Why we believe now is the time to consider investing in lithium

The share prices of companies operating in the lithium industry have performed poorly in 2023. Pella’s analysis of the Global X Lithium & Battery Tech ETF (excluding Tesla and Lucid, which are automobile companies) points to the lithium and battery sector declining 20% this year, while the MSCI ACWI (local currency) delivered +18%.

We believe that the poor performance can be explained by:

1. deceleration in electric vehicle (EV) sales growth;

2. cathode companies (key lithium customers) drawing down their inventories (relative to sales) to the lowest levels since 2020.

The share price declines have materially improved the valuation metrics of many lithium companies. Meanwhile, we believe that EV sales are likely to continue growing strongly and cathode companies’ inventories will have to be rebuilt. If proven correct, these factors point to a drastic improvement in the lithium sector’s investment fundamentals.

This article provides background information into the lithium market, followed by the reasons we believe lithium demand is likely to materially exceed supply by 2025, and a brief discussion on why supply is likely to undershoot expectations. The demand-supply imbalance will push up the price of lithium and, with it, the share prices of lithium-related companies.

The primary markets for lithium are EV batteries, other batteries, ceramics and glass, and other applications (e.g. medicinal). The EV battery market is the fastest growing, by a considerable margin, and is the key driver of the lithium market.

EVs include passenger cars, heavy duty trucks and buses, and two/three wheelers. Passenger cars currently account for 90% of the EV battery market and is likely to retain the largest share of that market over the long term. This means the transition of passenger cars away from internal combustion engines (ICE) towards EVs is the key determinant of the lithium market.

There are two types of passenger car EVs: (i) battery EVs (BEV); (ii) plug in hybrid EVs (PHEV). BEVs are powered entirely by a lithium battery and don’t use any petrol. PHEVs are powered by petrol and a lithium battery that is recharged via an electricity socket.

Figure 1 - BEVs Vs. PHEVs

The key drivers of passenger car lithium demand are: (i) shift towards EVs; (ii) mix of the types of EVs sold (BEV, PHEV); (iii) target range of the EVs; (iv) vehicle weight. Pella’s analysis is that these factors point to a massive growth in demand, which we believe exceeds current market expectations.

We believe that most people understand that EV sales are likely to grow considerably. However, we also believe that most people don’t appreciate how much the average amount of lithium per EV is likely to increase. This is the key reason that Pella forecasts lithium demand will exceed current expectations.

NMC batteries offer superior performance and dominate the EV battery market outside of China. LFP batteries are considerably cheaper than NMC, and the performance differential between these batteries and lower end NMC batteries has narrowed. LFP batteries are extremely popular in China and is starting to take share in other countries.

Pella calculates that the lithium content of a NMC battery is 160g/kWh and a LFP battery is 185g/kWh. On a like-for-like kWh basis, LFP batteries need 15% more lithium than NMC batteries.

The table below illustrates Pella’s calculation of the amount of lithium per EV by model type. Some of the interesting observations of this table are:

• Massive range in lithium used – Chinese mini-EVs use less than 5kg of lithium whereas large US pick-up trucks and luxury vehicles use more than 15kg of lithium per vehicle.

• Cathode type has a notable impact on lithium demand – for example, the BYD Han has a smaller battery (88kWh) to the Audi e-tron GT Quattro (93kWh) but uses more lithium due to its cathode type.

Figure 2 - Examples of lithium per EV

The critical trend Pella anticipates is a change in mix in EVs away from the Chinese mini-EVs and towards larger BEVs, due to anticipated growing popularity of EVs in markets outside of China, predominantly the US.

The table below illustrates the ten bestselling passenger cars in the US this calendar year, until Sep-23. Three of the top four bestselling vehicles are pickups and nine of the top ten are either pickups or SUVs. These cars, particularly pickups, require larger batteries than the current market average. For EV sales to take off in the US, it needs to be in pickups and SUVs, which point to a material increase in the average battery size of EVs.

Figure 3 - Bestselling passenger cars in the US YTD (Sep-23)

The International Energy Agency estimates that in 2025, global PHEV sales will be 4.5m and global BEV sales will be 16m. In our analysis we assume no change in the number of mini-BEVs, meaning other BEVs are the source of growth. We also assume there is growth in the average battery size per other BEV due to mix shift towards large pickup trucks, which is the best-selling vehicle category in the US. 

Based on this analysis, Pella forecasts total EV battery, and by implication lithium demand will grow by 142%. Including the ongoing mix shift towards LFP batteries, implies a higher growth rate.

Figure 4 - Forecast growth in EV battery demand

The table below demonstrates the impact of the change in EVs will have on lithium demand, measured in Lithium Carbonate Equivalent (LCE) which is the standard measure of lithium demand, and assuming the other sources of demand grow 3% p.a. over the next three years.

Figure 5 - Lithium demand, LCE; kt

Based on this analysis lithium demand will grow 24% p.a. to 1,540kt by 2025. This is likely to be a conservative estimate as it doesn’t include mix shift towards LFP batteries, and growth from electric heavy-duty trucks and stationary batteries (e.g. home solar electricity batteries). Even this conservative figure is greater than current forecasts. For example, the Australian Government – Department of Industry, Science and Resources’ (Australian Government) most recent estimate of global lithium demand (measured in LCE) is 1,428kt in 2025. This analysis means demand is likely to exceed current expectations.

There is also a supply-side reason to be bullish on lithium. Lithium projects are notorious for their delays, which Pella understands from our discussions with market insiders, and are not fully factored into market supply forecasts. The Australian Government’s most recent 2025f lithium production forecast is 1,511kt (LCE). This figure is lower than our conservative demand forecast (1,540kt) and project delays would mean it is likely to prove optimistic. The result is that supply is likely to be below demand, the question is by how much.

The key risk to the above analysis is that large passenger car EVs don’t take off in the US. It is difficult to argue against that risk outside of holding our fundamental view that EVs are superior to ICE vehicles, and competition will result in price declines.

Another risk to the lithium market is that sodium ion batteries take share from lithium-ion batteries. Sodium-ion batteries are cheaper and safer than lithium but do not produce as much energy, meaning they are impractical for most EVs. As it stands, sodium-ion batteries are more likely to be a risk to lithium-ion batteries in stationary storage use cases, which is not a fundamental part of our lithium investment thesis. We don’t dismiss the potential for a scientific breakthrough discovery that makes sodium-ion viable for EVs, but if that did happen it would take many years for it to become a reality. We don’t consider this is a practical reason to avoid investing in lithium.

Reflecting our positive view on lithium, Pella initiated a position in Albemarle (ALB.US). That company is the world’s largest lithium processor and also holds stakes in some of the world’s largest lithium resources. Its vertical integration reduces its risk from fluctuating prices across the lithium supply chain. The company also has solid ESG fundamentals with a majority independent board and is actively working to reduce its water use by 41% by 2025, which is the key environmental concern for lithium miners. Finally, following a 32% price decline this year, it is now trading on an attractive valuation.

In summary, lithium stocks have been hit hard in 2023 but that has improved the investment fundamentals of the lithium market. Our analysis is that lithium demand is likely to materially exceed supply by 2025 due to growth in EV sales, and a mix shift towards larger EVs, while there are likely to be lithium supply delays. The key risk to our analysis is that large EVs don’t take off in the US. Sodium-ion batteries is another risk, but that would require an unforeseen technological breakthrough, which we don’t believe is a reason to avoid lithium.

Following the above, we believe it is worthwhile putting strong consideration into the lithium industry and Pella has initiated a position in Albemarle.