By all accounts, we have been through an eventful four years with the boom, bust, and recent boom again in the battery metals. While it is important to remember that it’s never “different this time”, I do think we are at an interesting hinge in the electrification thesis. This hinge is notable in several ways as the battery metals markets mature and only increase in their strategic importance.
The market consensus for just about any battery metal calls for steadily increasing demand with a supply response that is likely to keep pace only in fits and starts, creating opportunities and threats for an investor base that is growing as the battery metals opportunity continues to make itself all but obvious.
In my previous article, I focused on the “state of play” for different battery metals, calling that moment in time Churchillian and viewing it as the “end of the beginning”. While the general availability of the metals is important, this piece will focus more on the macro factors driving the current rally in the sector. I like to think of these forces as pillars underpinning this secular change in terms of how energy is generated, stored, and used. They can be thought of as the Four Ds: decarbonization, cost deflation, decoupling, and demand. However, it is the rise of geopolitical tensions and ESG that deserve a deeper discussion here. These forces will continue to play an increasingly important role in capital accumulation and allocation well into the future and I think require a reassessment of one’s investment rationale and philosophy.
CHESS OR CHECKERS? WHAT GAME ARE WE PLAYING?
Geopolitics and the associated tensions are set to play an increasingly central role in the global race to build electrification supply chains. This is one of the biggest changes in the landscape between previous cycles in battery metals and today. The line between economic security and national security has been blurred – perhaps permanently. One could argue that this line of thinking has steered China’s growth ambitions in recent decades, and it appears that other large trading blocs such as North America and the EU are set to follow suit, especially when you look at the trillions of dollars and euros of proposed stimulus directed towards “green growth”.
An increasingly assertive China has to date flexed its muscles mainly through its checkbook, encouraging outward-bound economic development through the Belt and Road initiative (BRI) and internal growth through strategies such as Made in China 2025. Much of the capital invested in lithium development in recent years has come from China in the form of equity, debt, or off take and this current and future supply has been locked up. Concerns around debt trap diplomacy have served to halt some of the initial progress made in the early days of the BRI rollout, but with respect to battery metals supply chains, China is well ahead of the rest of the world.
The pendulum has clearly swung away from a more globalized “flat” trading system and it appears that a Biden Administration will not change course from the previous Administration’s approach to China. The meeting the US and China recently had in Alaska did not go as well as either side wanted and so more of the same tension is to be expected. The isolation of China or surrounding of the country by democracies (which I think is the point of the Quad – Australia, Japan, India, and the US) is a theme to watch closely but is also an opportunity for countries around the world to exploit their advantages as a top tier low-cost supplier of critical materials such as lithium or nickel.
So, if a rising China is less willing to play by global norms, this raises an important question being debated in corporate boardrooms and political capitols alike – is decoupling or regionalization of supply chains the next logical step here? An interesting side effect of COVID is the focus on selective decoupling of supply chains and the general push back against Chinese dominance of battery metals. With the EU pushing forward with its own EV supply chain through planned the spending of trillions of Euros, North America is no longer just competing with China for capital and market share. This is another incredibly important development in battery metals since 2017. Separate supply chains for certain industries such as PPE, or critical metals are a real possibility over the next decade. Capital is widely available due to low interest rates and accommodative central banks and (rare) political will is in place, but the patience to see this through is the only outstanding issue. The competition for raw materials, intellectual property, and intellectual capital is now a three-way race between the three largest economic blocs in the world: China, North America, and the EU. What does this mean for raw material availability?
A LITTLE AIN’T ENOUGH (WITH APOLOGIES TO DAVID LEE ROTH)
Given the geopolitical backdrop, it has been encouraging to see the amount of capital raised in the lithium sector and recent M&A activity. Recent equity raises by Albemarle and SQM of over US $1 billion each combined with other equity capital raised in recent months put the total at over US $4 billion. For an industry that boasts global revenues currently well below that, this is a significant accomplishment and testament to the belief in future growth on the part of companies and investors. Additionally, the US $3.1 billion merger between Orocobre and Galaxy Lithium helps to consolidate the lithium producer sector while building a new market participant with both geographic and geologic diversity and a strong balance sheet. Incidentally, the strategy of growth via M&A has a history of success in lithium judging by the outcomes of the Lithium Americas-Western Lithium merger and the take over of Altura Mining by Pilbara Minerals. Though much more capital is needed, there may be a lesson in here for battery metals companies thinking about balance sheet sustainability throughout this decade.
