Baby Steps Into The New World Of Battery Investing

In the underlying materials market, opinions seem to swing wildly. One moment there is concern that there is going to be a glut of materials such as lithium; next, it is going to be so rare that alternative material technologies will have to replace it. These divergences are sure indicators that we are still in an immature market that trades on imperfect data rather than one with broad knowledge and understanding. Even research from established houses has sometimes been so wide of the mark that it has been met by those in the industry with a reaction of laughter or despair. There are many challenges faced by investors new to the space, and this article aims to provide some guidance and highlight opportunities for those looking to get exposure to the technical materials market.

Many of the companies involved in the new battery industry are broad-based conglomerates with only a small part of their earnings coming from their Li ion business lines. In addition, the industry has historically been made up of a protracted string of companies undertaking individual processes: extraction, primary processing, battery chemical, battery material, battery assembly. This was compounded by the fact that much of the value chain for the production of cathode (lithium based) batteries had little or no overlap with the anode (carbon based) supply chain. All these factors made it hard to anticipate which materials would reflect the growth in the sector, and a bewildering choice of where to invest.

“To get exposure to the underlying minerals, the only choice is through the mineral producers. But which of these are worthwhile and which are duds?”

Starting at the end of the process, battery assemblers are large conglomerates who have exposure to many unrelated businesses and revenue streams. Most of the large battery producers such as Panasonic, NEC, LG Chem and Samsung SDI are large electronics firms with diverse earnings so investment gives little actual battery exposure.

The next step back up the manufacturing chain is the battery material makers, specialists who produce cathode, anode, electrolyte or separator materials. These relatively small players are highly segmented – without in-depth knowledge it is hard to know who to back. This leads most investors to the most upstream part of the chain: battery minerals and battery mineral producers.

Unlike commodities such as oil, gold and coffee, battery minerals lack a standardised specification which can be traded through forwards or futures. I would argue that (with the possible exception of cobalt) any standardisation is a long way off because as battery technology changes, so do the specifications of the required materials. Hence, a frequent complaint of investors is that the market for these materials is not transparent, so they cannot do proper valuations. I would argue that this is all relative: granted, you cannot track daily prices of spherodised graphite or lithium carbonate on a Bloomberg terminal in the same way that you can many raw materials, but with a little detective work, it is possible to track down pricing for certain specifications and at least see trends over time.

There is actually an abundance of research published by some of the Chinese brokers which has substantial detail on pricing, industry trends and the performance of Asian participants (but you probably need to be able to read Cantonese!). To get exposure to the underlying minerals, the only real choice is through the mineral producers. But which of these are worthwhile and which are duds?

It is crucial to note that the battery material industry is not simply a mining business. Yes, all these products come out of the ground – but this is closer to an industrial chemical industry than a mining industry. Small discrepancies in the composition of the ore can make large differences to the applications for the product, and hence the price. A frequently noted example of this is the Bolivian lithium brines, which superficially look to be the most bountiful in the world. However, the high concentration of magnesium in the brine (which is both detrimental to battery performance and very hard to isolate given current technology) renders these uneconomic. Similarly in graphite, the crystalline structure and in situ impurities will have a significant impact on the yield and the viability of a project.

These factors are a large part of the reason why many technical materials projects have been substantially late and over- budget during the development and ramp-up stages. Management teams who have only mining experience may not appreciate how demanding the specifications of production really are, and investors do not appreciate the risks.

The first step in choosing a battery material producer is, of course, to pick which of the battery materials will provide you the best “tail wind” going forward. Of the several key materials that go into a battery, each with their different supply dynamics. Below I’ll try to give a brief outline of the different materials for cathode (lithium and cobalt) and anode (graphite).

Lithium

The lithium production industry has been around a lot longer than lithium batteries – it has a history of use in ceramics, pharmaceuticals and engineering applications. Lithium was often a byproduct and so the longer established producers are multi-product chemical companies such as SQM (a potash producer), FMC and Abermarle (multi chemical companies). Solely Lithium-focused producers tend to be younger and smaller but give you better exposure to the market. These include Galaxy Resources, Orecobre and Neometals, and developers such as Kidman and Tawana.

As noted, building and commissioning plants takes a long time to get right. Each body of ore is different in its geology and chemistry, so no single process fits every plant. There is also a long lead time in the planning and pilot testing. As a result, supply responds slowly to increased demand, so prices stay high for longer than many would predict. Don’t believe the development companies that tell you they will go from greenfield to production in 18 months.

