Q&A with Anthony Tse

A few weeks ago I asked GXY management if I could send through a few questions for Anthony Tse on behalf of share holders to be published on Hot Copper.
Anthony just emailed his responses this morning.
I have also been given permission by HC admins to post this.

Hope you find it interesting.



AC :

Hi Anthony,

Thanks very much for taking the time to do this for the Galaxy share holders.

There has been a lot of conflicting information released to the market this year with regards to the forward estimates of demand and pricing, particularly by Macquarie Bank. What are the keys things the “over supply argument” has missed?
Given that there are now so many prospective lithium operations where do you see the balance of demand and production over the next few years?
Do you see a strong case for higher pricing for Mt Cattlin’s next contracts?

AT :

The basics of demand and supply in economics is quite simple, if supply is greater than demand then price falls - if vice versa, then the price rises. From what we have seen in the market over the last 18 months, we have seen prices at 2.5-3x the level of where they were at the beginning of 2015. Earlier on in the year, many sell side analysts were very dismissive and that this was a blip, or this was just a "China price" ... but how have we seen this play out year-to-date ?

Well, prices for lithium carbonate in China run up significantly, and over the past 11 months we saw it run to RMB180K/t where it peaked in April/May, after which it tailed off down to levels around RMB120K through to October, and in recent weeks has actually showed signs of dialing back up to a range of RMB125-130K/t (USD14.5-15.1Kbnet equivalent) ... that represents a circa 30% drop from its peak, but today's price is still close to 3x of where it was for most of 2015 at around RMB40K/t. From my perspective, a sustained level of 3x historical price for a period of 12-months is not really a blip.

On the argument about this just being a China price, I would advise the skeptics to look into customs data from various markets, which is publicly available information. Tracking the ex-China pricing of lithium carbonate and hydroxide, imports for the former and exports of the latter, we see the following trends. Carbonate started 2016 at around USD6.4K/t (most of the imported carbonate to China is non battery grade) increasing month-on-month to USD11.7K/t by September. Hydroxide started at USD8.5K, rising to USD15K/t by September. Note that both of these are average prices, but looking at the different Li2CO3 importers (a breakdown is available within the data), interestingly the range of prices are between USD4.9K to USD18.2K per tonne - for LiOH exporters, the range was USD6.9K to USD29.8K per tonne. The average was obviously dragged down by the lower prices, which I assume are historical contracted volumes (and therefore historically agreed price) being delivered, and from the data it is clear that towards the latter part of the year, some of those contracts started to drop off.

Not wanting to get bogged down deep in too much data, but we are able to see similar uptrends in pricing throughout the year from import data in Japan and Korea, as well as exports from Chile and Argentina. Coming back to the "China price" argument, what we have seen evidently is that the "Rest of the World" pricing is playing catchup with China, even during the period when China ran up and then tapered off and then leveled off for several months between May and October, ex-China prices continued to rise.

So, back to Economics 101 - if, as some analysts are depicting, there is no shortage and in fact an oversupply, then why is price up ... and up so significantly. In terms of what "some analysts have missed" ... I think there could be a whole range of reasons.

Lack of understanding about the industry; lack of willingness to go and actually do the work to understand the market dynamics; lack of time and resources (some analysts in larger institutions have to cover up to a dozen companies in as many different industries) to be able to do a quality job; lack of willingness to do a quality job - when things have run as hard as lithium has in the last 18 months, it's very easy to say "oh it's just like rare earths/mineral sands/iron ore (select as applicable)" and just default to describe a bubble scenario, as it is an easy sell and saves them having to do the real work.

The irony about that last comparison of lithium to previously bubble like commodities, is that lithium (or its compounds) strictly speaking is not a commodity - it is not exchange traded, price is more or less set between producer and end user, limited participation from traders, it is not quite a homogenous product, product specifications are very important ... and as such, it behaves more like an industrial mineral or specialty chemical. Many financial institutions (at least in Australia) try to cover the sector with their metals and mining analysts ... the reality is that a much greater understanding of the value chain is required, and as one analyst who I have worked with described, he had to learn about dynamics across 4 different industry sectors in order to even start getting his head around how the value chain works. It is interesting that the Big 3 which are listed in the US, are mostly covered by industrials/chemicals specialist analysts, not metals and mining ... similarly for those companies listed in China.

