The lithium market has been very hot and more bulls are making their voices heard. One such new bull is Goldman Sachs (NYSE:GS), which recently put out a report suggesting that lithium is the "New Gasoline." Putting aside the fact that this is coming from the same company calling for $200/bbl. oil a few years back we think this claim is:
- Misleading with respect to the role lithium plays in a (H)EV.
- Based on optimistic assumptions derived from extending historic trends into the future.
Lithium is Not A Source of Energy!
Lithium is not a source of energy! It is a material essential for electricity storage in Li-Bs, but it is agnostic as to the energy source. Oil is typically not used to produce electricity, but other fossil fuels-coal and natural gas-are, while proposed alternatives cannot come close to competing with these electricity sources on cost. On the other hand gasoline is burned for its energy, and this is what powers internal combustion engine vehicles (ICEVs). This seems to be a part of a broader misconception with respect to EVs and the general consensus that they are "green." EVs themselves may not generate emissions, but they are powered by electricity that more often than not comes from burning coal or natural gas-out of sight, out of mind!
Lithium Demand To Skyrocket In Response To A Technological Development?
But what Goldman probably meant to say is that gasoline and lithium are similar in that an EV revolution will catapult lithium demand higher, just as the development of the affordable ICEV created substantial demand for gasoline. EV demand is certainly rising rapidly, at least on a relative basis. But since the Li-Bs in EVs use so much lithium relative to the size of the market even a modest increase in EV demand can put upward pressure in lithium prices, even if EV manufacturers currently use only~1/6 of the world's lithium. Right now EVs are expensive, and the savings of using electricity-which is consumed efficiently-as opposed to burning gasoline-which wastes an enormous amount of energy-is insufficient to justify the battery-fueled high price of the car. However, as the battery becomes cheaper so will the car, thereby making it more affordable, and eventually cheaper to buy and operate than a typical ICEV.
Optimistic Assumptions and a Re-Hashed Lithium Bull Case
Goldman's timing is very interesting, as the lithium market couldn't be hotter. We note a recent price spike in reported lithium carbonate prices;
In making its case for lithium Goldman rehashes arguments that we've seen numerous times. Lithium demand is going to rise dramatically upon mass adoption of EVs in lieu of ICEVs.
EV adoption will take place as battery prices come down, and the past trend of a 14% per-year price decline is likely to continue unabated.
These proclamations are nothing new. They have already spawned a wave of M&A among lithium producers. They have also pushed investors to bet on small non-producing lithium companies, and share prices of companies such as Nemaska Lithium (OTCQX:NMKEF) and Lithium X (OTCQX:LIXXF) have already skyrocketed.
Goldman (and the analysts that preceded Goldman in making bullish lithium proclamations) may be right that lithium demand is set to rise. But what if it doesn't, or what if it rises at a slower rate than expected? Goldman's projected 22% EV adoption, up from less than 3% today, in the next 10 years, is extremely optimistic. We believe this large EV adoption is contingent upon battery production costs coming down sufficiently to generate consumer demand for EVs that is based on superior economics (vis-a-vis ICEVs), and not the novelty appeal of EVs, or their apparent environmental friendliness.
Past trends aren't necessarily predictive of future outcomes.
(Source: Nassim Taleb's Antifragile: Things That Gain from Disorder).
Professor Turkey here, like our Goldman analyst, is projecting turkey population trends into the future without realizing that Thanksgiving is around the corner. Similarly, there could be a "Thanksgiving" that interrupts the battery cost decline trend. We note that the report does not give another reason to believe that battery prices will come down.
But it gets worse: the downtrend in battery costs could very well be exaggerated. John Petersen suggests that some of the cost reductions that companies are reporting are due to accounting phenomena and margin erosion rather than actual operational efficiencies.
Abandonment of cylindrical cell architecture by the electronics industry had a huge impact on battery manufacturers who suddenly found themselves burdened with excess capacity and falling demand for cylindrical products. That dynamic gave rise to two bad outcomes. First, many leading battery manufacturers were forced to take huge write-offs on their PP&E investments. In the case of Panasonic, the total approached $10 billion. Second, the combination of excess capacity and declining demand resulted in intense price pressure as manufacturers struggled to maintain production rates. The combined effect was a dual pronged erosion of battery prices as the write-downs eliminated depreciation costs and the margin erosion reduced end-user prices even further.
