Investors perhaps have not noticed, but within the EV supply chain industry—now worth over $1 Trillion (on Tesla alone!) there has been a huge debate about which EV battery would be dominant in the world.

The winner will be worth many tens of billions more than the loser.

And while Lithium-Iron-Phosphate (LFP) batteries have been The Ugly Duckling of the electric vehicle (EV) world, they look like they will beat out the longer range NCM (Nickel Cobalt Manganese) batteries.

The EV sector is growing so fast that this does not mean the end of nickel or cobalt—but is sure good news for lithium.

Investors see this in the buyouts that are happening of the lithium junior explorers, like Millenial Lithium (ML-TSXv) and NeoLithium (NLC-TSXv)—those two total close to CAD$1.5 billion in buyouts. (And by the way, I think ARENA MINERALS AN-TSXv) will be the next one.)

How many junior nickel companies have got bought out lately? ZERO.

The knock on LFP technology is range. LFP is not a sexy long-range battery – a nickel-based battery or the new kid on the block – a solid state battery.

But they’re cheaper than NCM, and as all the traditional automakers want to make a very inexpensive EV, they have to use LFP technology.

The only problem is now—there is basically no LFP production outside of China. And it’s Chinese companies wanting to buy up the lithium juniors to secure supply. 

A year ago, the western EV supply chain didn’t care about ex-China LFP production. But now that Tesla said (on Oct 22) that it will be using LFP for all but their premium brands–and VW said the same thing–and now the Market is DESPERATE for ex-China supply.

Electric Vehicles are part of the sustainable economy and having NO ex-China supply is not sustainable.

LFP batteries have been around for 40 years. This is a very mature technology. In fact, LFP battery technology is up against its theoretical limit for density – about 170 watt-hours per kilogram, or Wh/kg. 

That puts LFP battery at a ceiling that is far less energy dense (which translates into a lower range) than its cousins.

Source: McKinsey and Co.

More to Life than Density

Morgan Stanley put together a great visual comparing where NCM and LFP batteries shine:

Source: Morgan Stanley

LFP batteries are cheap. They are safe. And they last a long time.

An LFP based EV is going to appeal to any market concerned about cost. Morgan Stanley estimates that LFP batteries “cost 70-80% of NCM batteries”. 

The cathode cost per kWh is even less when compared to common NCM battery types:

Source: Morgan Stanley

Even Tesla uses LFP batteries in its standard-range Model 3 that are sold in China.

Push from China

No surprise that China is the hub for LFP batteries. According to MetalBulletin, “a total of 22.52 gigawatt hours of LFP batteries were installed in EVs in China during the first six months of the year, accounting for 42% of total installed batteries.”

The acceleration of LFP adoption in China coincided when the Chinese Community Party (CCP) turned off the taps on high nickel content batteries two years ago.

In other words, the guys in charge have given the thumbs up to LFP.

In fact, the adoption of LFP batteries in China seems to be accelerating. Credit Suisse pegged LFP battery installations at over 60% of all batteries in September.

Credit Suisse points out that:

LFP has seen market share gain through 2021 YTD thanks to its cost advantages to NCM batteries. We expect this trend to continue, given NCM batteries’ costs are unlikely to ease anytime soon. As a result, value chain companies (cathode, anode, etc.) with higher exposure to LFP batteries would benefit from LFP battery’s market share gain.

In many ways the LFP battery is far more robust battery than the competition. Applications where cycling is an issue – where the battery is being charged and discharged many, many times, (think: heavy duty-type applications, like electric buses or fleet vehicles, or some renewable energy storage applications) is far better suited for LFP.

Innovation is Still Taking Place

Second, while LFP cell density may have reached its limit, improvements to the overall battery design have led to incremental improvements in the density of the package.

China has been at the forefront. About the same time the Chinese government was limiting high nickel content batteries, BYD (BYDDF – PNK) developed a new “blade” battery design for LFP.

Source: Pushevs.com

The blade looks like a downhill ski without the lip. Its long, narrow form creates its own structural integrity, meaning you do not have to add metal to the battery pack just for strength.

The result is a far lighter LFP battery pack even if the density of materials had not changed.

This sort of design could only be done with an LFP battery. An NMC battery would heat up too much if you did a blade design with it. While the density of the LFP has not changed, the pack density has gone up a lot.

The BYD Blade battery is proprietary. But undoubtably other companies are already working on tweaks to the architecture to squeeze a bit more weight out of their own LFP designs. Already CATL – another leading battery manufacturer out of China – has managed their own, denser LFP battery as well.

The LFP market outside of China is just starting to gain traction.

The Korean company SK Innovation’s standalone battery unit SK recently said that they are looking into LFP battery development for lower-priced vehicles.

The CEO of Ford (F – NYSE), Jim Farley, said Ford would use LFP batteries on some of their commercial vehicles.

When Volkswagen (VWAGY – PNK) held their Power Day in March they said that LFP would be used in some VW entry-level EVs.

Consequences of Adoption

The composition of LFP batteries has other knock-on effects.

LFP batteries are unique. They take no nickel, no cobalt, and no manganese. The more LFP’s take share, the less incremental demand for these metals.

On the other hand, LFP batteries use more copper and more graphite than other battery types.

Source: Bernstein

Leveling the Playing Field

LFP batteries are not going to be “the game-changer” for electric vehicles. They are more like the field leveler.

