studies to figure out who can survive in this market. Companies with sufficient cash on hand who operate in low cost regions are well-positioned to advance their assets and come into the market during the next terrifying wave of absurd pricing.

Analysts can do a reasonable job of forecasting logical price windows over longer periods of time that are sufficient to drive certain production levels. The lithium market is still small enough that the behaviors of individual players are not noise - they are sufficiently significant to swing pricing over shorter time periods.

Volatility is inherent to creating the scale of opportunities that exist in lithium. Bears and bulls are like broken clocks in that they'll all be right at some point along the cycle. I come at my decisions by forming views on what I consider to be the key high-level metrics: EV penetration rates, lithium intensity in an average battery pack, government policies that impact EVs, and whether investment dollars globally will hold people accountable for ESG and climate goals. Hope is not a plan. Decide which forecasts most accurately reflect the correct assumptions today, but be willing to form new views as the universe unfolds.

The lithium market will not be purged or cleansed of chaos in my lifetime. I recommend procuring whatever toolkit of remedies allows you to go through the cyclical experience in relative peace. Just whatever you do, don't wear white pants.

Popular Remedies for Cyclical Pain (Image: GoodRX)