Tesla: The New Atacama Debutante

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Summary

  • As a result of the Saskatchewan Potash/Agrium merger of late last year, international regulators ruled that Potash divest a 32% stake in the Santiago-based SQM by April 2019.
  • SQM, originally a crop nutrient producer, now is one of the world's most productive and cost efficient sources of lithium from ancient salt beds in the Salar de Atacama.
  • Since 2014, SQM has had a politically explosive relationship with Chilean government authorities that was just recently resolved last month.
  • Tesla, hard-pressed to make good on its overtly aggressive production schedules for its mass-produced Model 3, is currently engaged with SQM and Chilean authorities in hopes of a deal.
  • That deal could include both a long-term supply agreement and possibly the build-out of a lithium hydroxide processing facility in Chile.

Tesla (NASDAQ:TSLA) is reported to be in exploratory talks with the Nutrien Group (NTR) for the purchase of a 32% stake in Sociedad Química y Minera de Chile (NYSE:SQM) worth an estimated $5 billion, according to recent news report in the Financial Times (30 January 2018). NTR is a Canadian firm formed from the merger of the two fertilizer giants Saskatchewan Potash and Agrium late last year. A regulatory stipulation placed on the merger required the divestiture of Potash’s 32% stake in SQM, once predominantly a crop nutrient producer, that now happens to sit atop the world’s premier lithium brine deposits, the Salar de Atacama in the northeast corner of Chile. SQM is one of the world’s largest producers and lowest cost sources of lithium brine. Tesla could now be following a newly minted 15% Toyota (TM) partnership with the Australian company Orocobre (OTCPK:OROCF) operating in the Cauchari-Olaroz salar in neighboring Argentina, as global car makers begin to coordinate a growing demand schedule with locking in long-term supply chains for raw materials that provides the means to make mass-produced electric cars happen.

Tesla’s possible foray into the lithium space should come as no surprise. It also comes at a highly opportune moment for both companies. In mid-January, SQM finally settled a long-standing, politically contentious dispute that dates back to 2014 with the Corporación de Fomento de la Producción (CORFO), an advisory government agency charged with promoting Chilean economic development. Long outstanding issues regarding the payment of back taxes and unpaid royalties for lease rights combined with equally contentious environmental compliance and corporate governance issues finally came to a head last fall with the conditional approval of the Potash-Agrium merger that required the divestiture of Potash's 32% SQM stake. Simply stated, SQM's forward lease arrangement with the Chilean government in the Atacama was politically toxic, rendering the possible sale of the NTR's stake all but impossible.

Last week, the CORFO made the recommendation to the Chilean government to move forward. The essence of the CORFO-SQM deal is as follows:

  • Julio Ponce Lerou, the company’s controversial president, controlling shareholder and erstwhile son-in-law of ex-Chilean dictator Augusto Pinochet, would be stripped of any executive role in the company and would be banned from a board seat with the company;
  • No member of Ponce family would be able to assume an executive position in the company or sit on its board;
  • No member of the Ponce family would be allowed to enter into any agreement to acquire a controlling interest in the company until 2030.

With the largely political baggage of the Ponce family removed from equation, the question of future SQM lease, royalty and lithium extraction thresholds became politically viable. The new agreement allows SQM quota to rise from the current 180,000 tons to 349,553 tons of lithium equivalent until the contract expires in 2030, breathing new life into the NTR divestiture.

For Tesla, the production difficulties that have plagued the Model 3 program have become a ringing reminder of just how difficult it is for a niche player in the automobile manufacturing space to morph into a mass-production operation in essentially a year’s time. The physical dimension of ramping up production to 500,000 vehicles by year’s end is daunting enough. Current projections of passenger car deliveries in North America based on January’s monthly total comes to 3.654 million units, of which Tesla currently projects out at roughly 45,000 units or 0.012% of the total. At 500,000, the Tesla percentage of projected North American passenger car production comes to about 12% for the year. Only the January totals of passenger cars for Toyota at a projected 771,876 and Nissan (OTCPK:NSANY) at 645,660 would deliver more cars over the period.

Beyond the physical dimension of productive capacity is, arguably, the more singular component for an electric car manufacturer — that of matching the current demand for battery packs with the available supply of lithium hydroxide. To date, Tesla has relied on Japan’s Panasonic for its battery packs for current production levels of Tesla output. The company’s new Gigafactory, now about 30% completed, will eventually carve out a footprint of some 1.9 million square feet in the Nevada desert with 4.9 million square feet of operational space capable of producing 35 gigawatts of annual or about 1 billion watts/hour of generating capacity, according to company statistics. Tesla’s Gigafactory in the Nevada desert is now ramping up its production capacity. With just under 30% of the structure now completed, the facility was designed to phase in capacity over the course of time. While the battery packs have largely been the purview of Panasonic, the current phased completion of the Gigafactory will likely see Tesla assuming the control over the supply chain logistics. The missing component? - secured, long-term lithium hydroxide supply lines.

