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Lithium: A Secular Energy Storage Growth Trend

Updated: Oct 19, 2022

A research piece made possible by a collaboration between Ayesha Tariq, CFA and Mayhem.


Summary:

  • Battery and storage technology has become much more important in our race to find environmentally sustainable solutions.The demand for lithium, one of the primary inputs, is set to increase 42 fold by the year 2040.

  • This rising demand is causing outsized increases in the price of input because of supply side shortages, which in turn are related to insufficient funding as well as inefficient pricing in markets.

  • Investments in production need to come from partnerships with manufacturers and from capital allocation through the financial markets.



A Quick Primer on Lithium-ion Batteries, and Why They are Used


  • High energy density: lithium is lighter and holds much more energy than other materials.

  • Less self-discharge: lithium-ion batteries lose much less power during usage than other types.

  • Lower maintenance: most other batteries need maintenance to ensure proper function; but lithium-ion does not have that issue, easing usage.

  • No priming necessary: lithium-ion batteries are ready to use after they are charged, reducing the amount of work necessary. Other battery types need to be primed.

  • Wide applicability: lithium-ion batteries can be used in small personal devices all the way up through electronic vehicles and grid power storage.


What goes into a Lithium-ion Battery?

While lithium is not a significant element within lithium-ion batteries by weight, it is also a very light metal. That being said, without lithium there is no lithium-ion battery, thus the importance of the element cannot be discounted as its akalai properties are another part of what make it an ideal element for energy storage.

White Gold: Opportunity within a Troubled Industry


The recent surge in commodity prices, and the episode of price squeezes on the LME, has certainly brought to light an interesting quandary we face in the market for electric vehicle (EV) inputs. For a race that we want to win quickly, companies in the space have been surprisingly slow in finding an efficient process for production and pricing. This delay is doing the industry no favors as we are now seeing the impacts begin to manifest.

As the push for environmentally sustainable solutions intensifies, the demand for lithium is set to soar. According to the IEA, by the year 2040, the demand for lithium will increase 42 fold compared to 2020 levels, with the majority being consumers by EVs and storage solutions.

As the world moves toward a future that relies more on both renewable energy generation and storage, there will be a myriad of additional demand drivers for lithium coming online that will continue to grow over time. A surge in appetite for the ‘white gold’ is set to propel the lithium industry to new heights, offering both investing and trading opportunities within the space.


EVs: A Promising Sector with Too Many Vulnerable Players


Given that almost a third of an EV battery’s cost comes from lithium, a supply shortage will drive up the price of EVs, deterring consumers from adoption. The industry has been subsidized to a large extent to bring EVs to market, but as the subsidies fall away consumers will pay the price for higher input costs.


EV adoption rates are sure to slow, if affordability becomes an issue. The rise of cost in lithium, as well as lack of availability of supplies for some battery producers may also create additional headwinds in the EV industry, especially for more vulnerable players. Combine this with other factors, such as limited availability of other key metals like cobalt, and nickel, as well as the shortages of semiconductors, and we can see there may also be opportunities to take positions against these same more vulnerable EV companies. Something we may cover at another time.


A Deep Dive into the Lithium Industry


Lithium production facilities can take anywhere between five years to 10 years to be fully functional depending on the project location and type of lithium being produced. The return on mining lithium has not really been worth the investment for most capital providers. Hence, the space remains neglected and unethical practices prevail. There just isn’t enough being poured into the research and development of more efficient production practices.


In fact, instead of additional investment in the space for battery technology to alleviate supply constraints, mines are now being shut down due to environmental concerns, and rightfully so. The new Chilean government has been arguing against the production of lithium salts in the Atacama Desert using irreplaceable fossil water because of its damage to the environment.


Much to the distress of producers, the lithium market is still driven by longer term contracts fixed at lower prices and only to serve the actual requirement of battery manufacturers. Negotiations typically take place annually or biannually. As such, there is often a time lag between actual market pricing and what producers will be paid. This also means that producers often don’t get paid enough, and there’s little by way of additional investment going into mining and production, particularly ethical production as a result.

While we do see somewhat of a shift towards shorter-term contracts, the process needs to change drastically. What is required is a partnership between manufacturers and producers such that risk capital trickles down to the eventual mining process. This would be an ideal way to create the investments needed not only to mine locations ethically but also attract the right talent and expertise for efficient production methods. At present, most lithium mines are of much smaller scales than other commodity mines. There isn’t even sufficient research into how much these mining techniques can be scaled.


