What Can We Learn From Cobalt's Fundamentals?

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Includes: AMMCF, AMSLF, ARRRF, CBBHF, CBLLF, CCWOF, CMCLF, CMCLY, CTEQF, ECSIF, ERMAF, ERMAY, FTSSF, GLCNF, GLNCY, KBGCF, NILSY, PANRF, PTNUF, PWMRF, SHERF, USCFF, VALE, WCTXF, WMNNF
by: Joshua Hall
Summary

The demand for cobalt in chemical applications has exceeded that for metallurgical applications in recent years.

Almost all the world's cobalt is produced as a by-product of DRC copper mines and non-DRC nickel mines.

Glencore is preparing to flood the market with new supply from its Katanga and Mutanda mines in the DRC.

Investors should prepare for lower cobalt prices.

Background

Cobalt is used in metallurgical and chemical applications. Metallurgically, cobalt is used to strengthen and enhance alloys for high temperature and magnetic applications. Chemically, cobalt is mostly used in batteries. To a lesser extent, cobalt compounds are used in pigments for the distinctive blue color it imparts.

In recent years, the demand for cobalt in chemical applications has grown much faster than the demand for metallurgical applications. Palisade Research noted,

The use of cobalt in batteries has grown by an average of 13% annually over the last ten years; at the same time, the use of cobalt in metallurgical applications has only risen 3.4%.

About half of cobalt demand in 2016 came from lithium-ion batteries and about 1/5 of this (10% of overall demand) was for electric vehicle ("EV") batteries.

Almost all the world's cobalt is produced as a by-product of copper (64%) and nickel (31%) mines.

Cobalt as a by-product of copper production comes almost exclusively from the Democratic Republic of the Congo ("DRC") which is why about 2/3s of the world's cobalt supply comes from the DRC. DRC copper ores typically contain grades of .3% to .5% Co.

Cobalt as a nickel by-products comes from the leaching of nickel laterite ores and the smelting of nickel sulfide ores.

Laterite ores generally have nickel grades running from .5% to 2% and cobalt grades running .05% to .15%. Cobalt grades of .15%+ or more in a laterite deposit should be considered high grade. An example of a laterite deposit is Clean TeQ's (OTCQX:CTEQF) Syerston project in Australia that has average nickel grades of .59% and cobalt grades of .13% (it also contains .042% scandium).

Sulfide ores generally have a bit higher nickel grades, generally running from 1% to 3%, and a bit lower cobalt grades, generally running from .05% to .10%. An example of a nickel sulfide deposit is Panoramic Resource's (OTCPK:PANRF) Savannah project in Australia that hosts average nickel grades of 1.7% and cobalt grades of .12% (it also contains .75% copper).

For the most part, if a person is going to invest in cobalt through a miner, they have to do so through either (1) a primary copper producer operating in the DRC or a (2) a primary nickel producer with by-product cobalt production.

Supply & Demand

I have a database of about 25 mines that produce most of the world's cobalt. I estimate that total 2017 mine production was about 110,000 tonnes and about 71,000 of this came from the DRC. Some of this comes from companies that publish a limited amount of detail on their production so in some cases it is not clear whether their reported numbers are mine production or refined production. Of this 110,000 tonnes of mine production, I estimate that total refined supply was about 94,000 tonnes.

Total cobalt demand in 2017 was about 100,000 tonnes which left the market undersupplied by about 6,000 tonnes. Limited inventories, strong battery demand, and an enthusiastic investment community has sent the price of cobalt soaring. Here is a monthly chart of cobalt that comes courtesy of barchart.com:

Most of the dated analysis of the cobalt market that is out on the internet continues with this scenario of undersupply and higher prices. However, this all changed in mid-December when Glencore (OTCPK:GLCNF; OTCPK:GLNCY) announced their cobalt production guidance for the next few years. Notably, their Katanga mine in the DRC is back online after 2 years of no production and is expected to produce 11,000 tonnes in 2018 before ramping up to 34,000 tonnes in 2019, and then settling in at a steady-state annual rate of 32,000 tonnes from 2020 onward. Cobalt production at their Mutanda mine in the DRC is also expected to increase from 23,000 tonnes in 2017 to 24,400 tonnes in 2018 and then to 27,400 tonnes in 2019. Overall, Glencore's ramp-up means they are going to add more than 36,000 tonnes of annual production to a 110,000 tonne market.

