They have been like two bulls walking confidently through a field.  But now it looks increasingly likely they will be two different animals—with the possibility of lithium turning into a bear.

Recent reports from BMO Capital Markets—on cobalt—and Morgan Stanley—on lithium—bring that relationship into question.  Increased supply is expected to weigh on the lithium market. Meanwhile the cobalt market will remain in significant deficit.

Cobalt Will Remain A Bull

BMO–Canada’s #2 brokerage by size–sees cobalt demand rising by 60% in 2025.  As they put it in a 26 page report on December 4 2017: “there is simply not enough supply to match this” demand.  BMO sees a doubling of the price of cobalt in response to the bullish market developing—including Chinese EV sales in H2 2017 being stronger than expected, up 110% YOY.  Europe was up some 45% and the US sales of Electric Vehicles were up about 25%, said BMO.

Why Cobalt Supply Won’t Respond

Cobalt is produced mainly as a by-product of nickel and copper mines.  Only a tiny fraction of supply comes from mines that just produce cobalt.  This limits the supply response even with higher prices.

In addition, China produces next to no cobalt domestically. Cobalt does not run the risk of a sudden government directed production increase from China.

High Risk Supply

60% of cobalt comes from the Democratic Republic of Congo (DRC).  A further 80% of anticipated supply growth over the next 5 years is expected to come from the DRC.  
The Economist recently devoted a front page article to the DRC.  President Laurent Kabila is in his 7th year of a 5 year term ;-) .  He is poorly supported yet does not want to yield his position.  

Perhaps foreshadowing a broader war, more than 10 of the Congo’s 26 provinces are experiencing armed conflict.  

During the last major war in the Congo, from 1998 to 2003, mines became the spoils of militias.  Output from the region fell sharply.

Scrap and Substitution

If you line up the announced projects that include cobalt production, it falls well short of anticipated demand.  BMO said that they had to make “aggressive assumptions” in order to come close to a balanced market in 2025.  This included:

1. aggressive substitution from non-EV demand
2. acceleration of scrap recover
3. move to higher nickel, lower cobalt content batteries

Even these assumptions have risks.  

Scrap recovery of cobalt is difficult because most cobalt is used in alloys and therefore can only be recovered into the same end use. 

Likewise, lowering cobalt content in batteries is no easy task. 

Cobalt plays an important role in battery stability.  BMO issued a separate research report where they raised questions about the stability of higher nickel (and lower cobalt) concentration batteries.  

The 8-1-1 battery design, which consists of 8 parts nickel and 1 part cobalt), is expected to be the next generation battery and would lower the cobalt content.  But BMO questioned just how close that battery is to being production ready.   They outlined a host of technical challenges that remain.

Analysts are not the only one’s that have taken notice of the coming crunch.  Just last week it was reported by Bloomberg that Apple was looking to source cobalt supply via long-term contracts directly from miners.  The iPhone maker is one of the world’s largest end users of cobalt for the batteries in its gadgets.

High Risk of a Cobalt Price Spike

BMO’s chart below suggests cobalt is both the top contender for a short term spike or long term shortage.

But The Lithium Supply Response is Robust

On Monday February 26, the lithium complex was rocked by a report by US brokerage firm Morgan Stanley that said lithium prices could decline by 45% by 2025.  

The week before, BMO came out with a similar forecast. In fact, BMO was even more bearish than Morgan Stanley.   Morgan Stanley projected addition supply of 500,000 tonnes of lithium by 2025.   BMO saw 540,000 tonnes.

The analysts have become more bearish as they see the backlog of projects balloon.  For example as the chart below shows, Morgan Stanley’s projections are a BIG jump over their forecast in the summer of 2017.

Greenfield Juniors 

The supply additions are coming from both greenfield and brownfield developments.
On the greenfield side, it’s the hard rock projects that are going to be first to market.   There are 5 spodumene projects in Australia that will be ramping to full production by the end of 2019.  They are already late, but the Market is expecting big supply ramps here late in 2018.

I was surprised the Morgan Stanley report didn’t make more hay out of this than the proposed SQM expansions (which I think are overblown and years away).

Not just Juniors Adding Supply

Big players Albemarle and SQM want to maintain their share too. Both are expected to double their production by 2021.  Last month SQM resolved a long-standing dispute with the Chilean government that will allow the company to significantly increase production at its Atacama mine over the next few years. 

Both BMO and Morgan Stanley expect SQM and Albemarle to add 200,000 tonnes of lithium to the market by 2025.  The other two established producers, FMC and Tianqi, will more then double production by 2025.

I’m not the only one who thought Morgan Stanley’s report was off the mark. Benchmark Intelligence, the leading trade publication in cobalt and lithium, dismissed the Morgan Stanley report findings out of hand.

BMO is expecting supply growth of around 25% per year from 2018 to 2022.   They think it’s probable that surpluses will grow to 273 kt LCE by 2021.   

The lithium market is a 200,000 tonne market expected to grow to a 350,000 tonne market by 2021.  The supply increases being projected by BMO are large compared to the base.  While surpluses will shrink post-2021, BMO is still expecting a surplus of over 190,000 tonnes in 2025.

All about Execution

The big question is whether all of these projects will arrive on schedule.  History shows that lithium projects are often pushed out months or years from their original completion date.

On their Q4 conference call FMC pointed out that 

They elaborated more recently saying that delays are often “years not months”.

This may be the Achilles heel to the BMO and Morgan Stanley reports.  Producers Orocobre and Albemarle have both had well publicized delays bringing new assets to the Market in the last 2-3 years.

What Happens to the Many Lithium Juniors When Capital Dries Up

Even if it all that new production doesn’t show up on schedule, its still a big backlog.   It isn’t good for the early and mid stage projects not yet on the roadmaps. 

There are lots of early and mid-stage juniors, mostly in the Golden Triangle (Chile and Argentina) being run by small operators.

These juniors could find that capital funding to get into production could be hard to find—unless demand ramps far fast than BMO expects, or these mines continue to see delays.

How To Play This–Be Very Cautious

The reports make it clear that the setup for cobalt companies is far better than for lithium.  Unfortunately, the universe of lithium and cobalt stocks does not line up well with the forecast.  

While there are many, many lithium stocks out there, cobalt stocks are few and far between.
I would be wary of any junior without financing or more than a couple years away from production.  Those that are closer to a market or that have firm agreements with customers are going to have an advantage.

On the cobalt side—it’s very difficult to find a pure play close enough to production to take advantage of the current bullish fundamentals.  There is no such thing as a senior pure play—and almost certainly never will be, being as cobalt is a by-product of nickel and copper.

EDITORS NOTE: I only own two lithium stocks–one with $13 million in the bank, the other with $23 million.  I expect the one with $23 million to have news out in the coming weeks that will forever lower the cost of production in the global lithium sector.  If you want to find out the symbol of this stock–click HERE.