Oil Ramblings – Post Doha

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For better or for worse the oil markets have captured the world’s attention. Multi-decade low oil prices have  a way of doing that. Everyone knew there was an imbalance that needed to work itself out, and although the market seems to believe the worst of the turbulence is behind us, I still believe there are future air pockets ahead.

Back in January, most people myself included believed Saudi Arabia’s main goal was to crush US shale, however, at the Doha Saudi Arabia showed its true colors. It seems there was general consensus among the oil ministers of OPEC, but Saudi Arabia stood out from the pack unwilling to compromise unless Iran froze.

Which to be honest, was a ridiculous proposition. Iran has the most spare capacity of all the OPEC nations and is only just ramping up production and with foreign investment set to pour into the country future production capacity is set to rise even further. Delaying all of that with a freeze makes zero sense, especially considering that oil revenues on a relative basis to Saudi Arabia are almost inconsequential.

Perhaps one of the more interesting surprises of the meeting was Prince Mohammed Bin Salman’s threat that Saudi Arabia could flood the oil market with 1,000,000 bpd of oil at essentially the press of the button.

This is a very credible threat. The Saudi Prince’s ability to efficiently make quick decisions with little resistance has drawn the attention and jealously of leaders around the world. I can only imagine how Xi is watching and thinking “if only I had that power”.

The Prince has very smartly changed the incentive structure in Saudi Arabia. Instead of subsidizing everything from water and food to electricity and oil which hides the real cost of these goods, the kingdom has decided to give the value of these subsidies directly to its citizens, who now know the actual market cost of these necessary goods.

The obvious result is less wasteful spending. Whatever oil the Saudi people don’t consume Aramco exports. On the margin this is increasing, further adding to Saudi oil exports. Throw in the expansion of the Shaybah oil field that will add 250,000 bpd, the young Prince’s threat is looking quite credible.

Whether or not Saudi hits its target of an additional 1,000,000 bpd is not the point. The point is, Saudi oil exports are increasing. As is Iranian production, if only they could get the ships necessary to export, we’d really see a huge drop. And with the rising oil price, US shale companies have been able to hedge their production at profitable levels.

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All of this points to another down move in the price of oil. How low do we go? I don’t know. Back in January I argued that Saudi should cut prices and increase production at all costs to kill off a sizable chunk of US shale once and for all. Unfortunately, that didn’t happen and you can see in the chart above, there’s been a significant increase in hedging. Although a lot of these companies still carry too much debt and the next down move will probably kill off a lot of weaker ones and finally put a big dent in the multinationals whose share prices have been quite resilient in the face of this record decline in oil prices.

Unbeknownst to most investors, supply and demand mechanics aren’t the only thing driving the oil market. Of course, you guessed it, I’m talking about the dollar. Looking at the chart below, you see oil started to fall as the dollar started to rise. And then as the dollar peaked in January of this year, oil bottomed at $26.50.

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I believe that the dollar’s rise is not over. Not by a long shot. We are in a consolidation period that will probably end by early July at the latest, if not much sooner. The mechanisms for this rise and their explanations are for another article. The point is, if the dollar resumes its uptrend, then oil will fall.

Lastly speculative positions in the oil futures market are coming off record levels. When you combine that with the fact that producers are actively increasing hedging, you see that the speculators in record numbers are on the wrong side of the boat.

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With all that said, I think WTI over $45 makes for a very good short and would continue adding shorts on the whole way up to $50. Once again my time horizon is till early July for oil to start its down move. If it hasn’t happened by then, I would need to reassess my position. I don’t know how low it would go from here, and there are certainly a whole litany of variables that need to be taken into account, arguably most importantly is any central bank maneuvering such as Fed rate hikes or BoJ kamikaze money printing. But I think the trends, and positioning are on my side and will be watching closely to see how this all plays out.

Lithium: The Double Take

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This article is the equivalent of an investor double take. Much like the main characters in Michael Lewis’ book The Big Short who thought Greg Lipmann was trying to scam them, I too was skeptical about the potential of lithium and its future demand, but after writing this article I hope to solidify my position and convince others of that potential which exists in the future of lithium.

