Investors are still salivating at the prospects for Tesla Motors Inc (NASDAQ:TSLA)’s electric cars – particularly the Model 3.
But is all the anticipated hype really warranted?
There may, in fact, be a bumpy road ahead for the commodity sector and Tesla’s future.
Tesla’s electric cars require lithium-ion batteries to maintain power. These batteries are, in turn, supplied by Tesla’s Gigafactory – which remains under-construction.
The key components in a lithium-ion battery are lithium, graphite, and cobalt. And while Tesla has been reassuring investors that the Gigafactory has “adequate supplies or sources of availability” of these materials, the claim itself seems questionable since Tesla has no definitive offtake agreements with any miners for any of these necessary supplies.
And this is just the tip of the iceberg – the story for Tesla and electric vehicle makers gets even more interesting…
China, which controls the rare earth materials market with roughly 90% share of production, is looking to cut supplies of one of these crucial materials.
China’s Cobalt Caper
The material in question is cobalt.
Not only is cobalt a critical element in lithium-ion batteries, but it’s also used extensively in the manufacturing of smartphones, jet engines, and wind turbines.
In May, China Molybdenum Luoyang Co Ltd (HK:3993) – also known as China Moly – announced a $2.65 billion deal with troubled mining company Freeport-McMoran Copper & Gold Inc (NYSE:FCX) to purchase three crucial cobalt properties.
One such property is Kokkola Cobalt Refinery in Finland, in which China Moly acquired a 56% controlling interest. This refinery supplied over 10% of the world’s refined cobalt last year.
But much more importantly, China Moly acquired a 56% controlling interest in the Tenke Fungurume cobalt mine in the Democratic Republic of the Congo. The Tenke mine alone supplies 13% of the world’s mined cobalt supply, and holds 25 years of cobalt reserves in its possession.
The Tenke mine also contains one of the world’s most extensive copper deposits. In addition to their stake in more than half of the Tenke mine, China Moly also acquired 100% interest in the neighboring Kisanfu copper and cobalt exploration project.
The Congo accounts for about half the world’s supplies of cobalt and provides about 93% of China’s import of the mineral.
If the deal closes, China will control 62% of global refined cobalt production next year. As Edward Spencer of the metals consultancy CRU explained to the Financial Times, “The majority of the cobalt is headed to China. Their global hold is huge.”
China Likely to Stay in Control
It’s easy to see the motivation for China’s interest in cobalt.
Asian battery companies are behind the bulk of the world’s current production of lithium-ion batteries. And China accounts for more than 90% of lithium-ion battery projects in the pipeline.
The single major exception: Tesla’s Gigafactory.
Can anything stop China’s bold move to control cobalt?
Canada’s Lundin Mining Corporation (TO:LUN) owns 24% of the Tenke mine and the Kobbalt refinery. It also has the right of first refusal to buy those assets and has hired the Bank of Montreal to help consider its options.
The question remains as to whether a small company like Lundin – with a $3 billion market cap – can swing such a large deal to acquire those cobalt assets. It seems unlikely, unless a partner with deeper pockets steps in to give Lundin the necessary boost.
Thus, the cobalt industry gets even more interesting…
Cobalt Cliff
China’s soon-to-be hold on cobalt is crucial, because the demand for cobalt is expected to soar 62% over the next decade – thanks primarily to increased demand from the battery-makers’ industry, which has increased demand at an annual rate of 16% over the past decade.
That demand was met so far via increased supplies of cobalt from miners.
But now, those supplies are under pressure.
This is due to the fact that cobalt is often found and mined in conjunction with copper or nickel. With the prices of these base metals plunging, thanks to lower demand from China, cobalt – a by-product – will be mined even less.
In fact, the likelihood is high that cobalt supplies in 2016 will be 15% to 25% below this year’s demand.
Where are the battery makers like Tesla going to get their cobalt? The situation is drastic enough that it led John Petersen at InvestorIntel to call it a “cobalt cliff.”
Petersen is a lawyer, CPA, consultant, and a thought-leader on energy issues. His years of experience in corporate finance, natural resources development, and advanced battery technologies give him a unique perspective.
I wanted to tap some of that knowledge, so I called him to discuss the matter further.
He explained to me that half of global cobalt supplies are used in industries that absolutely must have the metal. Think General Electric (NYSE:GE) and its jet engines.
Luckily for companies like GE, cobalt makes up a very small part of costs. So they will be willing to pay whatever the price is for cobalt. The news is not as good for companies like Tesla, where cobalt costs are a higher percentage of production costs.
The effects of the “cobalt cliff,” Peterson explained, will be felt most by lithium-ion battery makers that are trying to buy the metal in a dwindling market.
Sellers will give priority to long-time customers like GE, rather than new kids on the block like Tesla.
Petersen believes supplies of the metal to the battery industry will fall 30% to 50% over the next year. This is not good news for all those eagerly awaiting their Model 3s.
Based on the apparent problems with global cobalt supply and China’s growing control over it, it’s hard to understand Tesla’s complacency.
Maybe Elon Musk believes in miracles! Nothing short of one will ensure that Tesla gets all the cobalt it needs to hold on to its footing in the automotive world.