A booming market 

Lithium is the third smallest atom in the periodic table of elements. It is an alkaline metal used to produce rechargeable and high-voltage batteries (more than 70% of its use worldwide). It is also used to manufacture special lubricants and alloys, to treat air contaminated by carbon dioxide, in the metallurgical, nuclear, fine chemical, rubber and thermoplastic industries. Today we will focus on its use in batteries. This is where its greatest potential lies and where all the attention is focused at the moment. 

Lithium does not exist in its native state in the natural environment but only in the form of ionic compounds. It is extracted from pegmatite-type rocks, clays or brines. From these extracted mining concentrates, the molten salt electrolysis technique is generally used to obtain an industrial metal. 

The world's proven reserves are estimated by the USGS (United States Geological Survey) to be around 22 million tonnes at the end of 2021, with identified (but unproven) resources of over 89 million tonnes. The majority of these proven reserves are located in a handful of countries represented by Chile (42%), Australia (26%), Argentina (10%), China (7%) and the USA (3.4%). 

All the signs converge towards the hypothesis of a speculative bubble quite typical of what we observe in the mining industry. In this respect, the case of lithium is quite similar to that of rare earths.

The rather recent surge in lithium prices (here measured with the price of lithium carbonate traded in China) is quite impressive. Between June 2020 and Oct 2022 The price went from about CNY 50,000 to just under CNY 600,000 per ton of lithium carbonate. In history, this kind of price surge in raw materials always ends up falling like a soufflé. 

The narrative of this speculative bubble is as follows: "The electric car will replace the gasoline car. It takes an average of 5 kg of lithium to make the batteries of an electric car. So by making simplistic projections with the growth of its use, we come up with a world demand that could be multiplied by four to six by 2030". And bang, that's how you create a bubble. 

Source : Statista 

What is important to understand is that, like rare earths, which are materials that are rare in name only, lithium is an abundant metal in the earth's crust. The supply is compressed episodically, generally without gravity, not because of the scarcity of the resource but because the extraction and refining infrastructures - which are costly and polluting - are lacking. 

When these circumstances occur, they lead to moderate but sufficiently attractive price increases that producers are willing to invest more in their mining and refining efforts; since this poses few technical difficulties, additional production comes to market immediately and the price of the metal adjusts accordingly. This is why the price of lithium is generally stable and not very volatile. 

But there has been a "narrative" in recent months that has led to a real explosion in prices. Because lithium is essential for electric vehicle battery manufacturing, demand is "logically" expected to rise exponentially - a rise that the two major producing countries, Chile and Australia (⅔ of world production), are slow to adjust their capacities to. So, these two countries are doing so either voluntarily, to extract maximum revenue from their respective mining industries, or for political reasons, as major mining projects are no longer popular in Chile, or even in Australia, which is hyper-dependent on China. 

Fearing a recession in China, Australian mining groups have slowed their growth investments, which has led to an explosion in the price of white metal. But until when? Probably not for long, because at these prices the reward for pocketing huge profits is so great that producers should not be slow to catch up with demand.. 

So, to recap :

1- Lithium is actually abundant: you just have to go and get it. 
2-Like rare earths, what is costly and complicated is not the extraction but the refining and transformation for industrial applications: more than a mining activity, we are here in a specialty chemical activity. 

Analysis of the main players 

For the sake of curiosity, however, let's take a look at the financial dynamics of the top five lithium producers listed in the United States. 

  • Albemarle Corporation  

Albemarle has never generated any cash profits (free cash flow) for its shareholders in the last ten years (that's a long time). All the money has been spent on capex (capital expenditures) and acquisitions. So far, there has been no tangible return on investment (ROI). In fact, revenues have grown very modestly over these long years. Accounting profits are largely science fiction, as investments far exceed depreciation. In passing, it should be noted that net debt has increased sharply over the period. 

The management seems to be quite lucid on the fact that the current market conditions are ridiculous since it took the opportunity to make a large capital increase (a sure sign in this industry). The shareholding is institutional and fragmented, and insiders are selling their shares like crazy at the current prices. In short, to be avoided at first sight. 

