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Lithium to Elevate Equities and Investor Mood

Commodities / Metals & Mining Apr 06, 2011 - 04:59 AM GMT

By: The_Energy_Report

Commodities

Best Financial Markets Analysis ArticleHouse Mountain Partners Founder Chris Berry points to the rising quality of life in Asia as competition for strategic resources that could push the cost of energy to the breaking point. There won't be a single solution, but more efficient electricity storage to power vehicles will be critical. High-capacity batteries are dependent on several metals, including lithium, which is still underappreciated by the commodity and equity markets. In this exclusive interview with The Energy Report, Chris shares some of his favorite lithium companies and why he sees dramatic upside potential in each one.


The Energy Report: You propose that development of lithium-ion batteries for electric vehicles (EVs) will drive increasing demand for lithium. But even assuming these new batteries, ultimately, have storage capacity of three, four or five times that of conventional nickel-metal hydride batteries (NiMH), they still have to be charged with power that comes from a source like coal, hydro, solar, wind, nuclear or whatever. My question is how do EVs alleviate the drain on resources? What's the benefit?

Chris Berry: You know that's a great question because it's one that a lot of people struggle with, me included. People say that with electric vehicles you're just trading dependence on oil for a dependence on coal or other dirty fuels to power your car. I don't see one form of energy winning over all others.

I think coal and nuclear will probably lead the way in powering electric vehicles and providing electricity in the coming decades. But there's definitely going to be a role for renewables, such as solar, to play in places like Phoenix, Arizona and hydropower in the northwestern United States, for example. One thing to remember is that, as the rise of the middle class in Asia continues, there certainly will be increased auto demand coming out of these countries, which means increased fossil fuel demand. This gets us back to your question, the net benefit of using EVs is resource sustainability and finding the right balance of baseload power sources. You can charge a battery from many different power sources; and, as battery technology continues to advance, so too will the power sources. But there likely won't be a singular winner.

TER: Does your investment theory assume that higher oil prices will spur development of lithium-ion (Li-Ion) battery technology?

CB: I think that's one of the keys but I'm not sure what the tipping point is; for instance, I don't know if it's $150 or $200/barrel. Higher oil prices are already filtering down to higher gasoline prices at the pump. As gas prices continue to rise, people start getting a little antsy and that filters up to politicians who can spur research and development (R&D) through increased funding on the Federal level. I just hope it's not a matter of too little too late, as development of Li-Ion battery technology is a global competition involving multiple countries throughout the world.

TER: What's being done now to advance lithium-ion battery technology?

CB: There's a global competition unfolding right now to own the next-generation battery technology. Four countries are the real players here. South Korea and Japan are producing Li-Ion batteries currently, while the United States and China are playing catch-up. The competition is focused on finding a battery chemistry around which you can build an entire industry. If you own the intellectual property, you can own the supply chain, which creates manufacturing jobs—something we've lost in this country over the past decades.

Currently, China is investing more in battery technology than any country—to the tune of hundreds of millions of dollars—even more if you consider its entire cleantech spending budget. In 2010, China invested $34 billion in cleantech research of which battery technology is a part. In the mid-1980s, the country created what it called the "863 Program," which still exists today under the Five-Year Plans it uses as a guide for economic policy. The 12th Five-Year Plan, by the way, which was just released is thought to be the "greenest" in China's history. That could say something about Chinese leadership's priorities. The 863 Program has a mandate to develop high-tech and cleantech industries; so, if you want to know what China is spending R&D dollars on and where it is focusing, looking at this data is a good start.

In the U.S., President Obama helped spur development of lithium-ion battery technology with the American Reinvestment and Recovery Act of 2009. To establish a battery-manufacturing base, $2.4 billion in grants was earmarked. The Argonne National Laboratory is also at the forefront of the research to find that next-generation breakthrough. Billions of dollars in grants have also gone to the private sector in the U.S. I've called this a 'Manhattan Project' or 'Cold War' because, really, we are trying to outspend and out-innovate foreign competitors to own this intellectual property. That's the name of the game going forward.

TER: As an investor, do you have a preferred type of lithium ore? Hard rock, brine or clay? Which is best?

CB: I'm not sure if one is better than the others; I think each deposit has its own pluses and minuses. Typically, brines are the cheapest from a cost-per-ton standpoint but it can take up to 18 months to produce the lithium. On the other hand, hard rock producers can adjust to a spike in lithium demand more quickly because they can increase the rate at which they mine the ore. But they have a higher—arguably the highest—production cost among any of these ore sources. Clay is right in the middle.

TER: Which lithium producers do you prefer?

CB: The four major lithium producers are working with the highest grade of known resources currently. On the hard rock side, Talison Lithium Ltd. (TSX:TLH) has its Greenbushes operation near Perth, Australia. It has 3.5%–4.5% lithium oxide, which is extremely high for hard rock deposits and is, in fact, the highest-grade lithium produced in the world today. That gives the company a distinct production economics advantage. Talison is an interesting story because it's the only pure-play lithium producer listed on an exchange globally. It came public through a reverse takeover of a small junior called Salares Lithium in Chile. As I mentioned, Talison is producing the highest-grade lithium in the world and because of that, it is supplying 75% of China's lithium needs—nobody else comes close.