As Morgan Stanley describes (my highlights):

EVs do not require extreme range, they need low cost and higher manufacturing volume. These may be reasons for LFP becoming the choice for mass market models – it is by far the cheapest and most scalable (in production volume) EV battery chemistry that exists today,at least 20% cheaper ($/kWh) at the pack level than nickel-cobalt battery packs.

While the headlines continue to go to the newest and longest-lived batteries, LFP keeps chugging along out of the spotlight. It truly is the underdog – the tortoise – in this race.

And we all know how that turned out.

Any company providing a big assist to a western-based LFP supply chain will be worth a lot of money. But how do investors play it?

NatGas is like the boy who cried wolf.

So many years.  So many promises.  So many disappointments.

But the price keeps going up – and on days when the price goes down it is less than you’d think.

The forward curve looking at January 2021 has been on a tear since the spring:
 

Source: Bernstein Analysis

The signals are screaming strength, which means natural gas has our attention.
 

what’s going on?
 

Where is this strength coming from?  As usual, a lot of it is storage.

Storage is below the 5-year average in the USA.  By the end of October, the beginning of heating season, inventories should be around 8% below normal.
 

Source: Morgan Stanley

But that clearly is not the whole story.  Natural gas storage levels a touch below normal would not warrant a spike to $5.

Another piece of the puzzle is Hurricane Ida which took 2 bcf/d of natgas production from the Gulf of Mexico (GoM) offline.  GoM production is about 2.5 bcf/d give or take, so Ida basically wiped it out.  This happened in an already tight market, and that gave us a price spike.

But we all know hurricanes come and go.  The chart above is for January gas.  All that Ida production will be back online by then.  There is more going on than just a storm.
 

Natural Gas is Global

 
A big piece of what is going on stems from what is happening outside of North America.  There is a BIG natural gas problem overseas.

The United Kingdom has become the poster boy for natural gas shortages.   In the UK gas prices have gone up so much that two power producers have already gone bankrupt!  1.5 million homes are dealing with bankrupt providers.  And it isn’t even winter yet.

Reporter Javier Blas of Bloomberg, says that the UK is seeing its “highest ever wholesale electricity prices”.  The government is talking about the possibility of “rolling blackouts” this winter.

Steelmakers and zinc smelters in Europe are curtailing production “due to sky-high gas prices”.

Citi came out with a BIG forecast last week.  From Bloomberg:

“Citigroup Inc. more than doubled its Asian and European natural gas forecasts for next quarter and said prices could surge as high as $100 per mmBtu in the event of a particularly cold winter”

Now, as context, winter prices in New England can hit $100/mcf on a really cold day every few years (because FERC won’t approve new pipelines up in there, which is very ironic given that the Marcellus is so close). But that’s just for an hour or so.

Citi is talking about a trend. This is not an impossible call.  Look at LNG prices right now.  Prices are parabolic and going higher:
 

Source: Bloomberg

If you thought inventories in North America looked a little tight, it is nothing compared to Europe.
 

Source: Bloomberg

Europe’s gas storage is 73% full versus a 5-year average of 88%.  Storage last year bottomed at end of winter at 29%.  This year it is starting out 22% lower than last year.
 

EUROPE COULD SUFFER THE WORST
 

If you do the math there is a very real possibility that Europe runs out of gas by next spring.

Europe’s problems begin with their renewable strategy.  As they rely more on wind and solar for electricity, prices are bound to get more volatile.  

What we are seeing in the UK right now is largely because the wind is not blowing.  Meanwhile the coal plants that used to provide the baseload power have already been retired.

With mandates already in place across the world – in both Asia and Europe – this is only going to get worse. 

Clearly, coal is not coming back.  Relying more on Russian gas is certainly far from ideal.

The only politically viable bridge fuel is LNG.

It is no coincidence that LNG buyers from Asia have been knocking down doors to shore up long-term supply.  These are the same buyers that were trying to get out of contracts a few years ago.

While US natural gas is not tied at the hip to international prices, the upward pressure from LNG is increasing.    This year may be the year where LNG finally drives North American prices – as two large LNG export projects come online. 

Two LNG terminals start up this winter: Calcasieu Pass LNG (1.3 bcf/d) and Sabine Pass LNG Train 6 (0.7 bcf/d).
 

Source: Morgan Stanley

2 bcf/d adds up to and extra 700+ bcf of offtake over the course of the year.
The LNG “squeeze” out of Europe and Asia means new LNG export capacity will have no problem finding a home.

You can count that 700 bcf on the books – there will be no problem exporting LNG.

Counting in the LNG molecules led to a pretty amazing forecast from BloombergNEF back in July.

A hat tip to Calgary based SAF Group for first reporting that BloombergNEF forecast an end of October storage number of only 2.64 tcf in 2022.
 

Remember this year we are looking at end of October storage of 3.4-3.5 TCF—trillion cubic feet.  Full storage would be 4.2 TCF

It does not take a genius to see that this kind of storage number would lead to much higher gas prices.  SAF Group pointed out that the last time gas storage was under 3 tcf, Henry Hub was over $10 – and that was 20 years ago, when demand was far lower.
 

The Third Leg: Discipline

 
We’ve got storage and we’ve got LNG.  But every chair needs at least 3 legs.  The third comes from producers.
Producers are showing discipline.

Overseas discipline is coming from Russia.  In fact, much is being made of whether Russian natural gas production is being artificially held back – that Russia is using their gas production as leverage over the battle for the Nord Stream 2 pipeline.

