SQM - an over reaction?

From @niu

I posted these thoughts yesterday - the gist of it all being that there is a lot of inaccurate reporting that has created something of an unnecessary panic.
Given that some better informed commentary is starting to emerge, it probably deserves a thread to collect these thoughts... First though, my humble effort with basic maths error corrected (still waking up and realising that 2017 has been and gone). Next post is a great read.



Ok, now I mentioned the SQM downdraft, and it probably merits a thread of its own, but worth mentioning here all the same.

There have been some shocking stories
"Australia’s emerging lithium sector has been rocked by the news that one of the world’s biggest players could now more than quadruple its production...."

"...SQM’s lithium brine operations in Chile’s Salar de Atacama region are the lowest-cost in the world, and the company now has the ability to lift its output from about 52,000 tonnes a year of lithium carbonate to 216,000 tonnes a year by 2025...."

"...Analysts at Morgan Stanley said the news would be a negative for lithium equities, given SQM would also be permitted to ultimately expand to as much as 350,000 tonnes a year..."

Similar stuff at the FT
“SQM, the global lowest-cost producer, yesterday got the right to increase 4 to 6 times its annual lithium production quota. We expect SQM to aggressively recover market share from 2020 and see downside risk to the lithium price ,” said analysts at Morgan Stanley. “Negative for global lithium equities.”


Ahemm...
No wonder the market went in to a panic.
Ok, so what to make of all this. Well it seems to me that some have missed the devil in the detail. Some aspects have come out as, well, as much as I hate the term, "fake news", or in more traditional parlance - "bollocks..."

Ok, so some background. SQM and Chilean government regulator CORFO have been in a long running battle. SQM have had a quota in place allowing them to extract 1 million tonnes Lithium (measured in elemental weight not LCE...) by 2030. So, note very carefully - not an annual amount, and not LCE. They were so far ahead of that pace that they were at risk of exhausting their quota years ahead of schedule. These comments from Bloomberg last year

"Soc. Quimica & Minerao de Chile SA last month announced plans to increase its capacity to produce lithium carbonate from 48,000 to 63,000 metric tons a year. At that rate, it would reach its output limit of about 1 million tons well before the concession with Corfo, which owns the land, expires in 2030. Extracting more from the area would require applying for new licenses. SQM is embroiled in a dispute with Corfo over royalty payments.

“We estimate it will reach its quota and be forced to stop producing lithium in the Atacama salt flat in 2022,” Corfo Executive Vice President Eduardo Bitran said in an interview from his Santiago offices. "

SQM publish all sorts of data in their quarterly reports but enough to see (p4) that they were trucking along at 12kt LCE a quarter last year - lets call it 48ktpa LCE in round numbers, and they are investing 50m USD over 2017, 2018 to lift to 63ktpa LCE (p6)

Ok, so what is the this new deal all about? Well you will find it here

First they pay a one off settlement of 17.5mUSD to end the past arguments

Then come the ongoing payments -
* They will be paying an effective royalty of 19.14% on Q3 2017 prices of 12,600 USD/t. The royalty applies at 40% on prices above 10,000 USD/t so this will hurt.
* 10.8m to 18.9m USD/yr to be contributed to R&D efforts
* 10m to 15m USD/yr to the local communities
* 1.7% of sales revenue (on top of the royalty) for regional development

Then they are obliged to offer 25% of their product at preferential prices (equivalent to the bottom end of export pricing) to value add manufacturers in Chile.

Ok, so their cost structure ex Chile just got hiked upwards. Will they still be able to claim Atacama lithium as the cheapest on the cost curve? We'll see.

But then we get to the bit that roiled the markets - the spectre of over supply. But what did the announcement really say?.
The authorization by CORFO to increase the production and sales of lithium products produced in the Salar de Atacama. Subject to prior authorization by CCHEN, the Agreement considers that SQM Salar will have the right to exploit, subject to compliance with other agreed conditions, process and sell during the term of the Agreement (until the end of 2030) up to 349,553 metric tons of lithium metallic equivalent in the addition to the approximately remaining 64,816 metric tons of lithium metallic equivalent from the originally authorized amount. The sum of the above amounts is equal to approximately 2.2 million metric tons of lithium carbonate equivalent.

Now it is important to realise the numbers that are mentioned there are not annual numbers - they are the total quota until end of 2030 and expressed in elemental terms not LCE (conversion factor is 5.3). So when you read
"...the approximately remaining 64,816 metric tons of lithium metallic equivalent from the originally authorized amount...."
This means that they had about 345 kt LCE quota remaining on their original contract, and yes, as Mr Bitran suggested, at 62 ktpa they would have had to shut down in about 5 years - 2022...

Suddenly, I think you can see someone mis-reading the following lines
"...up to 349,553 metric tons of lithium metallic equivalent in the addition to the approximately remaining 64,816 metric tons of lithium metallic equivalent..."

and then it comes out as an analyst saying that they will
"....be permitted to ultimately expand to as much as 350,000 tonnes a year... "

Fake news...!

Ok, so what about 216 ktpa by 2025?

If we take 2.2mt LCE total quota over a 13 year period, it averages to 157 ktpa.

If we take 2.2 mt LCE total quota over a 13 year period and assume a compound growth rate in output from current levels, it comes to around 167 ktpa by 2025 (with around 16.9% CAGR)

If we take 2.2 mt LCE total quota over a 13 year period and assume a very unlikely straight line growth rate in output after the initial 62ktpa expansion, it comes to around 191 ktpa by 2025.

So 216 ktpa in 2025? I'm just not seeing that number in the quota, nor in SQM press releases. I cannot even find the year 2025 getting a mention...
That FT article quoted analysts at Deutsche Bank expecting 164 ktpa by 2024. A better guess, but a guess nevertheless
To be honest, I think everyone is guessing, but with the LAC and KDR JVs at full steam ahead, I think they might have their hands full getting close to 164 ktpa at Atacama by 2024.

216 ktpa in 2025 - Fake news...!

Interesting to see the Joe Lowry & Chris Berry take on this deal

Over the next few months, I am sure that the SQM picture will become clearer and the seemingly insatiable demand will be plain to see once again...