SQM is set to increase its lithium capacity, taking advantage of a very competitive position and a sliding royalty scale that protects them at times of low prices. Their cost position is expected to improve due to economies of scale with announced expansion plans. Even in cases of extreme unforeseen price drops, SQM has proved to be resilient and diversified enough to manage production levels to maintain prices.
SQM a new entrant
Traditionally, SQM was not a lithium focused company. Lithium only reached 20% of SQM’s revenues in 2016, stepping up as its second most important business line. SQM has been and still is predominantly a fertilizers company. Lithium growth has helped to offset the decrease in revenues from another business segment namely iodine, whose price has decreased at a rate 18% per annum in recent years, so SQM’s realised annual average price has fallen from $53/kg in 2012 to $20/kg in 2017.
For SQM, in terms of revenues, its most important segment is specialty plant nutrition1. Before 2016 the second most important segment was potassium compounds2 , which has now been relegated to third place by lithium.
All SQM’s market segments including iodine are profitable, on a cash cost basis as reported by SQM. Iodine was once considered a commodity of the future, in part due to its use in polarising films in LCD and LED screen.
Iodine – managing down costs for profitability
Nowadays, iodine is mostly used in medicine and polarising films for LCD and LED screens. Given the technological advances in the latter sector, we can trace a jump of 50% in per capita consumption of iodine to the period between 1995 and 2005 – from 2.9 grams per capita to 4.3 grams, due to the rapid development of LED technology. In this period, the compound annual growth of demand was 6% and prices also increased at a solid rate of 5.5% per annum suggesting constrained supply.
SQM’s iodine business dates to the beginnings of the company and it was amidst this positive market environment that SQM decided to invest in expanding their capacity. In 1985, they started obtaining iodine through heap leaching and then further expanded their processing capacity during the boom times. Good business expertise allowed SQM to take advantage of the situation, with shorter lead times than their competition and revenue contribution from the iodine business grew until it peaked at 24% in 2012.
Prices continued to increase until 2012 – partially fuelled by the unfortunate Fukushima disaster3 . However, prices have decreased ever since. Despite this, SQM has been able to decrease its costs and keep the unit profitable, this included a restructuring process leading to the closure of its older – more expensive – facilities. SQM has concentrated most of its production in its newer Nueva Victoria plant. We estimate that over the past three years SQM’s market share has been of around one third of global supply by volume.
Lithium – new agreements and increasing economies of scale support profitability
In the late 1990’s SQM invested in developing the Salar de Atacama, which allowed them to enter the lithium business in 1997. Their production volumes creating a market oversupply, and prices dropped by around one third. SQM continued to expand their lithium capacity to reach 48,000 tonnes LCE per annum (tpa) in 2011. Based on SQM’s 20-F fillings despite the sustained reduction in lithium price, SQM’s lithium unit remained profitable. This begs the question what would happen if prices were to decrease strongly again from current high levels as new capacity from many participants enters the market? To answer this, we need focus on the Salar de Atacama operation.
Understanding the salt flat business
SQM’s lithium is produced from the Salar de Atacama, a salt flat. This asset was initially developed as part of their fertilizers business to extract potassium chloride and potassium sulphate, as well as boron. The operation is optimised for potassium production which therefore has the highest recovery rate, ranging from 47%-77%. At the same time, the recovery rate of lithium is around 28%-40%. Lithium extracted at the Salar de Atacama is then hauled to the Salar del Carmen for processing into lithium carbonate and lithium hydroxide, with 48,000 and 6,000 tpa capacity respectively.
By considering the costs incurred at this operation, we can estimate that their net of by product (NoBP) cash costs have increase substantially, though this is largely due to a decrease in realised potassium prices. Despite this increase in costs, growth in lithium prices have largely offset it and as a result, profits at the brine operation have increased by 45% between 2012 and 2017.
SQM is currently investing in expanding lithium carbonate capacity to 70,000 tpa, has planned a second capacity expansion to reach 120,000 tpa and a third expansion to reach a grand total of 180,000 tpa of lithium carbonate. At the same time, it plans to invest in a second lithium hydroxide plant with a capacity of 7,000 tpa. We expect new economies of scale to arise from these expansions.
Competitiveness
At the same SQM has always been conscious of their effect in the market and has proven it can focus on more profitable business when the time requires it – such as was the case with iodine.
To realise their declared strategy, to “successfully develop and implement all lithium expansion projects of the Company, acquire more lithium and potassium assets to generate a competitive portfolio.” there is a clear intention to continue growing at least to the capacity which they have already declared. Their latest agreement with CORFO provides incentives for SQM to grow even more by giving additional extraction quotas and including a sliding scale royalty rate making SQM’s revenues more sensitive to price changes. By running a sensitivity analysis on price with the CRU’s Lithium Cost Curve, at three different prices we can see that SQM’s operation is much more sensitive to price than others with this new royalty6.
As shown in the charts above , we could argue that SQM’s business is somewhat hedged against price changes. On top of the analysis conducted here, in the future we would be able to account for some additional economies of scale that should arise from SQM’s planned expansions.
This means that while a price drop would not affect the sustainability of SQM’s business, it would certainly impact SQM profit, but this hedged cost structure means that it can remain profitable at very low lithium prices. Thus, a hypothetical steep decrease in prices translates to more expensive producers exiting the market – whilst at the same time SQM remains profitable.
Finally, as we have seen in the iodine market, SQM has shown that they are not afraid to reduce output in times of lower prices to focus on more profitable areas.
Endnotes:
- Composed of sodium nitrate, potassium nitrate, sodium potassium nitrate, and other specialty blends and fertilizers.
- Composed of potassium chloride and potassium sulphate.
- Iodine pills are commonly used to prevent radiation poising.
- Including derivatives
- Including derivatives
- Assuming the recent royalty rates would have existed in 2017
- Note that the charts only consider brine operations, and that hard rock operations are usually costlier.
