The Lithium Year in Review - 2017 - Joe Lowry

I realize there is most of another month left in 2017 but let’s face it: in December South America has both Christmas and early summer vacations; North America also goes into Christmas mode but now, in most cases, calls it the “holiday season” to be politically correct. Japan has the “bo nen kai” (忘年会) period of year end parties, the Emperor’s birthday and then year-end party preparation – you get the idea. December is not the most productive month around the globe so I am probably safe writing my thoughts about 2017 a bit early. I started the year posting about what I thought were two key themes in 2017 1) The need for lithium industry consolidation / alliances 2) Argentina as the next great lithium province Progress was made in both areas as SQM and Ganfeng invested in juniors forming what I like to call the unofficial “Lithium Star Alliance”. Despite some big talk, ALB is yet to make a significant acquisition move in the junior space. After purchasing an interest in Talison from Tianqi and buying China’s Jiangxi Jiangli, ALB now seems to be convinced they can grow quickly from existing assets since clearly they waited too long to deploy their “non-core asset” sale cash while Ganfeng and SQM made nimble moves to secure additional resources. Maybe Cool Hand Luke Kissam will surprise us before his beloved Clemson Tigers lose their next football game. I doubt it. The other member of the “Big 4” lithium companies, Tianqi, is focusing their energy on expanding the Greenbushes spodumene operation and building a large hydroxide plant in Australia. Tianqi is now the only major that doesn’t have an interest in multiple, significant lithium resources. Ganfeng has transitioned from a “no resource” player to a major with a broad resource footprint (Mt Marion, Cauchari, Mariana, Pilbara). A good mix of brine and hard rock assets surpassing their middle kingdom rival. Former major, FMC, completed the first phase their 20K MT hydroxide capacity expansion. They do not have resource capacity to support the next phase. Initially they said they could easily “source carbonate” at “attractive prices” from the market by 2018. It is now clear FMC’s strategy was ill conceived on many levels – the carbonate shortage continues so economically sourcing feedstock isn’t going to happen. As the world moves to mostly hard rock hydroxide production, FMC’s carbonate based hydroxide expansion was poorly timed and will leave them at the high end of the cost curve vs their larger rivals (ALB, SQM, Ganfeng and Tianqi). You knew I had to bring up the “House of Cards” at least once any time I write about FMC’s hydroxide business. Ironically, in the future, FMC would be much better off selling carbonate rather than hydroxide given they use carbonate as a feedstock while the majority of their competitors don’t. Carbonate prices are now higher than hydroxide in China (the world’s largest lithium market) and while that may be a short-term phenomenon – longer term hydroxide and carbonate are likely to sell at approximately the same price. Why? The best brine assets produce carbonate at a lower cost than the best hard rock; however, the same is not the case for hydroxide due to processing differences. For most of the last few decades brine operators who produce hydroxide from carbonate dominated the industry and needed to charge a premium to cover capital investment and conversion costs. In a changing world where most of the hydroxide capacity is hard rock based there is no logical reason for a premium for hydroxide. Sorry FMC – your hydroxide strategy is as we say in the southern US “a dog that doesn’t hunt”. On a more positive note, in November FMC made peace with Catamarca province and announced a significant resource expansion. It is no secret that Catamarca mining officials are not fans of FMC given they extract lithium from Catamarca but keep their office and plane in neighboring Salta province. FMC’s 20 years in Catamarca have resulted in very limited economic return for the province. The “new deal” will improve the situation.  FMC has made similar expansion announcements in the past that never happened but this time may be different as they are taking the steps needed to make an expansion a reality. From my perspective, FMC made the announcement and mended fences in Argentina to better position the anticipated spin off of their lithium assets into a pure play lithium company. In terms of the lithium industry consolidation theme, a combination of FMC’s assets with a multiple asset junior like Galaxy makes perfect sense but agreeing on valuation would be a major stumbling block. If FMC manages the spin-off process well, the “newco” has the potential to be a significant player rather than the lithium “also ran” FMC’s current management has “created”. In 2017, Galaxy leapfrogged FMC into 5th place as an LCE producer. Granted they are not producing lithium chemicals yet only spodumene concentrate but they are the owner of a world class brine asset, Sal de Vida on the same salar in Argentina as FMC. Clearly the themes of industry consolidation and rise of Argentina are linked as the South American country holds a more diverse brine resource base than their neighbor across the Andes. Another significant event in 2017 (technically 12/30/16) was ALB’s agreement with CORFO. ALB can now expand their capacity significantly but as their multi-year ramp up of LaNegra II demonstrates they will likely have significant issues delivering on Cool Hand Luke’s promises of 80K MT of carbonate capacity in Chile by 2021 and a total of 165K MT LCE capacity globally FROM EXISTING ASSETS. Don’t look for more than 120K MT of