I’d like to preface the rest of this article by stating my affinity for RealVisionTV. I watch, at the very least, two videos a day. Every major China video I’ve watched at least three times, I’m currently on round 4 of Simon Ogus’ two part China series (please bring him back!). I like to think I use the service more than any single person on earth. As a math, physics and engineering student who hasn’t taken an economics course since high school, the lessons learned from its catalog of diverse and insightful perspectives are immeasurable. So when I first started looking into the lithium story a little over a week ago and  began to realize the potential of this story,  a thought hit me – not one person on RealVision mentioned lithium. Not a single one.

Well isn’t that strange? Because when you look into the lithium story, it seems obvious, almost too obvious. You don’t even have to look that deep before the story begins to tell itself.

And if you are like me, you are kicking yourself for not having recognized this story sooner, but fret not, because to steal the title from my last post we may be late to the party, but it’s only just begun.

It wasn’t until Tesla announced it acquired over 250,000 pre-orders for its model 3 in the first 48 hours (which is on par with Apples first iPhone!) and Elon Musk announced Tesla would need to consume the entire world’s lithium ion battery production to accomplish its goals of 500,000 EVs per year by 2020, that people started to look into the lithium story (although my grandfather will tell you of the time he thought about cornering the market way back in the late 70’s).

But actually, the subplots have been in place for years, intertwining and building off one another. Lithium battery technology has been improving at a rapid pace. Electric vehicle popularity has been on the rise since (we can thank Tesla for that). China’s polluted cities, demand for innovation, and unlimited credit spree have created huge incentives to propel EV demand forward in the largest auto market on earth. Xi Jinping recently signed the Paris accord further cementing China’s commitment to green technology. Even central bankers are backing green technology! BoE Central Bank Governor Mark Carney has publicly discussed the importance of “Green Bonds”.  You may need to read this paragraph twice, because it is hard to believe the demand side is this good.

So in the face of rapidly rising demand, we have to ask ourselves, what’s supply doing? Well currently there are about four companies (outside of China) that produce the majority of the world’s lithium, and their ability to increase production is quite limited. Let’s not forget 1/3 of the world’s known lithium reserves are locked away in Bolivia a veritable black hole of resources. On top of that, because lithium’s price rise has been so rapid so fast, only recently have companies been able to acquire the necessary funding to develop projects which are still years away from production.

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As shown in the chart above demand will most likely outstrip supply for years to come. The obvious beneficiaries of this will be current producers that either can expand production or whose prices are not fixed by contracts, as well as well funded development companies that can make it to market in the next few years.

As I said in the opening, the 2016 lithium story may be as obvious as short US housing in 2007 (although in hindsight shorting the banks was arguably the better trade), but perhaps it is more aligned with long US shale in 2010. Simply put, the economics of a previously KNOWN resource changed virtually over night and the rest is history. As a matter of fact at today’s lithium prices, it seems almost every major development project in Argentina and Chile is not only viable but insanely profitable.

The obvious result is increased production. A lot of it. I haven’t run the numbers yet on all the potential finds and what that added supply would do to the market yet, but there will be a huge surge eventually, which is another reason why I like to compare the current lithium rush to US shale. However unlike shale, the lag time between when a project is planned and when it produces are years apart. Which is why I believe there is AT THE VERY LEAST FOUR YEARS before supply catches up with demand. I expect it to be much longer than that especially considering demand for lithium is growing much faster than demand for crude did, +10% for lithium vs 1.5% (crude).

But it’s not just Argentina and Chile that are experiencing a “white gasoline” rush, the US which which has a history of resource rushes dating back to the country’s birth has made sure that lithium is no different. There are at least a dozen exploration companies some of which started off prospecting for gold and silver have now pivoted to lithium.  Nevada is now in the midst of a 1849 style gold rush. Perhaps if Las Vegas ever gets a NFL team it will be named the 16er’s, or the Tesla’s or even better the Musks. I’ll let you picture the last one’s mascot.