On the question regarding demand supply and the prospective operations in the pipeline, I would first like to make a slight but important distinction between a "prospective lithium project" and a "prospective lithium operations". With the former, I understand that there are now well over one hundred companies listed on the ASX that all purport to have a "lithium project", and globally there have been some three hundred plus projects listed by some estimates and research. This is a familiar picture, whether in my former industries which went through the internet, mobile, e-commerce initial bubble-then-burst-then-finally-a-boom, or in the resource and commodities, where we have seen similar mad rushes into various specific sectors over the years. It's no wonder many analysts and outsiders who have not spent much time in the space say that this level of interest and activity in the lithium sector is just like this or that commodity boom. The difficulty for many investors - institutional and retail investors alike, is to try and filter through all the noise on both the demand and the supply side, to try and figure out what exactly are the fundamentals and dynamic of the industry ... this cause is not helped when we have sub-par research based on very loosely pulled together assumptions and a very limited understanding of how the sector actually works.

In the real world, new supply can only really be guaranteed to come online if either one it is built/being commissioned, or has been paid for already with construction now needing to be completed. Planned projects will always be subject to funding, and until the total CAPEX has been taken care of by way of financing, one cannot assume that those particular projects will come online in their indicated target timeframes. I have tried to address this aspect of underfunding on a slide in Galaxy's latest investor presentation. There you will see analysis outlining the fact that if we are looking at an incremental 120-150kt LCE of demand coming online by 2020, then in order to meet and balance that demand, as of today we only have visibility on around somewhere between a half to two thirds of that. If financing is not completed for those capital investments (currently, we're probably at least a billion dollars short), then how is supply expect to achieve a balance with the future demand. That argument alone, even before we also take in account that projects take time to build and get into steady state production at nameplate (up to 3 years for hard rock project and up to 6 years for a brine project), that invariable they are delayed in development and that budgets may be overrun, I believe lends a lot of weight to the view that the industry will continue to be in a tight supply situation until at least 2020, if demand growth is to continue on it's expected trajectory.

As a result of these market current dynamics, I am confident that the 2017 pricing achieved for Mt Cattlin's product will be at more favourable levels than those for 2016.


AC:

At this point the successful start-up of production Mt Cattlin is the main focus of the company.
Can you tell us a little about what has happened there this year with regards to the plant upgrades?
There was a great deal of share holder disappointment when the first shipment was delayed.
Can you talk us through the reasons why GMM’s forecast of September shipment was missed?
What advantages have the plant upgrades produced and why has it been necessary?
What kind of production figures Galaxy are you currently expecting for the next 12 months?

AT :

Before the takeover, the GMM management had undertaken to expand the throughput capacity of the plant. When Mt Cattlin ran previously, it was rated at approximately 1mtpa - after the JV was formed, GMM took a view that this was closer to 800ktpa on a conservative basis, and after the expansion the plan was for this throughput to increase to 1.6mtpa. Additions to the flowsheet included reflux classifiers which have been engineered to assist in the mica removal process - mica levels in the past have been quite high, and while this did not prevent our previous Jiangsu Plant from being able to produce some of the highest lithium carbonate quality in the market (Jiangsu was a very advanced fully automated processing plant), it does mean that for less sophisticated conversion facilities, a higher consumption of energy when having to calcine and slightly lower efficiency when converting from alpha to beta spodumene. As announced recently, those upgrades and improvements to the plant have yielded some positive results on the product quality, which mica levels now down in the low single digits, but also lithium oxide grades now closer to 6%. This has given a lot of confidence to our existing and also new customers, that the Mt Cattlin product will be a very good feedstock for them to be using.