In North America, it is not political.  It is about returning cash to fed-up investors.  Knock on wood but it looks like producers have gotten religion – that they are not going to run up the rig count and flood the market.

What we are seeing so far in North America is remarkable restraint.  Rig counts in the Haynesville and Appalachia, which are the two primary dry-gas zones, have yet to recover to pre-Covid levels:
 

Source: Bernstein Analysis

Some of this is structural.  In the Marcellus/Utica, you just can’t get the gas out.   Even if they wanted to, producers can’t produce any more:
 

Source: Morgan Stanley

The same kind of discipline is happening with associated gas (natural gas from oil reserves) – the rigs counts aren’t recovering:
 

Source: Morgan Stanley
 

EVEN BIGGER PRICE SPIKES
Hinges on Winter

 
These 3 legs create the set up the winter for a potential “surprise”. 

THAT is what natural gas prices are trying to price in with that $5 January price tag.

The reason it is only $5 is because as usual, winter is far from certain.

The latest NOAA forecast is not yet predicting a cold winter.  The probabilities are that the important gas consuming regions will have temperatures “moderately above average”:
 

Source: NOAA

Above average is not going to cut it for a squeeze.

But – because this is weather no one will agree.  The Farmers Almanac says quite the opposite:
 

Source: Farmers Almanac

What you can say is–if we get a very cold winter, the United States could find themselves short of natural gas.

Now I know – if history has taught us one thing (and by history, I mean the last 20 years of natural gas prices) it is that natural gas producers can ramp up production if given incentive.

But on this timetable even the drillers can’t work magic.  January is only 3 months away.  You simply can’t drill and complete wells fast enough.

If it gets really cold this winter, we could see a BIG short-term spike in natgas prices.  Maybe not a Citi-lng-$100-gas spike, but a big one.

Natural gas futures don’t reflect this yet.  Because it is no guarantee.  If we see 70degF in January and there is no problem. 

But $5 futures are telling you there is a chance.
 

How Long?
 

The problem I see is that if we do get a big natural gas rally it may not have legs beyond 2022.

If you look at the big producers – Cabot, EGT, Southwestern – these guys are all FCF (Free Cash Flow) positive way, way below $5 gas.
 

You can make a good argument that breakevens across the Lower-48 are under $3/mcf.

2022 will be a bump year for LNG.  But after that, the next big export terminal, Golden Pass, does not come online until 2025 at the earliest. 

That means at least two lean years on the demand side.

Natural gas demand in North America COULD begin to face headwinds.  Biden’s plan to get solar and wind to 40% of the power grid may sound insane but you can’t deny that directionally, this kind of move is going to mean less natural gas demand.  Power demand is likely to fall below 20% of overall natural gas demand by 2030, from somewhere closer to 30% last year.

And on the other side of that coin, hydro power in the western US is much lower now with a drought going on.  I’ve recently written about how low US water reservoirs are there.

And it is possible (likely?) that all these renewable builds run into the same problems we see in Europe—meaning that natural gas takes on a greater role as “bridge fuel” as a result.

But even so, here in North America where the gas IS abundant, it is hard to see a “new era” of $5 gas as far out as the eye can see.  Breakevens are just too low.

Natural gas cried wolf and this time there really was one.  But – I’m not convinced that wolf is here to stay.  I think it’s more likely passing through.

That means gettin’ in while the gettin’s good.  For traders, there will be a time to take gains and move on–probably some time this winter.

But the trend of higher natgas prices may be here for a few years, as countries experiment with renewable energy strategies, and keep the lid on coal.
 
 

Keith Schaefer
Publisher, Investing Whisperer 

Water is our most basic commodity. I am only weeks into my deep dive into water investing but I can draw one conclusion already: finding a good water stock is not an easy task.

It’s a very timely topic as earlier this week the very first US Federal Tier 1 water shortage was declared–on the Colorado River.  The massive Lake Mead reservoir–created by the Hoover Dam–is only 35% full. It’s a critical water source for 40 million Americans across seven states, says The Washington Post.

With all this data, water stocks SHOULD present big opportunities–shouldn’t it?

I sat down for a conversation with Clay Landry last week. Clay is the Managing Director of WestWater Research, an advisory firm specializing in water asset transactions and valuation services. Their proprietary Waterlitix data is used to track spot water prices in California for the Nasdaq Veles California Water Index (NQH2O). 

Clay gave me the lowdown on the California water crisis. He laid out for me how California is in a pickle and how another year of low snowpack could create a situation where water prices could make a moonshot.

I left the conversation thinking – “I need to find a California water play”. 

For a while I thought that I had. I began looking at Cadiz (CDZI – NASDAQ). The stock fit the description to a tee – they sit on a huge water resource just a pipeline away from the metropolitan center of Los Angeles. 

What’s more, at first glance the stock looked cheap given the water it held (there is very little revenue like most of these water plays).

But as I dug into the details, I discovered nothing is so simple.

While Cadiz could turn out to be a winning water play, it has too much political risk for my taste and I’m not planning on buying it. But their predicament underscores a number of lessons for anyone looking to invest in water. Water means regulatory risk, political risk and the legal battles. This will only get worse as water becomes more scarce.

I’ll get to that shortly, but first let me tell you about the one big idea I am sure of – that California has a water problem.

The POTENTIAL For A California Water Crisis

A couple of weeks ago I wrote about Vidler Water (VWTR – NASDAQ). I framed that discussion around the 500-year drought across the west that has dropped the water levels of Lake Mead and Lake Powell to unprecedented lows.

