Spod Wars - How Should Lithium's Upstream Be Priced? (1)

Part One: How Is Spodumene Priced?

This article is the first of a three-part series on spodumene pricing. The follow-ups will be: Part Two: How Should Spodumene Be Priced? And Part Three: Why Should You Care How Spodumene Is Priced?

The idea for this piece came from a chat with Howard Klein and Rodney Hooper of RK Equity. In discussing potential topics for a podcast episode, our conversation was drawn towards the chess game playing out among the lithium industry’s hard rock players. With the jostling for market share, positioning and partnerships heating up, one factor we agreed was relevant to the power struggle is how spodumene is priced.

Our interest in this comes from different angles. Howard and Rodney are, naturally, most concerned with what these questions mean for the valuations and growth prospects for lithium equities – the podcast is called the Rock Stock Channel after all! My role at Fastmarkets meanwhile requires me to work from a position of independence and neutrality with industry stakeholders to develop the most appropriate pricing mechanisms for the markets we serve.

The discussion that followed was certainly enjoyable, but... we had to admit, somewhat arcane and rambling! To do this with the tape rolling we’d need to refine our thoughts, and for me at least, the best way of doing that is to write them down. In truth, I could have written twice as much. A complex subject like this has many angles and counterarguments to each point. So, if you’re interested in hearing us probe, challenge and unpick some of these ideas, as well as other perspectives on the lithium market, be sure to tune in for the next Rock Stock Channel podcast!

Why pricing matters

Adam Smith wrote in the Wealth of Nations: “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own self-interest.”

At the heart of this ‘self-interest’ is the price governed by supply and demand, which dictates whether there is a profit to be made. This is why prices are so important. An effective price system helps deliver not only our dinner, but all our other needs and desires too. Electric cars are no exception, relying on intricate supply chains and efficient pricing of raw materials like lithium to facilitate their manufacture at a reasonable cost.

Lithium’s pricing mechanisms have evolved considerably over recent years. Old norms of negotiating fixed prices for multi-year supply agreements have increasingly given way to contracts linked directly to spot indices for lithium carbonate and hydroxide, providing a more transparent and dynamic market price signal. Exchanges such as the LME, CME and most recently SGX, have also developed cash-settled derivative contracts for these same lithium salts to facilitate risk management – a hallmark of a maturing pricing system.

But there is a key part of the lithium market ecosystem in which pricing practices remain more opaque and more varied…?

Spodumene

Something we hear frequently in the media is that China dominates lithium production, churning out some 60% of refined lithium carbonate and hydroxide (the remainder coming mostly from South America). What the mainstream narrative often misses though is that the Middle Kingdom relies heavily on imports of spodumene concentrate from Australia to feed its fleet of processors. And, as the demand for lithium has increased, the bottleneck in expanding production is proving most acute at the upstream end of the supply chain.

The proportionate escalation in spot prices from their late 2020 lows demonstrates this; lithium hydroxide has risen around 850%, carbonate some 1,090%, while spodumene eclipses both with a whopping 1,780% rise. However, in contrast to the increasing coalescence around a transparent index that we see in the pricing of lithium salts, approaches to pricing spodumene are still struggling to settle on an optimal structure, and far from all trade is achieving those striking spot price levels.

Elon Musk was part-right when he likened lithium production these days to a “license to print money,” but was wrong to ascribe that comment to the processing function. The real “software margins” currently sit with the companies holding the raw materials, either as integrated producers or merchant miners, and those in the box seats know it…

Chris Ellison, the founder and managing director of Mineral Resources, said during a highly quotable recent results call that: “If you own rock in the ground, you are God,” while if you “don’t own your rock, literally you are screwed ... by us.”?

He was referring to a cost curve of lithium hydroxide production (Source: Mineral Resources FY22 Results Presentation) highlighting the stark difference in margins between integrated producers, and third-party converters having to buy their spodumene on the open market. But, while Mineral Resources has partnered with chemicals producers and makes no secret of its ambitions to become an integrated producer itself, it is not one yet. And as such, it wants to maximize the value of its spodumene sales in the here and now.

Cue a restructuring of the company’s deal with Albemarle on the joint ownership of the Wodgina spodumene mine and the Kemerton hydroxide refinery. The rejigging now sees Mineral Resources increase its share in Wodgina from 40% to 50%, regaining control of product pricing, while decreasing its share in Kemerton from 40% to 15%.

Mr Ellison again: “I want control back of my pricing… they’re still going to sell our product, but they sell it under our model … we just take the price of the day.” This is language straight out of the lexicon of Mineral Resource’s other major market of interest – iron ore – and suggests a desire to shake up the way spodumene is priced.

How is spodumene priced?

There are four main ways that spodumene is currently priced:

1)?????Formula-linked to lithium hydroxide/carbonate PRA (Price Reporting Agency) indices

2)?????Linked to spodumene concentrate PRA indices

3)?????Fixed-price spot sales/auctions

4)?????Fixed-price longer-dated contract (1-12 months)

Each are used to a greater or lesser extent by different participants, and each has pros and cons.

Fixed-price spot sales, notably exemplified by Pilbara Minerals’ BMX platform auctions, are the purest form of market price discovery. By creating a competitive tension for the ‘marginal tonne,’ such deals provide transparent data points for the formation of spot indices like Fastmarkets’ SC6 basis Cif China spodumene assessment.

However, the frequency of such trade is currently still limited, and in any case, spot sales are generally a means to an end rather than a channel for moving large volumes. The real goal is for regular spot liquidity to support trust in an index, to which term volumes can then be linked. An ongoing preference among merchant producers for negotiating longer-dated deals though, at either fixed prices or formula-linked to downstream lithium salts indices, has seen a lack of full commitment to supporting and using a spot index.

Somewhat ironically, the participants understood to have made the most use of PRA spodumene indices have, to date, actually been the vertically integrated producers. Not because they necessarily choose to, but because they are required by tax authorities to use an independent third-party reference for internal transfer pricing.

One factor influencing spodumene pricing preferences is the question of how sales for the downstream products are structured. So long as there are still contracts for lithium carbonate and hydroxide based on market-lagging legacy mechanisms, there will remain pressure on spodumene pricing to be accommodative in order to safeguard converter margins.

Market forces could see this change going forward though. If Mineral Resources, for example, insists on selling spodumene to JV partner Albemarle for conversion at spot-linked prices, then the latter would surely incur unwelcome risk unless its downstream pricing was similarly reflective of the ‘price of the day.’

Such is the nature of feedstock-product pricing relationships. A golden rule of supply chain management is to keep price exposure 'fixed-to-fixed' or 'floating-to-floating', and market stresses in one segment therefore often precipitate changes in another. Over time, markets have a tendency to break into more granular pricing structures, with the value of each product reflecting its own supply and demand dynamics.

Check back tomorrow for Part Two: How Should Spodumene Be Priced...