In terms of timing, Galaxy completed its takeover of General Mining in late August - up until that point GMM had still been guiding to be producing at the end of September. Based on Galaxy's assessment, and we did engage Primero (who have a few key principals in their leadership team) to assist with that evaluation - the Board took a view that the original timeline provided was not going to be achievable based on where the project was in terms of readiness at that point. We decided to be more conservative on the commissioning preparation and startup timetable, and so advised the customers and Mitsubishi of the same. In hindsight, I still believe this was the right decision - we now find ourselves operational at Mt Cattlin with a higher than expected product spec and working through the ramp up. On startup operations, I much prefer a position of hitting or exceeding quality and having to work on quantity, rather than vice versa ... this was a similar approach taken at Jiangsu.

Production guidance for 2017 is at 160kt of lithium concentrate. With the delays from fulfilling 2016 orders, this will be adequate to satisfy the backlog as well as new orders for year, for which we currently have at least 120kt of demand from existing customers. At these production levels, it is equivalent to the plant running at 50% yield, but our aim is to increase that to 70% over time. I probably will want to wait until steady state operations have run for a while, so we can see if yields are dialling up as planned, before we think about selling any of the production over and above the initial 160kt.


AC:

Galaxy was one of the first lithium companies on the ASX and the only one to have operated a processing plant in China. We now see a few lithium companies concentrating on processing over production as their next strategy.
Galaxy appears focused on developing production assets instead.
What lessons has Galaxy learnt from Jiangsu and how do you see the situation going forward, with regards to the profitability of production/mining vs processing?

AT:

Yes, we did run downstream processing for a while and technically it was a good operation. Unfortunately, when I stepped into the CEO role in June 2013, the Company was in financial distress and the balance sheet under severe pressure. The sale of Jiangsu was a necessary step in the financial restructuring we had to go through in order to allow Galaxy to survive. You may also recall that back then we did not have the pricing environment that we see today - as such, in the current market conditions, there is a lot more margin to be had downstream than previously, and that is what I believe is motivating some companies to undertake initiatives on the processing side.

The only thing I would say is that the building and operation of a chemical plant to produce lithium carbonate and or hydroxide, is much more complex than just running a mine and processing concentrate. In order to mitigate risk, one would have to have a lot of industry IP - most of that operational IP of how to produce lithium compounds from spodumene, sits in China. One of the reasons why Jiangsu was built where it was, was because China has been producing these products for many decades - not only is it a known process, but there is an ample amount of industry talent that knows how to process, and the regulatory framework is well set up to deal with such an operation. In order to de-risk execution on such a strategy, knowhow is key - so for a group like Tianqi to build such a plant in Australia, that element of IP has already been taken care of and they would only have to adapt to the local market for permitting, environmental approvals, sourcing inputs and operational talent. For other junior companies, whose management track records may lean more towards knowhow in mining, I would recommend  tying up with strategic partners who have done this before, to help de-risk the execution of going downstream. The key question is then, if those same potential partners see the margins to be earned and they retain the knowhow, they know how much their contribution is worth - how much value would have to be given up and shared by these junior companies in order to fulfil this strategy of going downstream to the processing side.

I do not really see our strategy as focused on processing versus production - given that we have a portfolio of assets at different stages of development, we have an ability that many other companies don't of being able to play out multiple strategies in parallel. We can build out our business with near term production and cashflow (Mt Cattlin) while we continue to push on our flagship development to allow us to get back into the business of processing lithium compounds (Sal de Vida), while also evaluating options for whether our next project (James Bay) should be a concentrate only, or concentrate plus processing operations. One key advantage that I see Galaxy having, is that having experience in both the production and processing business, and the relevant experience and IP, we have some good optionality on executing our strategy going forward - we could do one or the other, or both. For Galaxy, the key is what structure gives us the best risk/return balance and value creation opportunity. In the meantime, if there are margins to be captured in the downstream, we would aim to capture some of that through pricing our Mt Cattlin product appropriately to achieve the same.