The Colorado River System (CRS) that feeds into these dams is the primarily source of water used by Arizona, Nevada Colorado and New Mexico. 

The CRS is also important to California, particularly to the southern part of the state where it provides 50-60% of the water. But for central and northern California the CRS is not important – it accounts for only around 4 million acre-ft of water annually to a state that consumes 40+ million acre-ft.

The most important water source for the rest of California comes is the snowpack of the Sierra-Nevada mountains.

The Sierra-Nevada snowpack accounts for ~30% of California’s water in a typical year. Sometimes more. This water feeds the Central Valley water system through multiple rivers that run from the mountains to the ocean.

Source: Watereducation.org

Last winter the snowpack in the Sierra-Nevada fell flat. The mountains received just 59 percent of their average yearly snow water; rainfall at lower elevations was also below 50 percent of normal. The snowpack was entirely gone by June – more than a month early.

So far this has not yet led to issues with water supply. State and federal managers have banked and conserved enough water that there is no immediate concern about water shortages in California.

But another year of low snowpack and California will almost certainly be looking at water shortages.

Water Prices Already Reflecting THE PROBABILITY

Markets always price in probability before the event. The California water crisis is no exception.

Water trades on one-off deals between the users of water – municipalities, industrial consumers and agriculture – and holders of what rights.

This can make the market opaque. But California is big enough and has enough transactions that a continuous price contract is possible.

Using WestWater data, NASDAQ has put together an index that tracks the water price in California – it is called the NASDAQ Veles Water Index (NQH2O). CME has a futures contract that lets you trade on the index.

For funds, this is a direct way to play California water. For the rest of us, it is not accessible, so we need to look for other alternatives.

Not surprisingly, the index shows a strong correlation with drought conditions.

Source: WestWater Research

Prices for water have been going up. The price of water in California was $250 per acre-ft at the beginning of 2020. It is now approaching $900 per acre-ft.

Source: WestWater Research

Where it goes from here will depend on the drought – meaning this year’s snowpack, but another poor year and some insiders believe it could hit $2,000 per acre-ft.

The Bull Case for Cadiz

Having read about the importance of Lake Mead to the water supply of some 30 million Americans, the following excerpt from the Cadiz 10-K is about all you need to know for the bull case on the stock:

The aquifer underlying the Cadiz Property contains between 17 – 34 million acre-feet of groundwater in storage, a quantity on par with Lake Mead, the U.S.’s largest surface reservoir.

Cadiz owns land that is sitting on top of a massive amount of water.

That sounds extremely interesting. But…

Water Ain’t Easy

Unfortunately, it is never that simple. Because getting the water to market is somewhere between “very hard” and “not gonna happen”.

The Cadiz Project is not a new endeavor. Cadiz has been working on getting their water to market for about 20 years.

How’s that possible?  Well, the heart of the issue is where the water is. Cadiz does indeed sit on a huge aquifer. In the heart of the Mojave Desert.

Source: Westwise Substack Blog

The Mojave Trails National Monument surrounds the Cadiz land package. The Joshua Tree National Park is just to the south.

To say that this is a “sensitive environmental area” would be an understatement. If you were going to dream up a land package that would check all the boxes for environmental activism, you could not do better than here.

Obama Says NO

In 2011 Cadiz tried to move water to the South, connecting their aquifer with the Colorado River.  But to do so they had to build a 43-mile pipeline along a railway route through Bureau of Land Management (BLM) land. 

Source: Sacramento Bee

Under the Obama administration this is was a no-go. Cadiz was shot down in 2015 by a BLM guidance that said Cadiz could not use an existing federal railroad right-of-way for the pipeline.

Trump Says YES

But then in 2017 Trump took over.  Now there are A LOT of politics here and I don’t know what led to what but the end result was that the Trump run BLM turned over the Obama decision and said go-ahead and build the pipeline.

Was that the end of it? Think again. One thing you have to love about the States is that there are checks and balances. Nothing gets approved unless the courts say yes too.

Courts Say NO

Are you starting to get the feeling that no answer is forever?

The Sierra Club and Defenders of Wildlife took the BLM (and by association Cadiz) to court, arguing that the BLM had overstepped their bounds and the court should block the pipeline.

(There is more to it, has to do with railway rights, where the pipeline would have been located, but if you want to know the details you can read the court filings).

What is important is that the environmentalists won.

This was a blow to Cadiz. The stock dropped to the single-digits in early 2019.

It recovered briefly in the spring of 2019 but got a second whack courtesy of the California government. 

California passed a new law in July 2019 that was aimed almost exclusively at Cadiz. The law was signed by Governor Newsom and prohibits Cadiz, one of the largest private landowners near the Mojave National Preserve, from transferring water from a groundwater basin near a national preserve, national park or other state and federal wilderness areas unless state lands officials determine it would have no adverse effect on groundwater resources, habitat and natural resources.

You would think that this would put Cadiz on the mat for good, but you would be wrong.

Cadiz Tries Again

Cadiz, with the help of the outgoing Trump administration, had another card up their sleeve. In December 2020, just before the Trump administration seceded to the incoming Biden administration, the BLM made one last judgement.

This one was again for a pipeline, but a different one this time. In early December Cadiz bought an old, unused oil pipeline from El Paso. About two weeks later the BLM affirmed two right-of-way permits that enable them to transport water through an existing 30” buried pipeline asset that crosses over both the State Water Project and the Mojave River Pipeline on its 220-mile route from Cadiz.