  • Lithium Americas Corporation 

We are dealing here with a purely prospective player, unlike Albemarle, which does have a proven operating business. Lithium Americas Corporation has several sites in the United States and Argentina (we know how mining projects in Argentina end up) in the development phase. At first glance, this is a speculative situation. The first three shareholders are a Chinese group, a hedge fund in London and a hedge fund in Singapore. These highlights plus the name ("Lithium Americas") are a real eye-catcher for the unsuspecting. We were about to forget but they also made big capital increases thanks to the mania of the moment. 

  • Piedmont Lithium 

Like its competitor Lithium Americas, Piedmont Lithium is also purely prospective, still in the development phase, but has sites concentrated in the United States, specifically in North Carolina and Tennessee. It's good to be in a safer jurisdiction, but for the record it's extremely difficult to get permits to mine in the US. Here too the ownership is heterogeneous, divided between individuals, unknown hedge funds and offshore structures. 

  • Livent Corporation 

Like Albemarle, Livent has a proven operating history and expertise in refining but operational and financial performance is both volatile and disappointing. The group does not generate a free cash flow profile. For the time being, it is even burning $50 million a year on average over its six-year history. It has compensated for this by raising $800 million. 

At the shareholder level, we find a lot of institutional investors (index managers), a typical "ownerless corporation" as we unfortunately find many today. These index companies do not generally participate in general meetings and are not very involved in the respect of their rights as shareholders.  

Resources are concentrated in Canada and Argentina (as we said, South America is not the safest place to be). The manufacturing bases are in the US, China and India. And two-thirds of the turnover is made in Asia (and therefore in China, which represents a significant geopolitical risk). Red flag again here: insiders are aggressively selling at this price. 

  • Sociedad Química y Minera de Chile S.A 

Sociedad Química y Minera de Chile, or SQM, is surely the best of the five. Here we have a more complete operational history because SQM is a reference player in the industry. SQM is a large producer of lithium and related products but not a pure player - it is a diversified chemical group. The company has a proven track record of profitability, but results are overall quite volatile, which is typical of the mining sector. It should be noted that over the last decade, the group has generated $3 billion in free cash flow, which is a good point. 

But is it reasonable to pay an enterprise value (EV) of $27 billion? It means that it would take 90 years with equivalent production to recover its investment. As you can see, this is an unreasonable investment. Of course, the asset is strategic and virtually non-reproducible, but it is still an exaggeration of the prices in the whole sector. 

Last year, the group completed a large capital increase of $1.1 billion. SQM has returned more dividends over the last decade than it has made in profits. Hence a significant increase in debt. This is never a good sign. Even if the balance sheet remains very good, we are not at all in the pattern of a hyper-leveraged commodity producer. 

Moreover, there are unfortunately also many hedge funds in the capital, another sign that does not deceive as to the risk of speculative bubble of the whole sector. 

SQM seems to be the only good pupil but (very) expensive. Albemarle may be "legit" too, but it is not earning cash in a sustainable way, at least not yet. So of course, if these new stratospheric lithium prices become the norm in the future, these players will be more profitable than in the past. But we know what happens to the "new normal" in the markets. 

Conclusion 

This very quick overview allows us to verify what we already suspected: the sector has a hyper-speculative profile. All signals are red: absurd valuations, parabolic stock prices, serial capital increases, "easy" narratives, a packed and invested retail clientele, hedge funds in the capital, insiders selling at these prices, etc. The signs do not deceive. 

As I explained in a previous article on deceptively "rare" metals, we must beware of easy shortcuts such as: "the advent of electric vehicles will lead to a strong demand for lithium and strategic metals, which will cause prices to explode in the face of a dwindling supply". 

Mark Twain, even back in the day, liked to poke fun at the mining industry by saying that a mine is a hole with a liar sitting at the top. 

I invite you to keep in mind this phrase from John Templeton: the four most cherished words are and will always be: "this time it's different".