Similarly, you should be sceptical about predictions for the future of the lithium market. The DSO model (which assumes ore is able to be shipped to customers prior to beneficiation) seems unlikely to be viable in the long term as the processes required for removing extraneous material is specific to each ore body. Equally, I am doubtful that customers would commit to building plants at a cost of $50m to $100m without long-term ownership of raw material feedstocks. Lastly, most lithium ore is 1 to 3 per cent lithium, but customers require 6 per cent. That means transport costs for un-beneficiated material are higher. Still, the market at the moment means customers in China will take any material to get secure supplies.

Graphite

The graphite industry is in many aspects a few years behind that of lithium, but with signs that history is repeating itself in terms of lack of foresight of trends in supply and demand. Again, the industry has been driven by producers in China who created cheap, low-cost graphite for a range of industries. Now, the increasing quality demanded by the battery sector and the diminishing supplies in China means alternative supplies are required. There are large projects underway in Africa – However graphite is not a commodity and both the ore body and the end product must have the correct attributes to meet market needs.

Some of these projects have a large percentage of their material in amorphous form which, while it can be used for the steel industry, is not applicable to the battery and electronics industry. Similarly, the impurity profile is also crucial, with elements like vanadium and uranium being highly detrimental to batteries. At the moment, most of the graphite being used in batteries (about 70 per cent) is synthetic. The driver to switch to natural graphite is cost, but quality and characteristics need to be maintained, so it is likely that a few high-quality projects will become key suppliers to the anode market. It’s all about quality, not quantity.

Cobalt

Cobalt is currently the most in vogue of the battery materials. It is also the only one that has a more normal trading market. Nevertheless it does have its eccentricities as cobalt is largely a byproduct, and therefore supply has been determined by the pricing and demand for the primary host material, copper. Another problem is that the vast majority of cobalt has been sourced from the Democratic Republic of the Congo (DRC), which prompts ethical questions and concerns over security of supply. Several new companies are now seeking out projects elsewhere in the world, most notably Canada. Cobalt is more of a commoditised market and the processing technology is more established so risks should be lower.

Manganese

Although this is an increasingly important battery chemical, the total battery related demand at present is around 300,000 tonnes vs a potential supply in South Africa alone of around 15bn tonnes. Hard to see a substantial uplift in the pricing, given these supply/demand dynamics.

Other Industry Trends

The top concern in the battery industry at the moment is security of supply. The large numbers of separate companies and the disjointed market in the supply chain has meant that price signalling up and down the chain has been weak. Many battery producers had no inkling that there would be supply constraints as demand increased. At the same time, none of the demand pressure was obvious to investors in primary producers to give them the capital to acquire assets and invest in development. Markets in many battery materials are thin and this has led to nasty surprises for battery producers in securing inputs and volatile prices. Now with battery producers investing billions in new production facilities, they need to know that they can run these at capacity with a stable supply of material.

One of the impacts of this search for input stabilisation is consolidation both up the supply chain and across the various materials which in turn is creating a shift in the relative power of the different stages of the industry. An example of this has been the shift in relative power of battery chemical companies and extractors. A few years ago, the price setters of lithium were the companies (mainly in China) who converted spodumene to lithium carbonate. The scarcity of supply of primary lithium feedstock meant that converters had little market power, with battery material companies and assemblers agreeing direct deals with primary producers on future production, and using the processors to convert the material on a set cost basis (toll manufacturing).

“Investors should take note that forward-looking companies have started to look at combining assets across different battery materials.”

There is now consolidation at all levels of the supply chain. Their loss of pricing power has now prompted converters to try to invest upstream and make company acquisitions to secure raw materials. For example, Sichuan Tianqi’s acquisition of half of Talison, and Jiangxi Ganfeng’s 43 per cent investment in Neometal. At the other end of the process, as research and development has become more expensive, battery producers are cutting out the intermediary step of battery material makers and bringing this business in-house. Investors should take note that forward-looking companies have started to look at combining assets across different battery materials. If you had asked me three years ago whether it made sense to combine a lithium and a graphite producer, I would have seen few synergies.

As more consolidation happens elsewhere, it is now possible that the buyer for lithium carbonate will also be the buyer for cobalt and graphite. Simultaneously, mining companies, trading houses and electronics companies are looking to add battery material divisions, so companies that can be moved to a consolidated model may trade at
a premium.

Another market theme is jurisdiction. Security of supply means not only having a contract that gives you access to material, but enforceability of that contract. That means that supplies from stable countries will carry a premium. Western producers also are seeking to avoid dependence on China, and certain countries in Africa and South America are less desirable due to political risk, from export controls to tax and royalty regimes. The dependence on DRC for cobalt is the most obvious example, but there are others: Tanzania recently changed the rules on graphite, affecting producers there.

The battery industry is a developing market with changing technology and difficult pricing, but that is the opportunity. With constant need for development capital there will be plenty of activity and scope for attractive returns.