On the brine side, the same can be said with Sociedad Quimica y Minera de Chile SA (NYSE:SQM; SN:SQM) in Chile. It produces lithium from the Salar de Atacama, an extremely high-grade brine lake. I know it can be controversial, but I prefer hard rock production due to the ability to scale to both size and demand more quickly.

TER: Talison's market cap is just under $500 million. That really sounds low considering it's the only public pure-play lithium company. From what I understand, it supplies one-third of the world's current lithium market. So what am I missing here, Chris?

CB: It's still a new story, relatively unknown. It has been public only for five or six months now, and I think the market may not understand the pure-play aspect of this company, which is extremely powerful. The other three major lithium producers globally are SQM, FMC Lithium Corporation (NYSE:FMC) and a specialty company Chemetall (Pty) Ltd., which is a division of Rockwood Holdings, Inc. (NYSE:ROC). All three of these companies trade on the New York Stock Exchange between roughly $50 and $80 per share but are known for the specialty chemical aspects of their businesses. SQM is a great example. It is a huge potash producer with lithium produced as a byproduct. Lithium accounts for just 8% of SQM's total yearly revenue and yet the company's one of the largest lithium producers in the world, even though the company views it as a byproduct.

So, the point with Talison is that it's the only one that owns this pure-play production space, has the highest-grade lithium in the world and is still in its public company infancy. As Talison continues to increase capacity and supply high-grade lithium to China (predominately), more and more people are going to find out about this. There's also additional exploration upside at the Salares 7 brines in Chile that it acquired in the reverse takeover of Salares Lithium. I think the stock is really undervalued given the stranglehold Talison has on the lithium space.

TER: Does Talison own its entire supply chain?

CB: Not currently. The company supplies two types of concentrates—one is a technical grade and the other a chemical grade. The technical grade is used in glass and ceramics, which account for 30% of global lithium demand. The chemical grade is what TLH sends to China for conversion into lithium carbonate for batteries. Talison has begun a scoping study to evaluate the possibility of building its own lithium carbonate plant.

TER: How much can Talison increase margins by owning a lithium carbonate processing plant?

CB: It's hard to say without knowing the capital costs. If the company can build and operate the plant with expenses of less than $2,800/ton to produce lithium carbonate (which sells on the open market for around $5,000/ton now), it could see some really healthy margins.

TER: So, at this point, Talison is more of a growth story than a value story?

CB: I think it's a growth story, but there is unrealized value here. The fact that Talison's customers are dependent on it for the quality of lithium the company produces, and also that Talison is not only selling 100% of what it produces but working to double production capacity, should only cement its place as a globally dominant lithium producer.

TER: I note that TLH has pulled back by almost one-third over the past three months. Was there any particular tipping point, or was this a technical issue? (Others also pulled back during that time.)

CB: With respect to Talison, I think it's likely a technical issue. The lithium space, in general, has had a few hiccups lately. Some interesting companies are still out there, however. One example is Western Lithium USA Corp. (TSX:WLC; OTCQX:WLCDF), a lithium clay explorer based in Nevada. It has a very large resource called Kings Valley in Nevada where it has produced battery-grade lithium in pilot tests as recently as late last year. That provides a high degree of confidence regarding any metallurgy issues.

The company is working on a prefeasibility study (PFS) this year and continuing to drill and increase the size of the resource. The good thing about lithium is that, unlike rare earths, the United States is not 100% dependent on lithium imports. There's plenty of lithium out there in stable geopolitical locales and Western Lithium's Nevada deposit is an example.

The questions are: What's the cost of production? What's the grade? Western Lithium has said it will be able to produce at just under $2,000/ton, which is slightly more expensive than the brines but a heck of a lot cheaper than the hard rock guys. This company is planning to be in production by 2014. It's doing all the right things to position itself to achieve this; so, Western Lithium has a great chance.

Another interesting early stage play is Rock Tech Lithium, Inc. (TSX.V:RCK; OTCPK:RCKTF; Fkft:RJIA), which is focused on hard rock lithium and rare metal deposits in Canada. The company has a historical resource that it's working to bring into NI 43-101 compliance by this summer. The location of the deposits and a wealth of historic drill data are two reasons this stock interests me. The whole lithium space has been under pressure recently as have many lithium juniors, but I think it's been a market overreaction more than anything specific.

One possible cause of the recent depressed stock prices could be that Galaxy Resources Ltd. (ASX:GXY) was planning on doing a $250M IPO in Hong Kong to increase its footprint in the lithium space but delayed it due to market conditions. I think that may have hurt the price of many of the lithium juniors more than any other reason.

TER: Do you expect Galaxy to proceed with its IPO this year?