operating capacity at the end of 2021 and even that figure is probably a stretch. ALB clearly has no chance of getting “50% of industry growth” that they have often declared they will capture going forward. Mr. Kissam has done a wonderful job of managing earnings but his claims of where the company will be four years hence is a check that is going to bounce. I expect by some point in the first half of the next decade that ALB will be the #3 LCE producer behind both SQM and Ganfeng – the strongest operators in the industry. ALB simply isn’t very good at executing and operating new projects. Their recent growth has been via acquisition. There is nothing wrong with growth by acquisition; however, ALB didn’t acquire the skill sets required to enable expansion of their existing asset base. ALB benefits from but doesn’t operate Talison. They had to buy a Chinese company to become a credible player in hydroxide. Prior to buying Jiangxi Jiangli, ALB was a bit player in hydroxide having just built a new plant in NC that was by any objective standard “less than successful”. Yet Luke is now claiming he can more than double existing in capacity in four years from his existing resources. The troubles starting up LaNegra II illustrate the problem with that idea. What has changed that will make LaNegra III a success?  I would be remiss in a review of the year if I didn’t mention Orocobre. Despite the slow ramp-up, ORE is clearly a real player in the industry now. Whether high pricing saved them or not is a moot point. They are here to stay (or be acquired). Although many thought lithium peaked as a “story” in 2016, I am of the camp that lithium is in the midst of “15 years” rather than “15 minutes” of fame. The periodic table isn’t going to change any time soon – lithium is a key enabler of what will ultimately become an industrial revolution size transition to green energy not a “story du jour”. Unfortunately, analysis and coverage of the lithium story is still quite poor. All the recent interest in the lightest metal has yet to see the big banks develop a cadre of competent analysts. The furor created by Deutsche Bank’s June report about DSO (aka direct shipped ore) causing a near term oversupply and depressed pricing is a great example of wrong-headed writing on the space. What actually happened? More than half a year later most of the DSO is still unprocessed and “blowing in the wind” at various spots across China. Lithium carbonate prices went up sharply since the report was published and the writer now has another job. Expertise in any field takes time to build. Lithium is still a tiny albeit important market – it will take a few more years for lithium to have the quality of analysis it deserves. There are exceptions like Toronto based Mac Whale (the best name in lithium) and Shanghai based Jingwen Sun. DB is also improving but after the DSO debacle they needed to.  I already briefly touched on price. Although I have written multiple times about the “new normal” for pricing; I was surprised when carbonate price in China again crested $25/kg this year. Longer term my thought is that pricing in the teens over the next few years is an appropriate global average “guesstimate”. Should some of the anticipated new capacity be delayed, pricing in the $30s in not out of the question. Anyone that follows my @globallithium twitter account knows I spend a lot of time traveling the world to discuss the market. In addition, this year I have done over 100 “expert” calls from my home office. These calls put me in touch with investors from New York to Perth and Istanbul to Buenos Aires. I enjoy getting the perspective of people new to lithium. Most of the callers are very intelligent and just want access to quality information about a potential investment they know little about. Many calls end with me being asked "who else is knowledgable in this field that we can talk to?" Unfortunately, my list has fewer names than the fingers on one hand. Almost no one gets that the supply – demand imbalance is actually worse that stated over the past couple years. What do I mean? Part of the supply story since 2015 has been a lowering of global lithium chemical inventories from months to weeks/days. If you are a cathode maker in Japan or Korea where there is no local production and currently limited inventory; you pray every day that there is not a strike or an earthquake in Chile that cuts off your supply. So when the “oversupply in 2019” camp starts talking consider the fact that rebuilding inventory is a battery industry priority which potentially adds up to 30% to the demand line in the first year when supply is abundant. We aren’t going back to single digit global average carbonate pricing per kg for several years. On second thought - maybe never. 2017 was a year when virtually all the positive surprises were on the demand side and most of the negative surprises were on the supply side. I am looking forward to 2018. Execution of the key hard rock projects in Oz (PLS/AJM) will be a bellwether for future pricing trends. However, the most important supply side story from my perspective in 2018 will be the resolution of the SQM / CORFO situation. I am hoping common sense prevails. I have a lot of college football to watch today which is why I didn't get to subjects like Tesla's production woes or Nemaska still not being financed or VW / BMW's flawed lithium sourcing strategies, or CATL trying to do a deal for #NAL or that fact that over 300 companies now have "Lithium" in their name and most are little better than scams. My advice which, of course, is not investing advice but IS simple to follow: focus on the majors and the top juniors. Stay tuned.