Talk of ‘perpetual lithium deficit’ sends new energy bulls into a buckin’ frenzy

Plus, production challenges in the iron ore game point to prices continuing to beat bearish forecasts, which is good news for the new band of leveraged juniors like Fenix.

The rebound of the lithium sector has been nothing short of spectacular. So much so, it is fair enough for investors to wonder if the recovery from two years of misery when over-supply concerns dominated is all said and done.

During that two years of misery, the commentary was that as lithium is abundant, which it is, demand would forever and a day be comfortably met by the next big expansion - or the next big project.

But because each lithium project is so much more complex than, say, your average gold mine development, the response time to an emerging supply shortage takes much longer than end-users of the battery material would like.

It is a scenario that is playing out now as the electric vehicle revolution accelerates, and as the use of mega batteries for the storage of renewable energy, takes off. The big question is whether lithium is facing the prospect of severe supply shortages in the coming years.

It’s a question that Macquarie’s equity desk addressed this week. It came up with a stunning answer – the lithium market is in perpetual deficit.

When was the last time a commodity was described to be facing a "perpetual deficit"? Has it ever been the case?

Naturally enough, a view on a perpetual deficit scenario affects price expectations. So, there is no surprise Macquarie has upgraded its lithium price outlook.

It has upgraded its price deck for lithium carbonate and hydroxide 6-13% for CY21-CY25, while its pricing estimate for the preferred hydroxide precursor, spodumene, has been increased by 7-30% over the same period.

“We have materially upgraded our demand outlook for energy storage system demand and marginally increased EV demand,” Macquarie said.

“This has translated to a material upgrade in forecast demand for lithium over the short and medium-term.

“In the longer term, we believe the lithium market is likely to be in perpetual deficit. As a result, lithium prices are expected to continue to rise, moving to an incentive price by CY24. Some new supply additions temporarily tighten the market in CY26, but beyond CY27 the supply deficit widens significantly.”

As it is, Macquarie has lithium hydroxide (Asia) rising from $US11,495t in CY21 to $US16,200 in CY25, and carbonate rising from $US10,399t to $US14,250/t in the same period.

Importantly for the WA spodumene producers, Macquarie reckons that the lack of independent suppliers should see spodumene remain tighter than other lithium markets.

That comes through in Macquarie’s forecast that spodumene will outperform by rising from $US652/t in CY21 to $US820/t in CY25, and $US840/t in CY26.

Now, it has to be said that the lithium true believers were awake to the potential for the emergence of a perpetual supply shortage as far back as September last year. It’s why the share prices of the lithium stocks have recovered in spectacular fashion since.

Still, Macquarie sees upside in the share prices for the lithium producers from here and already had share price targets on them that were well ahead of ruling market prices. With its upgrade of the lithium price outlook, it has taken its share price targets up another notch.

Its price target on Minerals Resources (ASX: MIN) is now 4% higher at $76, IGO is 9% higher at $9.50, Pilbara (ASX: PLS) is 13% higher at $1.80, Orocobre (ASX: ORE) is 10% higher at $7.80, and its merger partner Galaxy is 4% higher at $4.70.

Should those price targets come to pass, the total shareholder returns across the lithium producers (MIN and IGO are more than lithium) would range from 24% up to 54%.

So that opening question about whether share price action to the upside in the lithium space is all said and done because of the spectacular gains already posted since September last year is answered. It’s not.

The above thematic also applies to the lithium explorers/developers where leverage to the upside could become extreme should the scramble for new supplies develop as Macquarie and others suggest.

So watch out for the former lithium explorers that switched to gold or base metals coming back to lithium.

As for the lithium developers, they are in the box seat to ride the “new” lithium boom. They come with the added appeal of being takeover candidates for established producers looking to muscle up in the industry.

Three developers that could be worth watching are Ioneer ((ASX: INR), trading at 33.c), Galan ((ASX: GLN), trading at 92c) and Lake Resources ((ASX: LKE), trading at 34.5c).

Ioneer is the group that has just signed up an offtake supply agreement with South Korea’s EcoPro, the big cathode and cathode materials supplier. Galan is in the thick of things with the big boys of the industry in Argentina. Lake is also in Argentina where it is working on a disruptive approach to lithium production from brines.

IRON ORE:

The iron ore price continues to defy predictions that it is headed south in a big way. The current price of $US214/t is more than double the 2020 calendar year average of $US105/t and $US60/t higher than its price on December 31.

Monster global stimulus in response to COVID and Vale’s struggle in Brazil to meet its production targets have been the shorthand explanation for the steel-making raw material’s stellar price performance.

Of the two factors, it is supply-side issues that are starting to look more permanent than analysts, who have iron ore’s retreat to say $US130/t come FY23 and sub-$US100t in the following years, might suspect.

And it is more than Vale’s woes. It is also about the Pilbara and the impact of the new importance given to traditional owner heritage issues over the once free-wheeling ability to bring on the mine expansions and new developments needed to offset mine depletion, let alone increase overall output.

It is one to be sorted out by the political process. The big three of the Pilbara – Rio Tinto (ASX: RIO), BHP (ASX: BHP) and Fortescue (ASX: FMG) – can be part of the debate, but it’s not one they can solve.

How all that hits future production levels in the Pilbara remains to be seen. But the pressure on annual tonnages in a more restrictive development approval environment is going to bite at some point.

While no one is suggesting iron ore will be like lithium and enjoy a perpetual supply deficit, the pressure points are building. Apart from the record global steelmaking, there is pressure on Vale every time it rains, and the building pressure on the Pilbara in a post-Juukan Gorge world.

Better perhaps to just focus on the here and how. The iron ore price is what it is and it looks like it will remain elevated until well into 2023, if not beyond. That means spectacular dividend flow from the Pilbara big three.

The Vale and the yet to be fully appreciated Pilbara pressure points are also good news for the juniors that have got into production or are busting to get into production. The current price is dream stuff for them.

The potential for new junior producers like Fenix (ASX: FEX), 37c a share) to earn more than its market cap in a year has been mentioned here previously. And then there is the incentive and market support for iron ore juniors like CZR Resources (ASX: CZR, 1.1c) to get cracking with its project.

Smaller tonnage and less intrusive iron ore plays don’t come with the same heritage protection issues the monster mine developments of the Pilbara attract. But the returns at the current elevated pricing can be particularly sweet on any metric.

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