Lithium’s turning point clouded by stormy weather

Demand is facing headwinds, in China and to a lesser extent the United States, and supply is being reined in due to oversupply and weak prices. These negative developments will in time mean even stronger demand growth later when pent-up demand is unleashed; producers will have an even greater challenge to make up for the time they have lost by having to put projects and expansions on hold.

This stop/start evolution is typical of commodity markets, especially when demand is relatively small, but mining/brine projects by their very nature tend to be large. For example, lithium demand in 2016 was around 200,000 tonnes of lithium carbonate equivalent (LCE), but new projects coming on stream at the time had an average capacity of around 20,000-25,000 tonnes per year. So when five new projects started to ramp up in a period, as was the case between 2015 and 2018 when Orocobre, Pilbara Minerals, Altura Metals, Alita Resources (formerly Tawana Resources), and AMG Lithium started up, it is easy to see how the market became oversupplied.

Worsening matters is that this oversupply has coincided with a fall in demand, caused for the most part by a structural change in China - in the second quarter of 2019 the Chinese government revised its subsidies for EV manufacturers. Subsidy changes in the previous year caused sales to dip before a strong rebound (see chart). Sales slumped between July and November last year, however, after the second set of subsidy changes. 

There were three core reasons for this. First, EVs with ranges of below 250 km per battery charge received no subsidy, which effectively increased the cost of the cheaper EVs, and those with bigger drive ranges received a reduced subsidy. Second, China’s economy was suffering from the prolonged US/China trade war. And third, growing numbers of reports of battery fires and EV recalls had started to reduce buyers’ enthusiasm. China’s sales dropped by 4% in 2019 from 2018 after they had risen in that year by 62% from 2017. 

The outbreak of the novel coronavirus (2019-nCoV) has further hit EV sales and production hard, with sales in China over the first two months of this year falling by 62% from a year earlier.

In the US, EV sales remain erratic – they grew by 40% year on year in 2016, by 22% in 2017 and by 85% in 2018 before falling by 10% in 2019. We wait to see what impact 2019-nCoV now has on sales. The collapse in oil/petrol prices may prove another headwind for EV adoption in the US. 

Given that EVs have been the main focal point for lithium’s demand outlook and China has been the market leader in EV uptake, the drop in sales in China has unsurprisingly knocked confidence in the lithium market. The slowdown in the US has also proved a drag.

Change in front runners

Another structural change set to benefit demand for EVs, this time in Europe, is the phase-in of tighter vehicle emission rules in 2020-2021. These will force auto manufacturers to reduce carbon dioxide emissions from the vehicles they sell – carbon dioxide output per vehicle must average below 95 g/km, with high penalties for exceeding this threshold.

This means original equipment manufacturers (OEMs) will target battery-only EVs (BEVs) and plug-in hybrid EVs (PHEVs) to compensate for the petrol and diesel vehicles they sell that have high carbon dioxide emissions. Ahead of the change, European EV sales were gaining momentum – plug-in EV (PEV) sales grew by 45% in 2019 to 564,206 units from 2018. The outlook is exemplary – once Europe has either overcome the virus or acclimatised to it.

With EV sales in Europe now likely to gain market share at a fast pace for many years ahead of a ban on sales of internal combustion engine (ICE) vehicles, two main drivers seem set to emerge for EV growth and therefore lithium demand: Europe and China.

We expect the slowdown in EV sales in China to be temporary given Beijing’s focus on cutting pollution, its desire to lead the world in EV technology and because the auto market in China is not yet saturated. Car ownership per 1,000 people is 173 in China compared with about 600 in Europe’s four largest countries, 590 in Japan and 837 in the US.

The introduction of a wider choice of EV models alongside price falls stemming from new battery technology and economies of scale means that sales in the US and rest of the world are likely to grow. We therefore remain very bullish for lithium demand from the EV sector, especially since EV penetration rates are low. Globally, PEV sales accounted for 3% of total vehicle sales in 2019, so there is huge room for growth. 

Short-term oversupply
Although the lithium market is currently oversupplied, low prices are forcing producers to rethink their production plans, which has already led to output cuts, producer stockpiling and the halt of some expansion work. The production cuts will help to rebalance the market, which should start to cushion the price fall, and delays to expansions should again bring forward supply shortages.
While the former is constructive, that is by rebalancing the market, the latter is a potential problem given that the demand outlook is for exponential growth in a few years. As well, halting expansion plans runs the risk that producers will not be in position to raise output to keep up with demand. 

While new downstream capacity can be built relatively quickly – in one-to-two years for an OEM EV production line (Tesla, for example, built its Gigafactory 3 in Shanghai in just under a year), with similar times required for battery, cathode and precursor factories – it generally takes 5-10 years to bring on new greenfield raw material supply. Judging by the difficulties encountered by incumbent producers to expand brine output, it can take between two and four years to raise production.

The raw material then needs to be qualified for all downstream use, which can take some parts of the supply chain more than a year to complete. The upstream part of the industry is therefore the biggest area of concern.

Hardly a week goes by without an announcement of billions of dollars of investment in downstream capacity while lithium junior producers are struggling to raise development cash. Although some of the large incumbent producers have bought into some junior projects – SQM’s investment in Kidman’s Resources’ Mt Holland project, Albemarle’s buy into Mineral Resources’ Wodgina project and Ganfeng Lithium taking a majority share in Lithium America’s Cauchari-Olaroz projects, for example – other global diversified miners have not significantly bought into the lithium space. Many lithium juniors are therefore struggling to advance because they are struggling to secure funding.

The three projects listed above have combined capacity of about 100,000 tpy of LCE; according to our model, demand will rise by 50,000 tonnes in 2021, 70,000 tonnes in 2022, 100,000 tonnes in 2023, 145,000 tonnes in 2024 and 220,000 tonnes in 2025. To meet this demand growth, many more new projects and expansions will be required. The industry appears to be cutting it fine to ensure availability of enough raw material in a timely manner. 

While the low lithium price environment over the past year or so has delayed investment decisions, 2019-nCoV is piling additional stress on to financial markets, which is likely to delay those decisions further.

In summary, the environment of low prices is leading to production curtailments – a necessary development to help rebalance the market. Although the outlook for demand had been for stronger growth this year, the coronavirus outbreak is likely to delay this outcome. This could mean prices stay low for longer, thwarting investment decisions for longer. As well, the global fallout from the coronavirus may further delay urgently required investment decisions if supply has any chance of keeping up with demand once EVs and energy storage systems become more mainstream.