Aerial view shows brine pools and processing areas of SQM lithium mine on the Atacama salt flats
Last week Sociedad Quimica y Minera de Chile (“SQM”) announced (SQM, 2018) that it had ended its long-running dispute with Corporación de Formento de la Producción (CORFO). The associated agreement, which terminates in 2030, will allow SQM to increase production to circa 180 thousand tonnes (“Kt”) of lithium carbonate equivalent (“LCE”) per annum.
At Cadence Minerals, we saw this as a positive development both for the lithium market and for our investments. However, the markets and some analysts clearly did not share this view, with some lithium equities declining by as much as 20%.
Initially, the headline numbers within the SQM announcement are considerable, given that 180 Kt of LCE represents circa 90% of all lithium compounds produced in 2017. However, the reality is complex and more nuanced.
To fully comprehend the potential impact, we need to understand not only the impact of SQM’s agreement with CORFO, but also the broader supply-side risks. Capital hurdles, upstream supply-chain bottlenecks, and the lack of availability of raw materials all need to be considered in this analysis.
Holistically, it is clear to us that the markets have overreacted. The “supply wave” is going to be more of a ripple, and will be delayed.
Supply Side Risk
The exploration, development and commissioning of mineral deposits is a high-risk venture. The probability of discovering a world-class economic deposit is estimated to be just 0.07% (Guj, June 2009). With much of the forecast supply coming from undeveloped assets, we take a risk-based approach to understanding which projects have the highest probability of delivering the right product at the right time into the market.
Taking this approach, we saw a deficit in the supply chain which ultimately would have a knock-on effect in the adoption of electric vehicles (“EV”), which is the primary growth driver in lithium demand. Therefore SQM’s increased quota is certainly needed. Given their pedigree as operators and the nature of their assets, the risk of delivery is substantially reduced.
However, increasing production from the Salar De Atacama is not simply a matter of flipping a switch. It will take time to ramp up production as they will need to deploy the capital and process the brine, the latter of which can take up to 18 months. So the market will probably only see material changes in supply from SQM’s Salar de Atacama in 2020 to 2021.
In addition, two aspects of the new agreement could have a significant impact on SQM’s investment decisions going forward. First, the agreement terminates in 2030, at which point the assets and operations could be taken over by CORFO. Secondly, the lease rates applied to production by SQM would result in circa US$2,000 per tonne of lithium carbonate being paid in “royalties”, probably increasing the cost to over US$4,000 per tonne of lithium carbonate.
Therefore, with the relatively short investment horizon to recover the additional capital expenditure needed and the increased production costs, the question remains as to where SQM will focus its efforts.
Supply Availability as a Constraint on Demand
One of the risks we have been monitoring for the last year is that supply availability has the potential to delay demand in the EV sector. In 2017 we saw forecasts (Roskill, 2017) predicting that EV penetration rates will increase to 28% by 2026. This would drive demand for lithium compounds to circa 1 million tonnes per annum.
However, these forecasts are precedent on the EV supply chain working efficiently, and supply meeting demand on time. But often this is not how things work out. We just have to look at the recent history of the lithium market to see delayed commissioning, stuttered ramp-ups and lower-than-forecast utilisations.
This could mean fewer EVs were available to buy. Customers faced with the purchasing decision may either delay an EV purchase, or purchase an internal combustion engine (ICE) vehicle.
As it stood and factoring in commissioning delays, we modelled supply deficits in both the short and medium term. SQM’s additional production has reduced this uncertainty, and we believe that the constraint on demand is somewhat mitigated.
No Negative Impact for Cadence
The full impact of SQM’s announcement is still to play out. Undoubtedly supply will increase, but in the long-term, demand will swallow this additional capacity. Importantly, we do not believe there will be any negative impact on the assets in which Cadence has an interest.
In fact, even if we end up with a relatively stable price over the coming years, it will bode well for the capital requirements to develop Cadence’s investee projects, since pricing becomes less of a variable in the melée of funding discussions.
Overall the impact is that the reliability of the supply curve has improved, shunting some marginal, difficult or high-cost assets out of the supply chain. Cadence’s investment strategy is designed to identify assets that not only represent value but – critically – also have cost advantages that are irreplaceable.
Our existing investments match this profile. It is this type of project that has the potential to deliver excellent returns, and ultimately to become an integral part of the raw materials ecosystem that will fuel the EV revolution.
Guj, S. B. (June 2009). Estimating Historical Probabilites of Discovery in Mineral Exploration. Centre for Exploration Targeting, 16-21.
Roskill. (2017). Battery materials forecast (not in the public domain).
SQM. (2018, January 17). SQM informs about Agreement with COFRO. Retrieved from http://ir.sqm.com/English/investor-relation/press-releases/press-release-details/2018/SQM-informs-about-Agreement-with-COFRO/default.aspx