The extent to which prices have come down as a result of actual operational improvements as opposed to write-downs and margin erosion isn't specified, but these "improvements" are not sustainable and cannot be projected into the future.
We're surprised that more skepticism hasn't been leveled against the battery bulls who argue that costs have been coming down dramatically and that this trend will inevitably continue into the future. What is so surprising isn't that there's reason to believe that reporting companies are not trustworthy (although we can expect some bias), but that the entire EV/LiB/lithium thesis is contingent upon battery prices coming down. We're not saying it can't happen, but developing an investment thesis based on such a primitive methodology is shocking for such a prestigious financial institution.
Risks To The Bull Thesis
The "risks" portion of the report is given below.
This list is lacking, to say the least. Let's add to it.
A key risk to this thesis is the potential for improvements to ICEV energy efficiency and a reduction in the total costs of ownership for an ICEV. Lithium bulls constantly bombard us with evidence that the battery price is coming down, even though we've seen that some of the improvement is due to accounting trickery. They say that by 20XX that this development will bring EV costs of ownership below ICEV cost of ownership. However we never see any discussion of the improvements that can be made to ICEVs, despite the fact that we've been seeing them for the past 100 years. It follows that Li-B prices need to come down faster than the rate at which ICEVs are being made more efficient, and that this accelerated rate of improvement must sustain itself long enough for EVs to become more efficient than ICEVs. Even if EVs become more efficient there's no reason why ICEVs can't continue to become more efficient and again become less expensive to own than EVs. We note again that ICEVs are very inefficient in that most of the energy created by burning gasoline is squandered. This means there is a lot of room for improvement, and even companies developing EVs are working on ways to maximize the amount of energy utilized by an ICEV (e.g. Toyota (NYSE:TM)).
We note other improvements in ICEVs can adversely impact the growth of the EV market, a notable one being that cars are lasting longer. We've seen record car sales of late, and the newest models will presumably be the most reliable. It follows that those who have recently purchased cars are less likely to purchase an EV anytime in the next 10-15 years.
Another, more generic risk is economic weakness. As lithium prices rise production is rising as well in anticipation of growing demand for EVs. However a recession could slow down the market's development or push people to buy less expensive cars (invariably ICEVs at this point in time). Note also that 5/6 of the lithium that is produced goes into other end-products. A small decline in lithium demand as a result of overall market weakness can offset growth in the EV market and shift supply/demand fundamentals for lithium.
The Bottom Line
Lithium demand is probably going to grow long-term, and this growth can be dramatic. Lithium is probably a good investment, if made correctly. But the claim that lithium is the "new gasoline" is taking the story to an extreme that will not likely transpire. EVs may have a lot of potential, but for now they are consumed largely by enthusiasts and environmentalists, not by the public at large or your "average Joe six-pack." It is certainly plausible, and possibly likely that EVs will be developed for mass consumption in the next few years, but lithium bulls seem to underestimate the value proposition of the ICEV and the potential for auto manufacturers to improve the ICEV so that this value proposition improves. The current oil glut and low oil price certainly play into a scenario in which we will see slower uptake of EVs.
Meanwhile, lithium stocks are red hot, and it seems everyone is bullish. We wonder why Goldman is jumping on the bandwagon near what appears to be the tip of the hockey stick.
In 10-years those who buy today may be very happy, but after such a tremendous run in some of these juniors, and the lithium price in particular, we question the wisdom behind a lithium investment today.
We see contrarian opportunities in other critical materials for which past price spikes have brought about temporary oversupply and depressed prices. One in particular-graphite-is also found in LiBs. Graphite demand is expected to soar along with lithium as demand for EVs rises. But graphite has a built in EV "put" in that graphite is used in ICEVs (e.g. in brake pads) as well as in oil production (e.g. drilling fluids). You can read more of our thoughts on graphite here.
As always, we're looking for high-quality, dirt cheap businesses, and suspect that Goldman has missed the boat, at least for the time being
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.