Seasoned battery metals investors have debated the potential for a structural shortage of material which will underpin any shift towards electrification since early in the last decade. This is an important but nuanced argument and really must be thought through on a raw material-specific basis. While the trajectory for lithium or copper is clear, the electrification thesis will affect these markets differently give their overall sizes, dependence on battery growth, and pricing transparency. Given the vagaries in pricing and associated volatility, perhaps a strategy of just locking up raw material supply is no longer enough. I would argue that owning the intellectual property around resource extraction (such as direct lithium extraction technology), cathode and anode production, or battery recycling is at least as important going forward. There is no shortage of any battery metal “in the ground”. Certain battery metals contain known resources that would last decades even at current elevated consumption rates. The real challenge is in producing battery grade material at scale and the battery metals producers have historically found this a challenging endeavor, so a focus on more efficient extraction and production methods offers somewhat of a hedge to these challenges as supply chain infrastructure is built out.
ESG IS THE VIP
Finally, once we have established the “why” for building battery metals supply chains, the “how” will become increasingly important. This speaks to the newfound emphasis on ESG goals across the industry. Turbocharged growth, opaque pricing dynamics and oligopolistic market structures have left battery metals development to a relatively few companies and a few countries. For the industry to grow to meet surging demand to serve the EV and renewables markets, the origin and flow of materials such as lithium or rare earth elements must become much more transparent while also keeping a lid on costs. Ironically, a more transparent supply chain likely involves increased domestic mining capacity and should be a priority in global capitals such as Washington DC, Ottawa, or Brussels. This may drive up costs but is a worthy price to pay for supply chain transparency and self-sufficiency. We know we are going to need more raw materials to achieve aggressive decarbonization goals. Would you rather the raw materials come from countries where ESG criteria are more difficult to monitor? This is a key question facing all stakeholders involved with the decarbonization thesis.
Capital is the fuel that breathes life into the energy metals sector and is the bridge between ore in the ground and the battery in your car. With a more relentless focus on projects that adhere to a strict ESG criteria those projects that can demonstrate a strict adherence should be first in line for “green” funding. Capital always finds a home where it is treated well and jurisdictions with an attractive investment profile, proximity to major end markets, and respect for the rule of law would appear to be a prime destination for some of the capital needed to construct resilient battery metals supply chains. It is incumbent upon both the public and private sector to coordinate efforts to raise and deploy capital in an efficient and effective manner.
PIECING IT ALL TOGETHER
The bottom line here is that to hit even modest electrification goals (10%, for example) we are going to need an enormous amount more material and these typically small markets such as lithium or rare earth elements will need to scale flawlessly and aggressively – no easy feat when you consider the fact that these are really specialty chemicals that are being produced. New supply will have to come from existing players, new players, recycling, and a leveraging of technology. This is necessitated by the factors discussed earlier in geopolitics, supply chains, and ESG. While the demand appears to be there, a coordinated effort between the public and private sectors which focuses on R&D and project development is the optimal way to ensure supply from domestic sources or other allies.
The bullish narrative around battery metals has been amazingly resilient and accelerated somewhat because of the effect of COVID on supply chains. This perceived freight train of demand is about to run headlong into several industry-wide challenges including increasing product purity demands, decarbonization/ESG requirements, and a potentially inflationary supply chain rebuild. A key takeaway is cost curves for battery metals including lithium and cobalt will almost certainly have to rise, implying a positive outlook for battery chemicals producers that can finance, build capacity, and sell product to a growing list of downstream customers.
In the 20th Century, owning the raw materials in a supply chain conferred a competitive advantage. Just ask Henry Ford. However, the 21st Century demands something more as raw material control is not enough. Developing and owning the intellectual property around battery metals supply chains is the next Great Game. A holistic view of each piece of the supply chain and technology’s effects on it offers a front row seat to the opportunities and challenges that will confront investors as we move on from the “end of the beginning” over the next decade.