Whereas before Cadiz was trying to send its water south (via the Colorado River Aqueduct) now it was going to send it north (to Los Angeles).

Source: ESA

Did this mean that Cadiz has their ticket to market?

Ha! If there is there is one takeaway about water, it is that there is no straight path.

And the Courts Say…

In March of this year the Sierra Club and Defenders of Wildlife filed another lawsuit against Cadiz (remember these are the same groups that won against them when they tried to pipeline south).

I read through the Civil Case Complaint (it is available on Pacer). The essence of the complaint is similar to the 2017 one.

The plaintiffs are arguing that the decision to let Cadiz use the pipeline was prompted by a Trump administration that was biased and they overstepped their bounds.

Maybe more importantly, they are arguing that basis of the BLM decision is flawed.

The BLM said that they could come to a decision without a lot of extra environmental review because the pipeline was basically the same pipeline before and after Cadiz begins operating it.

The Sierra Club and Defenders of Wildlife say – wait a minute, this was an oil pipeline. Now it’s a water pipeline. That’s not the same. Therefore, this needs to go through a whole other channel of decision makers.

Now I am not a lawyer, nor do I play one on TV, so I have no idea.

What is a bit troubling is that the judge on the proceedings is the same judge (The Honorable George H. Wu) that ruled against Cadiz last time. And to add another wrinkle to the proceedings, it is the BLM that was the original defendant in the case – but the BLM is now the Biden BLM, not the Trump BLM.

If your head is spinning from all of this, you are not alone.

Again, I do not have the slightest idea whether BLM acted within the bounds of the law or not when they made their judgement back in December.

What I do know is that having

1. a judge that already has ruled against you and…

     2. an administration on the defendant side that would likely be more comfortably seated at the other table……are               probably not adding to your odds.

Can Cadiz Work?

Honestly, the biggest positive with this stock is that it simply won’t go down.

With all the negative press, the lawsuits, the hedge fund shorts (there have been shorts on this stock for years) and really a company that generates zero revenue, I would have expected the stock to be much lower.

The fact that it is not is telling you someone believes that this water will be valuable… someday.

Cadiz says they can bring their water to market with upfront capital cost of $400 million. My back-of-the-napkin math on that, sold at today’s water price, does not leave much upside in the share price.

But long-term water resources are not priced at spot. When we looked at Vidler they priced their long-term Nevada water supplies at ~$40,000 per acre-ft.

Sustainable California water could be worth double that.   If you think that’s the case, Cadiz has a lot of value at the current price.

Watch from the Sidelines

When framed in the worst way, the Cadiz story can look pretty ugly. As the LA Times said in an opinion piece in 2018, the Cadiz project is a way to “drain the desert” – YIKES!

On the other hand, the story could catch fire if framed differently. 

You could highlight that there is more water than Lake Mead and it’s a pipeline away from the population would be a good start!

For me, I can’t bring myself to buy the stock until this latest lawsuit gets settled.  Legal battles are not my cup of tea. A Democratic government and a Judge that has already ruled unfavorably just adds to that.

Judge Wu begins to hear arguments August 23^rd. There is a motion for summary judgement, which means a decision before the trial, and if that goes through it could come to a quick close.

I think its best to wait until that resolves and then reevaluate.

The water is not going anywhere.

Water stocks have been in a drought for 20 years. I have been hearing about the great potential for water stocks for at least that long. ‘Water will be worth a lot some day—maybe one day soon’ is the line I hear every few years. But investors have not made much if any money on this most basic commodity.

So when a 103 page research report on Vidler Water (VWTR – NASDAQ) arrived in my inbox, I was skeptical—as I will explain.

But with freshwater reservoir levels in the US Southwest now very low, and high-profile investors like SPAC guru Chamath Palihapitiya looking seriously at this sector—maybe the drought in water stock performance is over.

I was skeptical of Vidler at first as the story came with two quick strikes against it.

Strike one came when I realized that Vidler was the old Pico Holdings. I am familiar with Pico. Pico is a water story that has been around for years and, to be honest, it has never made anyone much money (except maybe management).

Then strike 2 came when I realized it is pretty much the same story it was with Pico. When Pico was making the rounds, it was all about water rights and home building. The home building angle seems to have gone by the wayside and investors are left with a water rights play.

My problem with water rights is that it’s a bit of all or nothing. Either you sell them or you don’t. In Pico’s case (now Vidler) they could not seem to sell the water rights for what they believed they were worth.

Behind in the Count but not done yet

After the first two strikes I was not holding out much hope for Vidler. But I kept on digging and I am glad I did.

My big issue when I started looking at Vidler was – what is a catalyst? A reason that those water rights might get sold some time soon.

As I dug into the story, I found there was just such a catalyst – and a big one at that.

The story the Hoover Dam and Lake Mead.

Water levels at Lake Mead are dropping like a rock right now.

There is a big drought throughout the west. That drought is having an impact on Lake Mead. There are a pile of articles you can find that describe just how bad it has gotten for Lake Mead, but a picture says 1,000 words.

Source: Bloomberg.com

That white bathtub ring is telling you where Lake Mead was versus where it is now.

This website tracks where Lake Mead is today versus its level over the past 5 years.

Source: Lakelevels.info

Lake Mead is lower today than it has ever been in the past. 

It came close to this level in 2016 but it quickly recovered. The drought ended – or at least went on sabbatical.

