Saturday, April 2, 2016

My kingdom for want of a nail

For want of a nail the shoe was lost.
For want of a shoe the horse was lost.
For want of a horse the rider was lost.
For want of a rider the message was lost.
For want of a message the battle was lost.
For want of a battle the kingdom was lost.
And all for the want of a horseshoe nail

The above quote is from a proverb that, according to Wikipedia, describes "a situation in which a failure to anticipate or correct some initially small dysfunction leads by successively more critical stages to an egregious outcome. The rhyme's implied small difference in initial conditions is the lack of a spare horseshoe nail, relative to a condition of its availability. At a more literal level, it expresses the importance of military logistics in warfare."

On Thursday of last week Tesla CEO Elon Musk unveiled the new Tesla Model 3.

In the first three days Tesla has received nearly 200,000 pre-orders for the car.

Demand for Tesla Motors' (TSLA) new lower-priced electric car surprised even the company's CEO Friday as 198,000 people plunked down $1,000 deposits to reserve their vehicles.

"Definitely going to need to rethink production planning," a surprised CEO Elon Musk said on his Twitter feed.

Musk unveiled the car Thursday night at a design studio near Los Angeles. It starts at $35,000 and has a range of 215 miles per charge, which is far more than most people drive each day.

The orders came from across the globe even though the car isn't scheduled for sale until late in 2017. But they could jeopardize a $7,500 U.S. electric car tax credit that many buyers are counting on to reduce the price. The tax credits gradually phase out after a company hits 200,000 in U.S. sales.

Of course Tesla is not the only company producing electric cars. I have written in the past that the supply of lithium for the batteries for all these cars is already a bit stretched. I am taking advantage of this supply/demand imbalance by owning Albemarle and Orocobre. 

I think that the lithium mining industry will be able to meet the demand over time. It is just a matter of making the investments and bringing the plants online. However, there is another commodity that is used in lithium batteries that has not been been discussed too often.

Cobalt is used in various lithium batteries in the cathode part of the battery. Unlike lithium which is mined specifically from lithium mines cobalt is primarily the by-product of copper and nickel mining. In fact 85% of the supply of cobalt is a by-product of nickel and copper mining.

That is bad enough for such a critical metal. Even worse news for future cobalt supply is that around 60% of the cobalt supply comes from the Democratic Republic of Congo. A big risk to the cobalt supply is the fact that the DRC is beginning to have political problems again as the current President is talking about extending his term in spite of the fact he cannot run again constitutionally. The last thing that cobalt supply needs is another civil war in the Congo which would potentially disrupt production. 

The other potential problem for the electric car market is that cobalt is not just used for cathodes in electric car batteries. Cobalt is used as an alloy in high temperature applications such as gas turbines for power generation and jet engines. It is also used in various other applications. 

The big problem here is that we are on the verge of a huge potential demand surge for cobalt and there does not appear to be a near term ability to increase production. Because cobalt is primarily a by-product of other mining activities miners will not increase the production of nickel and copper just for cobalt. In fact, because the world economy is slowing down copper and nickel mining is slowing down which will depress cobalt supply. 

 Even if their are no issues politically in the DRC there is another potential problem. 20% of the cobalt coming out of the DRC is mined by artisanal miners, many of which are children. It has been estimated that up to 40,000 children are involved in this activity. 

Children as young as seven are working in perilous conditions in the Democratic Republic of the Congo to mine cobalt that ends up in smartphones, cars and computers sold to millions across the world, by household brands including Apple, Microsoft and Vodafone, according to a new investigation by Amnesty International.

The human rights group claims to have traced cobalt used in lithium batteries sold to 16 multinational brands to mines where young children and adults are being paid a dollar a day, working in life-threatening conditions and subjected to violence, extortion and intimidation.

More than half the world’s supply of cobalt comes from the DRC, with 20% of cobalt exported coming from artisanal mines in the southern part of the country. In 2012, Unicef estimated that there were 40,000 children working in all the mines across the south, many involved in mining cobalt.

The EV revolution cannot be on the backs of children

At some point this will have to be addressed as this will become a PR nightmare for the EV companies. We cannot solve the climate change issue on the backs of African child miners.

While we are on a roll lets add another issue to the mix. Global jet aircraft sales are poised to grow massively over the next few years. According to a presentation by Airbus 32,585 passenger jet aircraft worth $4.9 trillion will be sold over the next twenty years. That is a lot of jet engines that will require quite a bit of cobalt. 

As stated earlier another big use of cobalt is in gas turbines used in power generation. As the world continues to industrialize the demand for electricity will increase. One of the big beneficiaries has been gas turbine electric generation due to lower emissions from natural gas.

The question seems to ask itself; if the EV makers are getting ready to ramp production of electric cars and the batteries in the cars require cobalt for the cathode, where will all the cobalt come from? I have already pointed out the supply issues with cobalt. 

There could be a huge bidding war for cobalt supplies. GE, Siemens, Westinghouse, Pratt Whitney, etc... have billions of dollars invested in plant and equipment to manufacture jet engines and gas turbines. I doubt that they will shutdown production so that Tesla can meet their orders for Model 3 cars.

What will probably happen is that the price will rise to a sufficient level to ration supply to its highest most efficient use. A sustained higher price will also encourage prospecting and development of primary cobalt mines. However any new mines would take years to find, develop, and bring into production. Another possible outcome would be the development of new battery materials that do not require cobalt. 

Cobalt prices are currently around $10 per pound but back in 2008 spiked to $52 per pound. We could see another spike as supply tightens and demand continues to grow. 

Author John Peterson has written that the impending cobalt shortage and the failure of the battery industry to plan for it is the biggest "oops"in supply chain management history.

Cobalt’s status as a by-product of nickel and copper mining precludes the possibility of abundant cobalt supplies for the battery industry. Competition from eight well-established industrial sectors that need predictable volumes of cobalt every year precludes the possibility that the battery industry will be able to outbid competitive cobalt users. Declining cobalt production during a period of rapidly increasing demand from a single industry is likely to have a highly adverse impact on cobalt prices unless somebody is sitting on a massive shovel ready cobalt deposit that doesn’t show up in the literature.

Something has to give and I believe that something is the battery industry.

Based on everything I’ve learned about supply and demand dynamics in the cobalt market, I’m convinced that cobalt will be a coffin nail in the prevailing mythology that cheap and plentiful lithium-ion batteries will usher in a golden age of cost-effective EVs and stationary energy storage systems.

So for want of cobalt will Elon Musk lose his kingdom? Even more important what will this lack of cobalt mean for the replacement of the ICE cars by electric vehicles? 

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