At a panel hosted by Chris Berry, Daniel Jimenez of iLi Markets and Kevin Smith of Traxys discussed risk management in the lithium space.
Lithium has had a good run so far in 2021, with prices rebounding since last year on the back of continuously strengthening demand from the electric vehicle (EV) sector.
As the industry continues to evolve and supply starts to play catch up with growing demand, investors are watching for ways to manage risks in today’s market.
At the recent Lithium Supply & Markets conference, held online and in person in Las Vegas by Fastmarkets, Chris Berry of House Mountain Partners led a panel discussion featuring Daniel Jimenez from iLi Markets and Kevin Smith of Traxys North America.
Read on for an overview of the five key aspects they brought up when it comes to looking at risk management in the lithium industry right now.
1. Demand and supply imbalance
Lithium investors who have been following the market for some time are well aware of the supply and demand dynamics of this market. The main driver of lithium demand is the EV sector, as lithium is essential in the batteries used to power these cars.
With forecasts for EV sales constantly being reviewed to the upside, and with actual sales materializing in the past year, demand for lithium is also expected to soar. But the supply story is a bit different — analysts continue to question where supply will come from in the coming years, and many have also highlighted the need for investment in the lithium sector.
“On the demand side, I think the risks appear to be very limited,” Jimenez said. “Probably the main risk comes from the supply side and the ability of the industry to supply the lithium units, to mine the lithium in order to supply the needs of the industry.”
The first in particular poses a risk. “If we look at the supply proposition of the next few years, by 2025 most of the incremental supply which will be needed will come from mostly greenfield expansions, which have an inherent risk — they have resources, they have technologies, they have people risks,” he said.
“Today there are not too many experienced people in the industry capable of executing on time, on budget, with a ramp up according to the design.”
Lithium prices have been performing better than many had expected so far this year, but investors are still wondering how this cycle is different from what the market saw back in 2017 and 2018. After trending upward during that period, prices for the commodity declined and then stayed at low levels until 2020, when the market began another uptrend.
At the same time, Traxys’ Smith said, forecasts are constantly being optimized as the demand side is evaluated, and as auto manufacturers make big capital and expansion announcements. But, he said, “there’s a bit of a leap of faith that comes with that.”
“Usually that will be easier to handle when there’s a consistent price signal from the market, but the going from US$20-something a kilogram down to US$6 back to US$20 in the space of three years makes that a little bit more challenging,” the expert added during the panel conversation. “I think the buzzword around our office as we look at our business and work with our partners in the space is finding sustainable economics that work for everyone.”
In the past, the price risk was always borne by either the seller or the buyer, because the industry used to operate with longer-term fixed prices, Jimenez explained.
“That’s how the risk was so to say mitigated by the two, but the truth is somebody in that equation always won and somebody lost,” he said.
For the expert, lithium futures contracts will certainly help to at least decide what risks to take for the short term, and they will be a valuable tool for some of the sellers and some of the buyers.
“Longer term though, futures will not help us diminish the inherent risk with supply and demand, and the price that is determined by supply and demand. And that is a risk which cannot be mitigated because futures will eventually only give risk mitigation for the period of the futures contract,” he said.
Environmental, social and governance (ESG) issues have always been around, but mining companies’ ESG credentials have faced more scrutiny in the past year as investors look to manage risks.
“ESG is something which is demanded by consumers,” Jimenez said. “And regulations can be as tough as you want, but if consumers don’t want your products because they do not consider you a sustainable operator, you cannot operate.”
For Jimenez, the lithium industry is trying to do things as sustainably as possible.
“There are mistakes, of course, from time to time, but I think they’re all working, they are aware of these limitations,” Jimenez said. “The industry needs to make the effort to communicate well.”
Similarly, Smith said that in many ways, miners are probably leading the charge in adopting ESG standards. “I think getting up and running and supplying the materials that are needed at an economically sustainable number with reasonable ESG metrics is a good starting point,” he said.
“And you can always improve from there going forward instead of getting tied into knots that hold material off the market or prevent supply from coming to market and disrupt the supply/demand balance that’s actually needed.”
4. Product quality
Another risk discussed during the panel was product quality, as the industry requires particular specifications that can vary among end users.
“I look at it and think that over time there’s going to be a convergence of standards out there, specifically with lithium quality in specifications. It needs to happen,” Smith said. “At the end of the day, if there’s still 10 or 12 different varieties of materials out there, it’s going to be very hard to drive that process forward (with) sustainable improvement in a meaningful way.”
Over the years, one thing that has happened is that the contaminant profiles required by the battery industry have become lower and lower, Jimenez said.
“So it’s not so much the lithium purity, which comes at the end of the day with it, but the elimination of contaminants in the process. That will probably continue to a certain point, but only to a certain point.”
Jimenez also explained that a lithium chemical can be refined for around US$1 a kilogram. “That is also something to bear in mind,” he said. “Especially when we look at new projects, should this project strive to produce a battery-grade chemical from the very beginning? It will be extremely difficult, but there is a whole industry capable of refining this technical-grade chemical into a battery-grade chemical in a much quicker way with lower capital requirements, probably with installed infrastructure already.”
A large portion of the EVs that are produced today come from North America and Europe. Jimenez pointed out that they essentially have to rely on lithium being mined in South America or in Australia.
“So there’s a clear intention by these two regions to bring the supply chain closer,” he said. “At the end of the day, I think this industry will have to have extraction everywhere and refining locally. I think that’s where the world is going to move in the lithium industry.”
For Smith, the interruption to logistics and supply chains from COVID-19 brought a great test to manufacturers, which had to figure out where the weak links were in their supply chains and get ahead of those before things could potentially get worse.
“That comes from diversifying supply,” he said. “We’re starting to see a little bit more of that down the supply chain, people identifying where the stops are in the flow of materials before they get to the OEMs, and that’s going to continue — and rightly so.”
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Securities Disclosure: I, Priscila Barrera, hold no direct investment interest in any company mentioned in this article.