But today is different. It is not expected to recover. Water levels have definitively dropped to a Tier 1 level.

What is Tier 1?

Source: Bloomberg.com

The tiers of Lake Mead are like lines in the sand. Beginning at Tier 1, when the water breaches this level water cutbacks ensue.

The Drought is Widespread

It is not just Lake Mead. The reservoirs upstream of Lake Mead, also along the Colorado River, are also very low. Lake Powell, which serves Colorado, New Mexico, Utah and Wyoming, has seen inflows this year that are just 33.62% of average. The water level at Lake Powell is at least a 10-year low (as far back as the data I saw went). 

There are 7 states that depend on Lake Mead, Lake Powell and the rest of the Colorado River Basin: California, Colorado, Nevada, Arizona, Utah, Wyoming, New Mexico.

As these states realized that water levels from the Colorado River Basin were unlikely to bounce back, they began to negotiate how the water would be divvied up.

In 2019 the Colorado River Basin Drought Contingency Plan was signed. 

You have to go way back to 1968, but because of a political agreement Arizona signed with California at the time, they will take the lion’s share of the Tier 1 cuts (this blog post describes the details).

In 2016 Lake Mead dropped below Tier 1. But because it was brief no Tier 1 water shortage was declared.

This time around everyone expects a Tier 1 shortage will be declared. I have not been able to find a single article arguing that it won’t be declared.

The Tier 1 shortage declaration is going to happen August 1st. It could be followed by a Tier 2 shortage declared next year, but that is going to depend on water levels.

Why this Matters to Vidler

As I said the first cut falls disproportionately on Arizona.

Vidler has two big assets. One of them just happens to be a lot of water… in Arizona.    

Vidler owns what are called Long-Term Storage Credits (LTSCs) in Arizona. LTSCs are essentially stored water that is recognized as such by the state of Arizona.  Because it is recognized by the state, it can be sold.

Vidler has LTSCs in Phoenix and in the Harquahala Valley – about 90 miles west of Phoenix. It is all essentially water that can be used by Phoenix – for a new subdivision, a new semiconductor plant, whatever.

Vidler has been sitting on this water for some time.  With the Tier 1 water shortage about to be declared, that is going to change.

That isn’t me talking. It is management. From the annual meeting (Vidler does not do quarterly calls because, quite honestly, nothing really happens that fast with this company):

We would expect once a shortage is declared in August that we would see the Phoenix AMA credits disappear, go to other users. We believe that we would start seeing a takedown… on the Harquahala… We have gotten more calls over the last year on Harquahala, and we have actually handed out contracts, draft contracts for review.

What are those water rights going to go for?  Again, management was quite upfront about this at the AGM:

As of July 1, 2021, Phoenix AMA pricing will be set at $400 per credit.

Harquahala credit pricing is close to the same.

Vidler owns 28,147 acre-feet of LTSCs in Phoenix and another 250,683 acre-feet at Harquahala. At $400 per acre-foot (AF), a sale of all their rights would gross them $110 million.

I’d look at that $400 per AF as a minimum. Likely, as those credits begin to be bought, Vidler will raise prices. They would be crazy not to.

Nevada Assets

The Arizona assets are clearly the near-term catalyst. But Vidler owns other assets as well.

These assets are in Nevada. Vidler owns underground water sources outside of Las Vegas and Reno and a pipeline that takes water from their wells to Reno.

The Nevada assets are actually worth more than what they have in Arizona. 

Near Reno Vidler has a 7,310 acre property called Fish Springs Ranch. Fish Springs holds 12,696 AF of water rights, including 7,696 AF that are already designated as water credits available for developers. 

There is also a 35-mile pipeline that can deliver 22,000 AF of water, a pump station, electric sub-station, and six wells that together cost the company $95 million to build.

A point of clarification: the water rights at Fish Springs, and throughout Nevada, are not quite the same as Arizona. In Arizona Vidler owns a volume of water – when I am quoting numbers, I’m telling you the volume of water they can sell.

In Nevada, what they are selling is a sustainable water rate – how much water (in AF) that they can extract per year.

That makes the water rights in Nevada worth a lot more on a per acre-foot basis than Arizona.

Again, going back to the AGM, management was kind enough to tell us what they are willing to part with the Fish Springs water for:

We are increasing our pricing by 5% as of July 1, 2021, to $43,575 per acre foot for residential development and $37,800 per acre foot for commercial/industrial development.

The math on this is somewhere between $291 million and $355 million for the 7,696 that is already permitted. Add on another $200 million once they successfully permit the other 5,000 acre-feet.

The Fish Springs assets are a 51/49 partnership. But there is a catch. Vidler has been putting up all the capital for the partnership and that capital receives a preferred return on sales – including accrued interest at 4.74%.

What that means is that before their partner sees a penny, Vidler gets the first $195 million from sales. After that, it is split 51%/49%.

In addition to the Reno asset Vidler has assets in Southern Nevada. They have 1,171 acre-feet of water rights in Lyon County Nevada, which would serve Carson City and another 3,288 AF of agricultural rights in that area.

At the AGM Vidler said that the sales price in Lyon County was “26,000 per acre foot, which will increase to July 1 — which will increase on July 1 to $27,000 per acre foot”. They also own a pipeline in Lyon County with 5,000 AF capacity.

Also in southern Nevada, they own rights for water that could be utilized by Las Vegas. Here Vidler owns 4,400 AF of water rights, of which 1,000 AF is for agricultural use. 