The point is, speculation is exploding, and some companies in Nevada such as Pure Energy Metals have already made finds around the existing Silver Peak project as well signed deals with Tesla for future production/sales agreement. Personally, from the initial estimates, the find may not be up to snuff, or at least the initial economic estimates even at today’s prices will get revised down considerably. But that’s besides the point. Companies are finding lithium in the ground right now. Pure Energy Metals may have been the first but they certainly won’t be the last.

The lithium rush isn’t confined to these three locations, I’ve found interesting projects in Mexico and western Australia, and there will continue to be more as the price of lithium remains way above cost of production even for the more expensive and inefficient producers. This will be a race to market, and whoever gets their first will most likely be a winner (at least in the short term).

Now I’ve spent this whole post talking up the greatness that is the lithium story, but before I end, I’d like to discuss a few of the bear cases for lithium. I think the first and most obvious which is the double barreled shot gun held by an ailing grandmother with Parkinson’s that stares all macro investors in the face when they wake up every morning is a Chinese hard landing. If that happens, being long lithium will be the least of your worries, and even then the world will re-calibrate and we will most likely continue move towards a green tech world. I’d hope by this point you have a trade for that scenario.

Moving on, for me, the biggest fear is the jurisdictions with the best resources, Chile and Argentina. Now I want to believe Argentina is going to behave over the next 4-5 years (my time horizon). They just had a triple oversubscribed bond offering which means the investment community has faith (or they really are just that yield starved). The new government seems on the surface quite competent and has worked hard to shed itself of the Kirchner regime’s stench. Many of the export taxes have been removed making lithium mining even more profitable. But perhaps once the government sees how wildly profitable these companies are, it may swoop in and take a bigger cut, and a bigger cut, and a bigger cut.

After all, we are players in a game with rules that constantly change, and no where has that been more apparent than in the resource space. I believe the same may hold for Chile, a country that has for a while placed strict licensing on lithium extraction. Permits have been hard to get but I expect that to change as the potential revenues become apparent.

Lastly, and without a bit of irony, I find my investment strategy somewhat dependent on Elon Musk and Tesla’s ability to deliver on its promises. After years of watching a company that sold 1/20th the cars of GM rise to half its value, and wishing it would only go higher so I could short it I now find myself wishing its success. Make no mistakes, Tesla has set a very high bar for itself that I still do not believe it will be able to reach.

However, I do not see this as a binary outcome. The demand for the model 3 is undeniable. My own brother wants one (Tr8r!). I am confident in Tesla’s ability to sell a lot of cars but perhaps not as much as the 500,000 it projects. However, it’s important to note that Tesla already has roughly 4x as many pre-orders for its model 3 than its total production of cars to date. That is an impressive stat to say the least, and although they will probably not hit the 500,000 cars per year by 2020 mark, their impact on the demand for lithium and the EV market will be undeniable.

Now I haven’t lived long enough on this earth to have the wisdom and experience that is needed to truly excel in this business but right now it feels like the wheels of fate have aligned for this brief moment of time to tell us something, except this time it appears to be screaming “LITHIUM!”


DISCLAIMER: This blog is the diary of a twenty something millennial who has never stepped foot inside a wall street bank. He has not taken an economic or business course since high school (which he is immensely proud of) and has been long gold since 2012 (which he is not so proud of). In short his opinions and experiences make him uniquely unqualified to give advice. This blog post is NOT advice to buy or sell securities. He may have positions in the aforementioned trades/securities. He may change his opinion the instant the post is published. In short, this blog post is pure fiction based loosely in the reality of the ever shifting narrative of the markets. These posts are meant for enjoyment and self reflection and nothing else. So ENJOY and REFLECT!

 

Lithium: Late To The Party But It’s Only Just Begun

“Beijing mandates a fleet fuel efficiency standard of 5 liters per 100 kilometers – about 47 mpg – that all automakers must achieve by 2020.”

