Lithium: 3 Things Investors Need to Know

There's always been a strong correlation between economic progress and the flow of materials, but the Industrial Revolution solidified the relationship. The 19th century was shaped by the vision of a steamboat entrepreneur named Cornelius Vanderbilt, who helped to break down geographic barriers between production and consumption. That opened the door for Scotsman Andrew Carnegie's steel empire and John D. Rockefeller's petroleum empire, each of which spanned the 19th and 20th centuries. 

It's too soon to write any one material into the history of the 21st century, but one is bound to play a significant role: lithium. Much as steel enabled modern infrastructure, lithium materials enable mobile power applications. As the world electrifies ground-based transportation and seeks solutions to intermittent power production from renewable energy sources, demand for lithium materials is expected to soar.

Before investors go rushing into lithium stocks, however, it helps to understand some of the basics. This guide provides a top-level understanding of the valuable metal and the long-term investing opportunity presented by producers. 

Image source: Getty Images.

1. Where does lithium come from?

Lithium is found in two types of deposits today.

Brine: A significant amount of the world's lithium reserves are found in concentrated deposits of brine, or salty water containing various minerals. An estimated 54% of the planet's brine deposits are held within South America's Lithium Triangle, which touches parts of Argentina, Bolivia, and Chile. Other major lithium brine deposits are found in the Middle East and the United States, especially in Nevada.

The quality and composition of brine resources varies greatly, although the highest-quality reserves are located in the Lithium Triangle. The Salar de Atacama brine in Chile has the highest concentration of lithium in the world -- but it's only 0.16% lithium by weight (although lithium is the third-lightest element in the universe). The world's second-most concentrated brine is the Salar de Hombre Muerto deposit in Argentina at about 0.06% lithium by weight.

The combined brine operations of Albemarle (ALB 2.03%) and Sociedad Quimica y Minera (SQM) (SQM 1.61%) in Atacama produced 27% of total global lithium production in 2019.

Brine deposits are losing market share due to a confluence of logistical and geopolitical factors, the lengthy amount of time it takes to bring new projects to the market, and the specific composition of lithium compounds produced. The share of global lithium production sourced from brine is expected to fall from 45% in 2019 to 38% in 2025. Absolute lithium production from brine deposits is expected to increase 170% in that span.

Rock: Mineral rock deposits are the other major source of lithium compounds. The most sought-after mineral is spodumene, which has been found to contain up to 7.7% lithium oxide content by weight. Major spodumene deposits are found in Australia, Brazil, Canada, and China.

Producers are increasingly favoring lithium sourced from rock deposits instead of brine for several reasons. First, they're present in a wide variety of geologies and geographies. Australia has the world's largest identified spodumene reserves and offers favorable regulations to mining and extraction industries. The country is also close to China, which is the world's largest market for lithium. That helps to explain why Australia is home to five of the world's nine largest lithium projects in development today.

A joint venture between Albemarle and Tianqi owns the Greenbushes project in Western Australia. At the end of 2019, Albemarle's operational capacity in the project could have supplied 12% of total global production. It was utilizing only one-third of its stake in the project.

Second, rock deposits are ideally suited for producing battery-grade lithium compounds, discussed in the next section. Third, rock projects are easier to bring to market, and have more predictable production profiles. 

The share of global lithium production sourced from rock is expected to rise from 55% in 2019 to 62% in 2025. Absolute lithium production from rock deposits is expected to increase 270% in that span.

Image source: Getty Images.

2. What are the main types of lithium?

Whether sourced from brine or rock deposits, raw lithium is purified and processed into two main lithium compounds and a group of specialty lithium compounds. 

Lithium carbonate and lithium hydroxide: These are the two primary lithium materials traded on markets today. Each compound is listed at a unique selling price in regional markets -- for instance, lithium carbonate in China trades at a different price to lithium carbonate in South America, and both trade at a different price to lithium hydroxide in either region. 

Lithium hydroxide typically trades at a slight premium to lithium carbonate due to its preferential use as a battery-grade material. Lithium hydroxide is expected to rise from just 22% of global production in 2019 to 51% of global production in 2025.

It's important to note that the default unit of measurement for all lithium resources, reserves, and production is a metric ton of lithium carbonate equivalent (LCE). Production of lithium hydroxide is measured in LCEs. While most producers now normalize their discussions of total output and markets to lithium carbonate, not every information resource makes the distinction. One metric ton of lithium content is different from one metric ton of lithium hydroxide, which are both different from one metric ton of LCE. Therefore, investors have to be careful when comparing different numbers quoted from different sources.

Specialty lithium compounds: There are numerous lithium compounds used in niche applications. Lithium stearate is used in industrial greases and lubricants. If you own a glass-ceramic cooktop in your kitchen, then your meals are made possible in part by the unique thermal properties of lithia. Metallic alloys containing lithium are even used to construct the fuel tanks of SpaceX rockets. That said, these specialty compounds don't represent a major opportunity for individual investors.

Image source: Getty Images.

3. How to invest in lithium producers

Why consider lithium for your portfolio? In a word: batteries. Total global demand for lithium is expected to grow over 260% from 2019 to 2025. That will be driven by an expected 599% increase in demand for electric vehicle applications.

The most direct way to own exposure to the opportunity is through producers. Albemarle is the world's largest producer, with an estimated nameplate capacity of 85,000 metric tons of LCE in 2019. While the company has delayed and reduced expansion plans in an attempt to balance the near-term market, it still expects to double its nameplate capacity by 2021.

That's also the year in which Albemarle expects to be free cash flow positive, aided in part by its unrelated high-margin businesses in catalysts and bromine. It should all combine to provide greater financial flexibility with respect to future growth and expansions. The company estimates that current investment plans would only utilize about 60% of its available resources -- the majority of which are valuable rock deposits -- by 2024. In other words, there will be plenty of opportunities for the company to position itself to respond to growing global demand. Plus, the producer is developing engineered lithium materials for next-generation battery applications, which could give shareholders increased exposure to end markets, too.

The other major producer that should be on the radar of investors is SQM. Similar to Albemarle, SQM operates a diverse business, with operations in agricultural fertilizers and specialty chemicals, which helps to offset exposure to volatile lithium markets still experiencing a fair share of growing pains. The company is comfortably profitable, and owns lithium assets in both the Lithium Triangle (brine) and Western Australia (rock).

The most noteworthy second-tier producer easily accessible to individual investors is Livent Corporation (LTHM). Unlike its larger peers, the company is all-in on lithium markets. That hurt shareholders in 2019, but the company's focus on battery-grade lithium hydroxide expansion in the next five years should put the business in a position to capitalize on global trends. Other second-tier producers include Lithium Americas (LAC) and Orocobre (OROCF).

Data sources: Company presentations and Yahoo! Finance.

There will be other ways to own exposure to the lithium market, such as energy storage product manufacturers and electric vehicle producers. But those end markets will come with unique obstacles, opportunities, and metrics for success. For example, the battery joint venture between Panasonic and Tesla only became profitable for the first time in the fourth quarter of 2019. 

By contrast, lithium producers are really only concerned with developing global lithium deposits at the lowest possible cost and selling as much volume as possible to customers in long-term contracts. As Albemarle and SQM have demonstrated, successful execution can create solid revenue and earnings streams, especially as a company's production footprint scales. 

Simply put, the investing opportunity represented by lithium is still in its infancy, but investors with a long-term mindset might see the value of owning a piece of the market today.