There are other assets too. There are multiple parcels of land around Las Vegas where Vidler has water permit applications in process. There is the land itself, some of which Vidler has leased out to solar companies for single-digit millions in lease revenue. 

AS THE WATER GOES LOWER,

THE STOCK COULD GO HIGHER

The bull case for Vidler has always been dead simple.

At $13 Vidler has a market cap of $232 million. There is no debt and a little cash. When you add up all their assets, they are worth a lot more than that.

Consider only the Arizona LTSCs and the permitted water at Fish Springs Ranch alone and you are already over $21 per share.

Getting to $30+, especially considering this water crisis is more likely to get worse than better, is not a hard task.

The problem with Vidler has always been when, when, when.

The Nevada assets are progressing – there are Reno developments, Las Vegas developments that will need Vidlers water – but nothing major is imminent (read: in the next 6 months).

So what this story is really about right now is Arizona.

And Arizona could quite possibly be at an inflection point.

If the Tier 1 shortage is indeed declared, then we should expect a speedy sale of the Phoenix LTSCs and at least some of the Harquahala LTSCs. Both Intel and Taiwan Semiconductor have plans to build plants around Phoenix. Those developments will need water.

If Vidler can sell all their LTSCs, they bring in $100 million+. Sell half and they bring in $50 million.

This becomes a catalyst because the current management is focused on return of capital. Again, from the AGM:

Our focus is to maximize our return on our invested capital. And that is evident by our Board and management’s equity ownership, which is over 11%, and the structure of our management compensation.

Vidler management did a $5 special dividend in 2017 and have repurchased 4.9 million shares through May 2021 (there are about 18.5 million shares right now).

The Chamath Connection

There is one other potential angle for Vidler. Another excellent blog post summarized a recent discussion between the well-known SPAC and VC investor Chamath Palihapitiya and other VC investors on their “All-in” podcast.

On the podcast Chamath talked about the opportunity in water and how the best way to own it is by “owning water rights”.

The blog post also provides some evidence that Chamath and his team may already have created a fund (most likely a charitable one) to own water rights.

Will any of this amount to anything? Hard to say. If Chamath and the VC cohort did decide that Vidler was worth owning, it would certainly be helpful for realizing the share price.

It’s the Weather Stupid

VC’s talking water smack is an interesting angle but the story is going to live or die on the Tier 1 water shortage.

I’ll be honest – I considered making Vidler a subscriber pick. The sum-of-the-parts is there. The chart is consolidating its new range and setting up well.

My hesitation is that the whole story turns on the weather.

Las Vegas and the south had torrential rains over the weekend. They are set up to continue through the southwest for the next week.

The longer-term forecast looks more constructive. The precipitation forecast for the southwest looks to be below seasonal until at least the new year.

Source: NOAA

But these rains do illustrate a point. It is tough to pitch a subscriber pick that turns on the weather. I guess I have had too many years of natural gas investing for that.

That said, there is clearly a catalyst here and the case can certainly be made that the stock is worth a punt. It is clear that Vidler is a better story than it has been in the past. The assets have always been there. We are now about to see what happens if catalysts materialize.

We are seeing a tug of war between the bulls and bears in the nickel market.

The bear camp is focused on increasing nickel supply coming out of Indonesia and, to a lesser extent, China, in the form of nickel pig iron (NPI).

The bulls camp counters by pointing to soaring demand from electric vehicles and a lack of high-quality Class 1 nickel projects in development.

For what it is worth, the bears have history on their side. Indonesia and China have been able to increase production of low-quality nickel (called Class 2 nickel) for years now—and in the process driven the price of nickel down.

Source: Bank of America Global Research

By all accounts, that is expected to continue. Bank of America (BAC – NYSE) expects Indonesian nickel production to increase from 600,000 tonnes in 2020 to over 900,000 tonnes by 2023.

Nevertheless, even with the coming onslaught of NPI supply, I am inclined to side with the bulls on this debate.

Not that I doubt the ability of Indonesia to produce low quality ore.

I’m just not sure there will be buyers.

On Thursday, Tesla (TSLE – NASDAQ) and BHP (BHP – NYSE) struck a major deal – for Class 1 nickel. Benchmark estimated the contract was worth 18,000 tonnes per year beginning next year.

The key word here is Class 1. Telsa and others want Class 1 nickel that will meet both their EV requirements and have an acceptable environmental footprint.

I think we are on the cusp of a unique turn in the nickel market. One where countries will balk at dirty metal – much in the same way we are seeing oil sands oil get the cold shoulder.

Europe Leads the Way

As with most things green, Europe moves first.

The European Union has plans for a carbon border tax. Any import is going to be scrutinized for content. If it is made from high carbon sources, a levy will be weighed.

This is Europe’s way of leveling the playing field. They realize that their own carbon reduction efforts are going to raise costs. They do not want low-cost/high-carbon competition under cutting them.

Other countries will follow. The anti-carbon movement in the US will only grow. China may not want to follow along, but once tariffs get high enough, they will have no choice but to follow.

In a few years, companies importing into any major economy will be providing an exhaustive list of where components and materials come from.

With this will come public scrutiny. If you are an EV company, even if you can handle the tariff do you want to explain how the nickel in your batteries is being smelted out of low-quality nickel, high-carbon nickel?

No way. In fact, this is exactly why we are seeing major EV producers – Tesla and Volkswagen (VAKAF – PINK) for instance– looking to secure long-term nickel supply.