Further consideration of this partnership would, of course, be the non-hazardous recycling of batteries at the end of their lives. At present, none of the EV manufacturers have really outlined what happens when these batteries cease to hold a charge or are otherwise thrown away. The improper disposal of lithium batteries is hazardous to people and the environment, which basically defeats the purpose of us moving to EVs. The disposal of EV batteries has not reached a critical scale as of yet. But, with the way EV sales are taking off, this is a valid consideration for EV manufacturers. In fact, it benefits the production process, as recycled lithium can then be used for new batteries.


We also need to see a more efficient financial market for lithium. A major factor for the efficient functioning of commodity markets remains the process of price discovery. And, there is little to none in the lithium market. Price discovery is where supply meets demand but, more importantly, it's an auction style process where buyers can meet the prices of sellers. This fosters an environment where a trader can find prices which they consider fair and efficient.


Without price discovery, there will continue to be an imbalance in the market, with supply constraints driving up prices as they did in 2021. According to Benchmark, the price of lithium and its derivatives used in battery production has increased over 400% year-on-year, fueled by panic buying instead of rational price discovery.


With the widespread requirement for lithium, the argument that lithium is a specialty chemical instead of a commodity, no longer holds water. There are of course, various grades and specifications but, the chemical with its varying grades can be commoditized by adopting benchmark pricing.


This is exactly what the LME and CME have started to adopt through cash settled futures and it’s certainly a step in the right direction. At this point, supply still remains constrained and the market perhaps, is still not large enough for speculative plays but it does allow for hedging transactions. Exchange-traded instruments open up avenues for new entrants into the market, including investment banks and traders. It affords greater price transparency and stability creating a more systematic way for funding to enter the space.


Given how important battery and storage technology is in creating a viable market for EVs and environmentally sustainable solutions, one would think that we’d have much more funding dedicated to the research. Yet we’re far behind. Not only do the manufacturers have to step up in terms of capital contribution but, financial markets also need to get involved to foster an environment for capital allocation.


Opportunities in the Lithium Space

The lithium industry has a number of major players. For the potential opportunities we discuss we will be focusing on two companies that are producing lithium which may be positioned to benefit from these growing secular demand trends.


Albemarle Corp. (ALB)

ALB has a bullish chart, with a strong uptrend and recent price action that is confirming a higher low via a breakout on strong volume and over a key supply zone. The recent breakout was catalyzed by their recent earnings report, with an EPS beat by 46% and a revenue beat by 10.6%.

With strong fundamentals, macro tailwinds, and a strong technical chart we like this setup for potential gains. We would be comfortable entering a long trade in ALB where it is now, using the breakout level of $230.00 as my stop, and looking for the stock to recapture its all-time high $291.48. Once achieving that high we would take half to two-thirds of our position off and let the rest run with a 4% trail stop.


Livent (LTHM)

LTHM has a strong looking chart. It is in a defined uptrend channel, and challenging an area of supply overhead. In order to give the bulls a real technical upper hand, however, we need to see the $28.02 level taken out to the upside on a weekly closing basis such that we take out a key area of demand.


At that point we would be inclined to take a long position with a stop just below that $28.02 breakout level. That will put the LTHM chart on a similar page as ALB, giving it some additional momentum as a technical tailwind.

Like ALB, LTHM recently had a strong earnings report with a 50% earnings surprise and 2.92% revenue surprise. LTHM has topped consensus revenue estimates four times over the last four quarters, and earnings estimates three of the last four.


Our upside target for LTHM would be $32.32. At that point we would be taking half to two-thirds of our position off, and looking to see if the all-time high of $33.04 is taken out. After taking off our core position, we would put in a trail stop of 5%.


In summary


The lithium industry seems to be an area where we can expect secular growth trends to prevail as the world migrates to more EVs, renewable power storage, and other applications for lithium-ion technology. Opportunities may exist in and around the space to take advantage of these trends.


4 Comments


Horse
Horse
May 09, 2022

This is absolutely fantastic work, very nice piece thanks for sharing it!

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Markets & Mayhem
Markets & Mayhem
May 17, 2022
Replying to

Thank you, Horse! :)

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Andy Featherston
Andy Featherston
May 07, 2022

Fantastic research and summary- thank you Mayhem and Ayesha so much. Very thoughtful.


I think this is the first time, we differ Mayhem. Healthy disagreement, though, is a good thing. I’d hesitate on either of these plays, ALB has a multiple over 40, margins of below 4%, debt to assets around 30%, and a price to sales of just under 8. Don’t get me wrong - I have a couple favorite stocks with far worse financials that I’m long on( with very small allocation) and thus I’m totally hypocritical in some sense :) - but I’d wait on these two plays a while for a better price. I bet we get one.

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Andy Featherston
Andy Featherston
May 07, 2022
Replying to

I wanted to mention too, I’ve been waiting anxiously for Redwood Materials (lithium battery recycling) to go public. I’ve been watching LICY as well, but talk about dubious financials!

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