This article is a digest of a presentation delivered by Core MD Lara Smith to delegates at the Cobalt Copper Africa conference in Zambia, July 2018.
- This article may make forward-looking statements
- We don’t have a crystal ball, but our research is always based on sources believed to be reliable (we do our bloody homework)
- From time to time we take fees in shares or options, so with respect to the cobalt market, currently we are not entirely independent
- Nothing in this article is to be construed as investment advice. If you do decide to invest, please note that it is entirely at your own risk and prerogative and we encourage you to do further research and due diligence
- Please don’t sue us
Who moved the stocks?
Cobalt prices have run up sharply over the last 18 months, encouraging excitement and exuberance in the investment world. Major companies have been hunting for direct supply agreements with miners lasting upwards of 15 years, bringing a flurry of new (and not so new) mines and exploration companies to the foreground.
The cash for these projects was raised pretty swiftly, with investors and end-users seemingly content with the market’s progress. But just as we thought we could pop open the champers and caviar, metal prices came off, share prices came off and investors from all corners of the globe are now calling us to ask – how do we read this?
When there is a major market crash isolated to a single share, we can usually blame the company. When it’s across many shares, we must consider what (if any) fundamental changes have taken place in the industry, potentially creating a “new normal”. We’ve managed to identify a number key factors that have reduced cobalt prices and caused the recent sell off in cobalt shares (hint: it’s China).
- Cathode formulations
- Chinese EV subsidies
- Centralisation of Chinese cobalt refiners
- Junior miners revising their capex estimates upwards
- New supply from old established miners, most notably Katanga
While none of this is breaking news, markets are not renowned for being efficient; they eventually grasp concepts that should have been obvious from the get-go, resulting in major panic normally accompanied by a massive sell off. Remember, miners and investors are not usually aligned, but the pattern we’ve identified follows normal economic theory, especially with respect to China’s actions. And we hasten to add that there is no need to make rash decisions at this point.
There is an expectation that new cathode chemistries will come to the fore. The most promising technologies are the lithium-sulphur and lithium-air batteries, though battery manufacturers are not expecting these to become commercialized before 2025 and 2030 respectively. This is another indication that the road to commercialization is a long one. In general, the risk of competing chemistries in the short term remains negligible.
As per the “efficiency of use principle”, humans will always look to use less of a thing over time as well as make it cheaper. If prices go too high, then there is a natural tendency to substitute. But in this case, cobalt is a long way from its historic mean price, and it is instead the issue of supply that is prompting manufacturers to attempt to reduce the cobalt content of their batteries, as well as the growing need to increase the energy density of the battery due to the longer range EV’s coming into the marketplace.
It remains fact that nickel and cobalt are the most effective battery additions to increase energy density and stability respectively, and it is unlikely that cobalt will be ditched since safety is of paramount concern when launching a new consumer product globally. There are some concerns that the current cathode will be supplanted by the new 811 nickel-heavy model, but the absolute best case scenario for its rollout is post-2025.
New Chinese EV subsidy breakdown
- Any vehicle driving at a range below 150km per charge will not receive subsidies
- Any vehicle with a range of 300km per charge will retain the current subsidy
- Any vehicle with a range of over 400km per charge will receive higher subsidies
In 2016, China indicated that the subsidies for new energy vehicles would decline by 2020, dropping 20% y.o.y until 2019 before returning to the 2016 levels in 2020. However, while the new subsidy program dispenses less cash overall, this is to encourage quality, not discourage production.
China is absolutely intent on entrenching itself in the EV market and demand from the world’s biggest consumer is not going to change. However, in the short term, this has weakened Chinese demand for cobalt salts, with traders left to liquidate their positions and export their stocks in the form of metals. 925 tonnes of cobalt was exported in the first quarter of 2018, representing an increase of 249% over the same period a year earlier.
At the same time, China plans to remove the current limitations on foreign car manufacturers; at present, any foreign manufacturer in China must have a 50:50 local partnership with a limit of two such joint ventures in total. It’s also worth noting that, for the first time, the country is opening up its mining of critical raw materials to foreign investors and operators. So for now at least, investors have panicked too early.
China’s policy is to increase control over its various supply chains. The country’s first step is to buy-up the raw materials either directly or by way of offtakes. China then consolidates the supply chain by ensuring a few very large processing companies take the lead, removing inefficiency by targeting the smaller, less economical players. They’ve already done this with steel, with coking coal, with rare earths (consolidated to 6 main producers) and now with cobalt (10 refiners are responsible for 73% of the output). This means that China enjoys control the raw material, the refined product, the quantities produced, and ultimately the price.
We stand at a turning point. Junior miners are starting to show results, graduating from explorers to advanced developers, and investors are watching closely. They make guesses. If there is a delay on project results, they assume the worst and hammer the share. If one producer disappoints on capex, the whole sector might become a target for shorts. At the same time, there is now a normal cobalt price correction underway and so the rules of commodity investing still apply.
A great project with low costs, good grades and efficient processing will keep investors confident. Too many marginal projects have been rebranded as cobalt projects and the results are starting to affect the market. For example, the industry had always factored in additional volumes from main players, especially Katanga, and as major mines such as these ramp-up production, smaller players and nonsensical projects get left behind, but so do those companies that constantly fall foul of their own deadlines.
In March, Katanga produced 27,677 tonnes of copper, up from 2,196 tonnes a year earlier. The expectation is to release around 300,000 tonnes of copper and 34,000 tonnes of cobalt by 2019. About a year ago we were unsure as to whether the company would be able to deliver on 20,000 or 30,000 tonnes. Now we expect that it will be the higher of the two, contributing further to investor fear. This has increased the abandonment rate of junior cobalt explorers, especially those with marginal and/or young projects.
Fundamentally, not much has changed in the market. The lithium ion battery market is undergoing a revival with billions having been committed over the last two years and billions more to be committed over the next five years to expanding production capacity. We are witnessing the birth of the multi-gigawatt hour production facilities, which we estimate will increase demand for lithium ion by over 100GW by 2021.
What has changed is the need for quality deposits. Capital has become more discerning, and we expect this to persist going forward. Miners managed to lose plenty of fund managers over the last 4 years, while tech stocks became a darling sector. Now the movement towards cleaner emission standards and batteries has rejuvenated investment in cobalt, nickel and copper etc. This is great, but miners are competing for capital, and investors will be watching very closely for unmet targets.
In short, the battery and EV trends are not going away, and cobalt continues to follow a pattern that could be identified by economics-101 students. The reaction to the price correction is largely unfounded and reflects the lack of adequate market knowledge at work in the sector. The flurry of marginal cobalt projects is entirely unsustainable and is contributing to the sell-off, but we should view this as refinement towards good, economical deposits. Just as the Chinese state trims the fat, so do markets.