As adoption of electric vehicles (EVs) and battery storage systems continues to accelerate, the technology powering the revolution continues to evolve and its potential impact on the basic materials that the batteries comprise of will impact commodity markets. This impact is only set to grow in the coming years, likely ending in a bull market for a number of critical commodities.
Notwithstanding the demand growth commodities such as nickel, cobalt, lithium and copper are poised to experience as EVs become the norm, some of the early price moves we have seen in commodities such as cobalt, were likely several years ahead of actual demand, or nickel, where factors completely unrelated to the adoption of the electric vehicle have pushed prices higher. Either way, it is important for investors, consumers and industry players to understand the changing dynamics of these critical electric metals, even when current moves may not be directly driven by factors relating to the adoption of EVs or grid storage batteries.
Nickel prices on the London Metals Exchange (LME) strengthened through the end of the third quarter and gains continued into LME week, closing up 42% to US$7.97/lb during the third quarter of this year alone. Higher prices were initially driven by speculation that Indonesia would implement a nickel ore export ban on January 1st, 2020. Price increases were also triggered by continued strong demand from China’s stainless-steel sector, as well as by concerns of a possible shutdown of one of the world’s largest nickel mines as a result of an environmental incident. In other words, a confluence of political factors, operational factors, and demand for steel drove the nickel move, not EVs or battery storage.
Nickel prices reached a high of US$8.45/lb on September 2nd, immediately following confirmation by Indonesian officials that the ore export ban will indeed take effect at the start of 2020. However, since October 1st, nickel prices have softened, mirroring the physical market fundamentals and speculation about LME warehouse levels decreasing without evidence that an increase in demand is supporting the reductions in inventory. These developments suggest an environment of increased nickel price volatility in the near-term. Moreover, nickel inventories on the LME and the Shanghai Futures Exchange (SFE) continue to decline. Total inventory levels have decreased significantly in 2019, declining by approximately 49% with the majority of that decline taking place in September. There is market speculation that the physical nickel drawdown is a result of inventory stockpiling by stainless steel producers, in advance of the Indonesian ore export ban taking effect, which will provide further fuel to price volatility over the near-term.
Demand for nickel continues to be driven by the stainless steel sector. According to CRU, stainless steel demand is expected to grow at an average annual rate of approximately 4% through 2022 with production emanating largely from China and Indonesia. Demand for nickel – particularly Class 1 nickel – from non-stainless steel sectors is expected to grow dramatically with maturation of the electric vehicle market. Class 1 nickel, along with cobalt, are key metals needed to manufacture the lithium-ion batteries used in EVs, as well as most of the electronics you use in your daily life.
Beyond 2019, a shortage of nickel suitable for the production of battery chemicals (which represents approximately 50% of Class 1 supply) is anticipated to build, as the current market prices are well below incentive levels needed to develop new nickel projects. As a result, no new Class 1nickel supply is expected to come on stream in the near term. The reality that Original Equipment Manufacturers (OEMs), battery manufacturers, and other market participants are going to face with their supply chain, is that while real demand boom for nickel may be several years off, in order to meet that demand billions of dollars of CAPEX needs to be spent today to advance the mining projects needed to meet the demand. In particular for nickel, capital raising is further complicated by the value destruction that has occurred by cost overruns for companies building high pressure acid leach (HPAL) facilities over the past 20 years. Not to mention, the fact that in addition to cost overruns, many of the HPAL nickel projects around the world have never reached name plate capacity. This complex interplay between mine funding, building, and production timing likely means that the nickel supply needed will not hit the market in time for projected new demand from EVs and battery storage systems. At a recent closed-door event in Washington DC, a Tesla representative was quoted as having grave concerns around sourcing nickel a few years out. This may cause dramatic price spikes to nickel, in the same way that stainless steel demand caused a nickel bull market in the super cycle. Another knock-on effect of the historic value destruction that has taken place within the nickel industry with new HPAL projects, is that the projects most likely to get funded are; either large nickel sulphide deposits, such as Turnagain owned by TSX-listed Giga Metals (see full profile on page 36-37) or Dumont currently owned by Canadian-based private equity firm Waterton; restarting marginal producers from the last cycle; or expansions at a handful of well-run currently operating nickel mines, such as Ramu Nickel.
While cobalt and nickel production are linked almost everywhere outside of the Congo, the story of cobalt over the past several years has been dramatically different than nickel. Cobalt saw a decade-high price of over $40/lb in 2018, on the back of a wave of anticipated shortages, as a result of battery demand. The increased demand drove the relatively thinly traded market to a decade-high price. In response, and mostly unanticipated, the price spike incentivized a massive artisanal supply response in from the Democratic Republic of Congo (DRC) leading to the commodity price falling from over $40/lb to nearly $12/lb in a short period.
Cobalt prices began rebounding over the summer, ending a year-long downward spiral. Higher prices in the second half of the year were driven by a shockwave sent through the industry when Glencore-owned Mutanda, one of the largest cobalt mines in the DRC, announced it will be placed on care and maintenance, effective at the start of the New Year.
While cobalt prices in the third quarter of 2019 showed signs of improvement, they were considerably off of the highs reached in 2018. The average reference price for standard grade cobalt through the end of third quarter was US$15.20/ lb, down 57% from US$35.21/lb over the same period last year. The yearover- year decline was driven by a combination of factors, primarily driven by artisanal supply from the DRC, which resulted in a material increase in supply. Other factors included increased available supply of processed cobalt in China, and continued inventory reduction by Chinese consumers in anticipation of lower prices.
Through LME week we have seen a continued rise in the cobalt prices which suggests that downward price pressure from artisanal supply out of the Congo has slowed.
Both the nickel and cobalt market are positioned to radically change as EV adoption accelerates and energy storage systems become more ubiquitous. That said, it should not be lost on investors that the primary driver of these commodities today is not the lithiumion battery. At some point in time the market will price in a future commodity deck that incorporates this anticipated demand. Investors who are long when this opinion becomes consensus stand to materially outperform the market. But until adoption of the EV and lithium-ion battery chemistries become the consensus view of the market, we will continue to see volatility in both nickel and cobalt pricing. Underlying commodity price volatility is likely to be magnified in equities volatility, for both good and bad, as the market moves towards a new consensus view of demand from EV adoption. To date, this volatility has prevented the capital raising needed for the capital expenditure required to build new mines to meet the demand on the horizon. Ultimately, the lack of projects under construction today will result in very interesting markets for investors to make money. There will however, be bumps along the way.