The supply increases do not stop with Glencore. Eurasian Natural Resource Group is expecting to add 14,000 tonnes of production in 2019 at their Metalkol mine in the DRC. Also in 2019, China's Jinchuan group is expecting to add 7,500 tonnes of production across three of its mines in China, the DRC, and Indonesia.

Overall, my analysis has total mine supply moving from 110,000 in 2017 to 172,000 in 2019! This would likely result in about 148,000 tonnes of refined production in 2019.

If the plans of these miners pan out, here is how the top producers would rank in 2019:

Company
2019 Estimated Mine Production (tonnes)
Amount of Total Production From DRC
Glencore
65,000
61,400
Eurasian Resource Group
18,200
18,000
China Molybdenum (OTCPK:CMCLF; OTC:CMCLY) 18,000
18,000
Jinchuan Group (trades in Hong Kong)
12,000
8,000
Sherritt (OTCPK:SHERF)
7,400
0
Vale (VALE)
6,300
0
Norilsk Nickel (OTCPK:NILSY)
6,000
0
Top 7 Total
132,900
105,400



Estimated Overall Total
172,000
127,000

Glencore is positioning to dominate the cobalt market in 2019. The DRC will remain the dominant jurisdiction as I estimate 74% of the world's production will come from there in 2019.

Cobalt demand is expected to be in the range of 115,000 to 120,000 tonnes in 2019 driven by incremental demand for EV batteries. Even if EV related demand for cobalt is significantly higher, say 35,000 tonnes versus the expected 25,000 tonnes, the market would still be oversupplied by more than 20,000 tonnes.

Strategic Conclusions

The DRC is a volatile jurisdiction and the Congolese government is moving to raise royalties on "strategic metals" (i.e., cobalt). A lot can go wrong there. George Heppel at CRU recently put out an informative piece detailing some of the potential infrastructure hurdles Glencore may face in this ramp-up. However, the extent of this supply increase is dramatic and investors need to pay attention.

Auto & battery manufacturers have every incentive to reduce or eliminate the amount of cobalt used in battery cathodes. They face a situation of either very high cobalt prices due to production setbacks in the DRC or modest prices with a continued over-reliance on the DRC as Glencore's production squeezes out some non-DRC competition.

If Glencore is successful at ramping up and maintaining their production targets, they may be able to bridge the supply gap needed to get auto and battery manufacturers to the full adoption of new technologies that are less reliant on cobalt (say, in the 2022 to 2025 timeframe).

Stockpiling auto & battery manufacturers, metals exchanges, and even investment vehicles (e.g., Cobalt 27; OTC:CBLLF) may scoop up the abundance of the first batch of new cobalt supplies, but the waves of supply following after it will be even higher. I estimate that total mine production will increase by another 15,000 tonnes in 2020.

Absent a major DRC supply disruption, I expect cobalt prices to peak in 2018 and continue to move lower thereafter. Investors should be prepared for lower prices. At this point, it seems that few are even aware of the danger.


Important Disclosure:

I am an investment adviser and owner of True Vine Investments, a Registered Investment Advisor in the State of Pennsylvania (U.S.A.). I screen electronic communications from prospective clients in other states to ensure that I do not communicate directly with any prospect in another state where I have not met the registration requirements or do not have an applicable exemption. Any investment advice or recommendations involving securities referenced in this article is general in nature and geared towards a readership of sophisticated investors. This article does not involve an attempt to effect transactions in a specific security nor constitute specific investment advice to any particular individual. It does not take into the account the specific financial situation, investment objectives, or particular needs of any specific person who may read this article. Individual investors are encouraged to independently evaluate specific investments and consult a licensed professional before making any investment decisions.

All data presented by the author is regarded as factual, however, its accuracy is not guaranteed. Investors are encouraged to conduct their own comprehensive analysis.

Positive comments made regarding this article should not be construed by readers to be an endorsement of my abilities to act as an investment adviser. My clients always come first.

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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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