SQM’s New Deal and the Lithium Market Sell Off
SQM finally ended an almost four year long dispute with the Chilean Government, with the latter allowing the company to expand their lithium production quota from around roughly 50-60K tonnes today up to 216,000 tonnes per annum (tpa) through 2025. As a result of this news, the markets responded by selling off lithium stocks across the board out of worries of an oversupply caused by SQM flooding the markets. Here’s our take on what Lithium investors should consider following this news out of SQM. Impact on the Market: In our opinion, while this is major news affecting the potential supply outlook, it may not meaningfully disrupt markets for another couple of years. While it’s not as extensive as starting from scratch, a brownfield expansion like this for SQM will by no means be an instantaneous change. It’s not like they can just flip a switch and flood the market with new supply. Thus, in the shorter term, the story has not changed. Pricing: We believe the Oligopoly, and SQM who will now be the driving force of that Oligopoly, will still strive to maintain price stability in order to create the most favorable environment for themselves. As the lowest cost lithium producer, SQM is in the driver seat because the major customers will be coming to them first. So they will bring new supply on in lockstep with market demand. Remember, pricing is important because the higher the pricing = higher margins = Higher Profits for a company = Happier Shareholders (potentially of course….if only it was that easy!). Junior Miners: The companies most affected by the news are the junior miners. Those that come online in the next 24 months might be able to carve out a piece of the pie for themselves. But in the longer term horizon, it’ll be tougher for the newer entrants to come into the market. SQM will have the capacity to keep suboptimal competitors out of the market if they choose. SQM’s announcement must not have been met with great fanfare from future producers who are still 3-5 years out from production, with higher cost/lower tier projects. To this point in particular, the financing market could be more challenging following this news for junior miners that still need financing. Consolidation: We believe the consolidation story becomes ever more important. The more prominent juniors that will be coming online relatively soon and/or have low cost operations could potentially look to buy up great assets that are in development to add to their portfolios and help build their market share. Furthermore, the bigger players (ALB and FMC as an example) will also be buyers in this environment. Think about it this way, ALB was recently complaining about the value of many of the Junior Miners and how much their stocks had run up. After today’s major selloff and potential future sell offs, this will be welcome and exciting news to a company such as ALB. Market Share: The expansion will allow SQM to dramatically increase their market share. The other dominant producers will no doubt have to scramble to find ways to match SQM’s large scale, low cost production. Albemarle, who also operates in the Atacama, but with a lower quota of 80,000ktpa (though they applied for 125,000ktpa) might not receive the same level of support from the Chilean government given that they are a foreign company. As such, they might look to different sources to bridge the gap, but more on that later. It should also be of interest to see what happens once FMC, one of the original members of the Lithium Oligopoly, spins off their Lithium business later on this year. Albemarle’s Response. Given ALB’s rivalry with SQM, we believe they will definitely be responding to this news. They want to be in the lead position in the lithium boom going forward, and will strategize to ensure that happens. For starters, they will probably try to maximize any quota expansion negotiations with Chile. Beyond that however, they will look to tap into any further expansions of their assets in Argentina, Australia, and the US. And finally, expect them to be very active in the JV, partnership, or M&A arenas. Management has stated that they are looking for new deals or opportunities, but we believe this news will definitely be lighting a fire under them to get something done. Even before SQM’s negotiations were finalized, SQM formed prominent JVs with Lithium Americas and Kidman Resources, while Albemarle did nothing. Now, ALB has even more ground to make up, and will look start the process soon. If not, we have no doubt that shareholders will let them know their displeasure by voting with their wallets. Just today, the stock was down over 11% before recovering some of those losses to end the day down about 7%. To put that into absolute terms, the company shed over $1.4B in market cap at the lows of the day. Buying Opportunity: Warren Buffett, one of the most famed investors, is famed for saying “Be Fearful When Others Are Greedy and Greedy When Others Are Fearful.” The Lithium selloff could be a great buying opportunity2 – the key is to look carefully at all producers following the SQM news release. As an example, current Junior miner producers such as NeoMetals (-3.4%), Galaxy Resources (-8.9%) and Orocobre (-3.7%) are all potential options to look into. Likewise, the story for 2018 producers and 2019 producers has largely not changed at least in the near term. Thus, projects such as Pilbara Minerals(-7.4%), Altura Mining (-6.9%), Tawana Resources (-5%), Lithium America’s (-15%), and Nemaska Lithium (-6.15%) might all be interesting plays to look into following the news release.