Tesla has already gone out and nailed down their nickel requirements via Prony Resources and Vale (VALE – NYSE) in addition to the BHP deal.

Car manufacturers are sending a clear message – they want to control where their nickel is coming from.

Will Nickel be Disrupted Again?

Earlier this year the nickel market took a tumble, falling nearly 10% in a day. The catalyst was news from the Chinese company Tsingshan, which announced they had a new process that could produce high-quality, Class 1 nickel out of low quality NPI.

Class 1 nickel is what trades on the London Exchange. It is extremely high purity – >99%.

NPI is far lower quality. So far its usage is limited to steel production because purity is not a requirement and the iron content is beneficial.

Turning NPI into Class 1 nickel is a little akin to turning lead into gold.

But what really freaked the market out with Tsingshan’s announcement was that they have done this before.

In 2008 nickel was sitting at $50,000 per tonne. That was before Tsingshan did something genius.

Tsingshan discovered NPI. Well, “discovered” – what Tsingshan really did was realize that since both iron and nickel were used in steel making anyway, an ore with a mix of both was not necessarily a bad thing. Nickel promptly fell into a decade long bear market.

So is Tsingshan about to disrupt the nickel market again?

I have my doubts.

Tsingshan’s problem, and really what I think is the meat of the nickel bull case, comes down to carbon.

It’s the Carbon Stupid

EVs and oil gets all the climate change headlines right now. But that is going to change. Soon any carbon intensive industry is going to find itself under the microscope.

NPI is far more carbon intensive to produce than Class 1 nickel. So far that has not mattered. But it will.

A recent study published in the energies journal estimated that the carbon intensity of NPI was nearly 5x that of producing metal nickel.

Tsingshan’s new process will only add to that. It will release sulfur into the atmosphere, use additional energy and, at least for now, depend on coal-fired power.

While the market worries about an onslaught of upgraded NPI, at I think we will see the opposite.

Instead of low-quality NPI being upgraded to Class 1 battery nickel, I believe we will see steel producers shy away from using NPI that comes with a high-carbon intensity price tag.

The World Steel Association has put together a tracking spreadsheet of steel decarbonization projects. So far, they have table 50 projects from many of the largest steel companies in the world.

Source: World Steel Association

This is just the beginning.  Steel producers expect to reduce carbon emissions by at least 30% in 2030 and by 95% in 2050.

To think that we will see a huge influx of carbon intensive NPI nickel—just as steel producers look to pare back their carbon footprint—is not reasonable. 

Talking Out of Both Sides

For the bears, it is a case of seeing one big picture but missing out on another.

The bears admit that the EV story is real. They concede that nickel demand is going to increase. But they kibosh the idea of a nickel shortage by pointing to all the NPI available.

It is not about EVs folks. It’s about carbon.

EVs are the tip of the iceberg. In 10 years what we are going to see is the measurement of the carbon content of everything.

That means that the nickel market that matters – the Class 1 nickel market– is going to need new, clean supply.

Ken Hoffman, the head of EV Research at McKinsey Co. has begun to sound the alarm.

Hoffman says we are 2 years out from a Class 1 nickel shortage. 

While Hoffman sees Class 2 nickel being in significant surplus for years to come, Class 1 nickel shortages could come as quickly as 2023.

Source: McKinsey Research

In fact, the only thing preventing the shortage from materializing sooner is that there is another shortage – in microchips – that is limiting EV production this year.

Without that, we would be seeing EV sales increasing from 3.2 million last year to over 6 million this year.

The chip shortage will be transitory. But without new supply, the nickel shortage will not.

That is why the time is now to look for the top quality, low-carbon intensity nickel projects. These will be the projects that the Tesla’s and VW’s of the world will go to as they try to secure the necessary supply of green nickel.

HOW I AM PLAYING THIS

NANO-TSX–NANO ONE.

The underlying scoop here is that BHP will ship Ni instead of nickel sulfate. This eliminates the economic and environmental costs of converting to Ni sulfate, and Ni being 22% the weight of NiSO₄ is about 5x cheaper to ship with 1/5 of the carbon footprint.

So yes, it is a good step towards more sustainable Nickel. However, when the nickel arrives at the cathode facility, it is first converted to sulphate then converted to hydroxide with all the sulfate going to waste using a tremendous amount of water along the way (sulfate waste = 1-2x the product stream). 

There’s nothing novel about this. Much of the Chinese supply chain already does this when the economics favour it, and the Nornickel/BASF JV is based on a similar concept.

But none of these approaches solves the sulfate waste stream problem, nor the added cost and footprint of the required lithium hydroxide, nor the subsequent costs of additional steps to lithiate the metals and coat the cathode.

Nano One’s One-pot and M2CAM technologies takes this concept several steps further. it eliminates sulphate and its wastefulness entirely from the process.

They use about 1/20th of the of the water. We also enable lithium carbonate as a feedstock, thereby eliminating the added cost and footprint of converting to hydroxide. And they lithiate and coat the cathode all in a one-pot process without the extra steps and costs.

FPX Nickel–FPX-TSXv

FPX has one of the largest undeveloped nickel deposits in the world in central B.C. Its unique geology–arawuite–means their nickel can be processed without smelting. I think it’s the greenest nickel on the planet, bar none. When the nickel majors start buying the juniors, this one should go first and should attract a high valuation because of its unique geology in a first world jurisdiction.

Keith Schaefer

Publisher, Investing Whisperer