CB: My understanding is that the company shelved it because market conditions weren't optimal. If things change, it may, but that's really a question that company management would be better suited to answer. I know Galaxy recently achieved production out of its Ravensthorpe deposit in Western Australia, which is a positive sign; so, perhaps the IPO can wait, as the company is now generating cash from the sale of its product. Galaxy also has done a joint venture (JV) with Lithium One Inc. (TSX.V:LI), which is another interesting company in that it has attracted the attention of not only a lithium producer (Galaxy), but also Korea Resource Corporation (KORES), GS Caltex Corp. and LG Chem Ltd. (KSE:051910; KSE:051915; OTC:LGCEY)—one of the largest battery manufacturers in the world.

TER: Considering the mindset of North American investors, is there something they're not seeing here? Because we're going to drive big vehicles, so perhaps we don't see the potential in these EVs?

CB: That raises a good point. I think there are certain psychological drawbacks to electric vehicles in this country today, and one of those is "range anxiety." It's the underlying question, 'If I get a Nissan Leaf and the battery dies after 75 miles, what do I do?' 'What do I do if I have to drive 300 miles?' That's why I think plug-in hybrids—those that have a small gas tank and an electric battery—are going to be more popular in the U.S., at least initially. I'm not sure if the size of the vehicle is as important an issue as finding the right battery chemistry that discharges more slowly and recharges more quickly than do current EV batteries.

TER: What about the concept of battery exchanges along the way where you might drive 75–100 miles and exchange that battery for a charged one?

CB: Absolutely. An Israeli company called Better Place is attempting to address this issue. What you mentioned in your question is essentially Founder Shai Agassi's business model. You drive and when the battery gets close to running out, you go to a depot and exchange it for a new one. Additionally, the company is working to set up a charging infrastructure and make its battery-switching technology and charging stations standard across different vehicle models.

You also raised an interesting point about infrastructure and battery-charging infrastructure in this country. I think this whole EV phenomenon is going to take place much faster in Asia, where the company's building its infrastructure from the ground up. In the U.S., there's a chicken and the egg problem. I'm generalizing here, but nobody wants to buy an electric car until they know there are ample charging stations and better battery chemistry in place. But governments and private industries aren't likely to spend, time, money and other resources building charging stations until they're confident there's enough EV demand out there. Ultimately, this is a multidecade phenomenon. Infrastructure buildouts are happening in places like Israel and Asia but, going forward, the real winners in this industry will own the entire electric vehicle supply chain—from raw material sourcing to battery manufacture to charging infrastructure. The race is on.

TER: Chris, I've enjoyed meeting you very much. This has been a tremendous pleasure for me.

CB: Me, too. Thank you.

With a lifelong interest in geopolitics and the financial issues that emerge from these relationships, Chris Berry founded House Mountain Partners in 2010. House Mountain firmly believes that the emerging quality-of-life cycle emanating from Asia is a "game-changer" that will affect everyone throughout the world for decades. With that in mind, the firm focuses on the intersection of three topics: 1) The evolving geopolitical relationship between emerging and developed economies; 2) The commodity space; and 3) Junior mining and resource stocks are positioned to benefit from this phenomenon. Chris spent 13 years working across various roles in sales and brokerage on Wall Street before founding House Mountain Partners. He holds an MBA in finance with an international focus from Fordham University and a BA in international studies from the Virginia Military Institute. Chris is also a member of the Canadian American Business Council. He invites readers to receive a complimentary subscription to Morning Notes, which provides analyses of emerging geopolitical, technological and economic trends. Go to www.discoveryinvesting.com.

Want to read more exclusive Energy Report interviews like this? Sign up for our free e-newsletter, and you'll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Expert Insights page.
DISCLOSURE:
1) Brian Sylvester and Karen Roche of The Energy Report conducted this interview. They personally and/or their families own shares of the companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Energy Report: None.
3) Greg Gordon: See Morgan Stanley disclosure that follows.*

*The information and opinions in Morgan Stanley Research were prepared by Morgan Stanley & Co. Incorporated, and/or Morgan Stanley C.T.V.M. S.A. As used in this disclosure section, "Morgan Stanley" includes Morgan Stanley & Co. Incorporated, Morgan Stanley C.T.V.M. S.A. and their affiliates as necessary.

For important disclosures, stock price charts and equity rating histories regarding companies that are the subject of this report, please see the Morgan Stanley Research Disclosure Website at www.morganstanley.com/researchdisclosures, or contact your investment representative or Morgan Stanley Research at 1585 Broadway, (Attention: Research Management), New York, NY, 10036 USA.

The ENERGY Report is Copyright © 2011 by Streetwise Inc. All rights are reserved. Streetwise Inc. hereby grants an unrestricted license to use or disseminate this copyrighted material only in whole (and always including this disclaimer), but never in part. The ENERGY Report does not render investment advice and does not endorse or recommend the business, products, services or securities of any company mentioned in this report. From time to time, Streetwise Inc. directors, officers, employees or members of their families, as well as persons interviewed for articles on the site, may have a long or short position in securities mentioned and may make purchases and/or sales of those securities in the open market or otherwise.


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