Currently, Tesla maintains a conditional supply agreement with Pure Energy Minerals (OTCQB:PEMIF), based in Vancouver, British Columbia. PEMIF retains the mineral rights of 26,000 acres of desert in close proximity to ALB’s Silver Peak mine, the only operating lithium mine in North America. The lithium concentration in production brines average about 160 ppm. The company claims about 9,500 acres of lithium brine, situated about 4 hours south of Tesla’s Gigafactory in the Clayton Valley desert region of Nevada. The company continues to drill samples and conduct geophysical surveys of its holdings, but remains far from entering a full-throated production phase.

Figure 1: Sociedad Química y Minera, Tesla, Albemarle (ALB) against the S&P 500 ($SPX)

https://stockcharts.com/c-sc/sc?s=SQM&p=D&st=2017-01-01&i=t83880199550&r=1517774210520

Enter SQM. SQM is already the largest producer and lowest cost lithium source in the world. Chile’s Salar de Atacama has produced some of the world’s highest concentrations of lithium at over 1,800 ppm which allows these ancient salt beds, and SQM, to claim such a mantle. The Atacama already produces just under 40% of the global lithium production through the end of last year. Between SQM and ALB, the two companies combined to produce over 62 tons of lithium carbonate in the past year, which is close to the entirety of Chile’s current lithium production. With the recent agreement with CORFO, SQM will be able to ramp up its lithium production in the Atacama salar where most of its lithium brine holdings reside. Interestingly, the news of the SQM-CORFO agreement sent lithium stocks plunging with market fears of new supply applying downward pressure on current prices. SQM (green line) fell just over 5% with the announcement while ALB (purple line) fell just short of 4%. Tesla (red line) fell just under 2% through Friday's market close (see Figure 1, above).

According to CORFO vice president Eduardo Bitran, the Tesla-SQM negotiations center not just on a long-term agreement to supply the car company with lithium hydroxide. What appears to be emerging is a CORFO push for a value-added lithium hydroxide generating plant to be included in the agreement. Further, that generating facility is to be built in Chile in exchange for favorable terms on sales of upward to 25% of SQM’s lithium production.

Of course, Tesla is one of a growing list of suitors which include lithium producers ALB and the Chinese lithium producer Tinanqui and Tallison Lithium LTD, the partners that form a joint operation with Wealth Minerals (OTCQB:WMLLF) and Chilean investors in the Seven Salars Project further south of the Atacama along the Argentine border. Earlier in the year, the Anglo-Australian mining giant Rio Tonto (RIO) had withdrawn a tender offer for the SQM stake. CORFO continues to frown on the potential for further market concentration of Chilean lithium assets. Allowing the SQM stake to be purchased by either ALB or Tinanqui would put about 70% to 80% of the world’s lithium assets into too few — and foreign — hands. The message here appears clear — the SQM stake will likely not be sold to a lithium producer.

The political loggerhead over the SQM stake appears to be breaking Tesla’s way. By striking an agreement with SQM to build a lithium hydroxide processing facility in Chile, it appears CORFO is offering Tesla a quid pro quo. Tesla needs a long-term agreement on the supply of lithium hydroxide to power both its cars and meet investors’ outsized expectations for the coming year and beyond. CORFO wants to retain as much Chilean control of country's lithium assets as possible and being able to dictate where the country’s lithium hydroxide is produced appears key to a breakthrough. Further, Tesla appears to satisfy CORFO’s requirement of not selling the 32% stake in SQM to another lithium producer, which likely dooms any bid by ALB or Tinanqui. Tesla appears tantalizingly close to assuming the pole position in this latest twist around the SQM stake.

Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.

This article was written by

Douglas Adams profile picture
1.58K Followers
Douglas Adams specializes in macro-economic research and turning theory into practical portfolio applications for clients over the past seventeen years. Mr. Adams recently formed Charybdis Investments International based in High Falls, New York where he is the managing director of a fee-only investment advisory practice with clients throughout the United States. As an author, Mr. Adams has commented widely on a diverse array of topics from Brexit to monetary policy to forex to labor productivity and wage growth. He holds an undergraduate degree from the University of California, a master’s degree from the University of Washington and an MBA in finance from Syracuse University.
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Disclosure: I am/we are long SQM, ALB, WMLLF. 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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