“In 2025, we don’t expect to be able to sell conventional internal-combustion engines [China], meaning we will be selling mostly hybrids including plug-in types” ~Keiji Ohtsu, Honda’s chief technology strategy officer

“In order to produce a half million cars per year…we would basically need to absorb the entire world’s lithium-ion production.” ~Elon Musk

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Between Elon Musk promising to consume the world’s current production of lithium ion batteries and China pretty much outlawing internal combustion engines by the year 2020 lithium demand is set to take off. Just last year Chinese sales of Electric Vehicles (EVs) increased 223% and a 4 fold increase from 2014.

Not surprising this has led to an absolute parabolic increase in the price of lithium in China as shown in the chart below.

Yeah… That’s insane. China is known to get what it wants and countries around the globe have been more than willing to accommodate their demand. Currently there are just four companies that account for the majority of lithium production which are:  Sociedad Quimica y Minera (SQM), FMC Corp (FMC), Talison Lithium Ltd. Thus the additional of production needed to meet demand will have to come from mines/properties that do not yet exist. This opens up a huge opportunity for amazing returns in this space.

Looking at the chart above, it doesn’t take a genius to know that 2/5 of those countries will not be invest-able for an American investor. Bolivia is not a mining/resource friendly country to outsiders and over the last decade has nationalized various industries as well as passed a 2014 law that prevents 35% of the country’s miners from working for private firms. Not to mention, Bolivian reserves are located in a moist area which slows the dehydration process as well as a very high Mg/Li ratio which further drives the cost of extraction hgiher. China is not an easy nor transparent country that I like to invest in.

Which leaves Chile, Argentina, and the US. The US has one major deposit, Clayton Valley, in Nevada and an unproven one in Utah. For now I’ll focus on the Clayton Valley where speculative companies have acquired rights to the land around it, hoping to stirke it rich. To my knowledge so far, one company, Pure Energy Minerals, has found a relatively low grade 800,000 tons of reserves in the surrounding area. Which is nothing to scoff at, however it pales in comparison to the untapped resources down in Argentina and Chile.

And that is exactly where I’m focusing my attention. On small exploration companies with good claims and if they also happen to be speculating around Clayton Valley as well then that’s a bonus. I also am interested in SQM, the Chilean company who as of now has 22% of its revenues coming from lithium, which is small but they’ve already partnered with Western Lithium to help them develop their project and we may come to expect a lot more of that as they have the technical know how and local resources to get these jobs done.

Now it’s not all sunshine and roses. There are road bumps and Argentina still doesn’t have the most prestigious record on the earth. Also with rising Lithium prices, and a historically greedy government, Argentina may swoop in and tax more of a company’s profits.

China’s economy is slowing down and although betting against them hasn’t been successful that doesn’t mean the future will be more of the same. And lastly, it’s an understatement to say that Elon Musk and Tesla have lofty expectations. Currently, Tesla makes less than 50,000 cars/year. Expecting to produce and sell 500,000 cars/year within 4 years seems quite ambitious to say the least. I know he’s building a gigafactory and wall street toured it and loved it but Tesla still has a long way to go.

Lastly there’s the threat of future innovation. With high prices comes high incentive for innovation. Although lithium ion batteries have dominated the space for more than a decade, it’d be foolish to think that dominance will last forever, especially in a world of big data, AI, and high incentives.


DISCLAIMER: This blog is the diary of a twenty something millennial who has never stepped foot inside a wall street bank. He has not taken an economic or business course since high school (which he is immensely proud of) and has been long gold since 2012 (which he is not so proud of). In short his opinions and experiences make him uniquely unqualified to give advice. This blog post is NOT advice to buy or sell securities. He may have positions in the aforementioned trades/securities. He may change his opinion the instant the post is published. In short, this blog post is pure fiction based loosely in the reality of the ever shifting narrative of the markets. These posts are meant for enjoyment and self reflection and nothing else. So ENJOY and REFLECT!