A Disconnect: Electric Vehicles and Cobalt and Copper Prices

Mike Smitka, Economics
Washington and Lee University

Some 80 battery EVs will be on the market by 2021. IF they sell at any volume, THEN demand for the underlying metals used in EV batteries, particularly lithium and cobalt, should rise. But instead prices have been falling for the past 12 months. So either traders aren't looking very far into the future, or they don't believe the EV revolution will actually occur.

First, the price of cobalt has dropped to about 1/3 of its peak of a year ago. Yet this remains a crucial component of battery cathodes for the lithium chemistries in current use. While the lithium spot market is thin and not where most trading takes place, those prices have also fallen (listen to the Global Lithium Podcast for details).

Cobalt Price from tradingeconomics.com, US$/metric ton

Lithium Price from tradingeconomics.com

The disjuncture surely isn't because investors aren't sufficiently forward looking. After all, the prices of both hit record highs in March 2018, as the Tesla stock fever took hold. Since then, however, the market has cooled – if not crashed.

One possibility is that there's a lot of metals production coming on-stream. That is, those close to the ground don't see a scarcity, rather they anticipate an increasing supply. That however is not what those in the mining industry are saying. While there's a lot of interest in brine extraction, none of those projects have started up. The geography makes that a daunting task – evaporating brine in a 4000m high desert remote from anything is a process fraught with challenges. Then the output has to be moved for refining. That refining is intrinsically expensive (you've a brine with Li and Na and K, all neighbors in the periodic table). According to insiders, capacity is not being added – again, listen to the GLP podcast. The various national governments also want to see that they get a share of the revenue, and so licensing is a drawn out process. In short, none of these are going to be producing much metal in the next 5 years. The same thing is true for hard-rock lithium resources in places such as Australia. Assessing the ore bodies, getting the permits, building the mine infrastructure, and building the refining capacity are all multi-year projects.

Cobalt is even more of a barrier. With the exception of a small mine in Tunisia, cobalt is a by-product of copper (and to a lesser extent, nickel) mining. However, the price of both of these metals has fallen, and mines are being closed, not opened. The best deposits are in the Democratic Republic of the Congo, which accounts for about 60% of global production. Much of the output includes metal from small, illegal mines employing child labor. While that may not matter for the Chinese market, it cuts into the amount available in countries with policies mandating ethical sourcing. Cobalt supply isn't going to grow in the next 10 years, and may even decline.

Copper Price from FRED

Nickel Price from FRED

the fall in prices ... must be a story of demand...

Thus IF the fall in prices is not a supply story, THEN it must be one of demand. Yes, interest rates have risen, and that ought to push commodity prices down. But the change in present value from discounting sales in 2022 at 3% instead of 0.3% isn't much – 3% compounded over 3 years drops the value 8.5%. That's a far cry from the observed 65% decline.

That leaves a decline in expected demand from EVs, which constitute the bulk of battery demand, and the fastest growing component. The main issue is that we now have increasing evidence that EVs don't sell. The GM Bolt, the Nissan Leaf, and the Renault ZOE have not been hits – though Renault to its surprise sells a lot of ZOEs in rural France, where home charging is practical. Ditto China, where BEVs sell in cities with high subsidies (including being able to jump the queue for license plates), and sell not at all elsewhere.

Then there's Tesla. Only in 2018 did the company reach cumulative US sales of 200,000 units [and hence the halving of the $7500 Federal individual tax rebate]. The Model 3 continues to garner news, but by Tesla's own admission it has tapped out sales in the US, and is switching its emphasis to exports to Europe and China. After all, the market for an expensive sedan is fairly small, particularly in a world in which demand is shifting to mid-sized SUVs. But while the target segment represents a strategic error on Tesla's part, the expensive part is common to all EVs. They just don't offer a compelling value proposition to consumers who don't care about fast acceleration, or about which drivetrain lies under the hood.

...people don't care what's under the hood of their car...

Part of the challenge is that, even with EVs in the mix, the fuel efficiency of vehicles on the road continues to improve. It's now possible to power a full-sized pickup truck with a 4-cylinder engine, thanks to improved turbocharging, fuel injection and computerized combustion timing, and a host of ancillary improvements such as lighter pistons, better piston rings and better bearings. Add to that improved body-in-white engineering with the mixed use of aluminum, magnesium, and varieties of high-strength steel, and modern vehicles can pass today's more stringent crash tests while holding down vehicle weight. (BIW improvements are of course available for BEVs.) Then there are today's 10-speed automatic transmissions, that leave the engine operating at its sweet spot more of the time. Meanwhile "light" electrification – electric fan and water and oil pumps, electric steering, start/stop systems, alternator power-boost systems, and potentially electric valves – are eliminating the parasitic drag of hydraulics and belts. As 48V systems diffuse, efficiency will continue to increase. Car companies, though, don't advertise these as "hybrids." But more and more, that's what people are actually driving. Again, people don't care what's under the hood.

For consumers, as Ed Dolan points out in a recent blog, fuel is a historically low component of the cost of ownership of a vehicle. Absent a carbon tax (or Persian Gulf war) that drives up the price of gasoline, the cost of batteries needs to fall below that of an ICE-powered car, given the perceived challenge of recharging on the fly. At present no such battery technologies are entering production, which means that they won't be available on a volume car in the next 8 years. Another alternative would be a change in consumer behavior, where households become comfortable with owning a small EV commuter car, and using short-term rentals for longer trips. In fact, people are opting for SUVs that can cover all usage cases, while short-term rental businesses such as ZipCar lose money.

...metals markets implicitly believe EVs are not the wave of the future...

To return to the main theme, I conclude that recent price movements in metals markets reflect a growing realization that battery electric vehicles are not the wave of the future. That will change if new battery chemistries prove out. But those chemistries won't use cobalt and may not use lithium. Hence sales of those metals into the EV market will remain small, and eventually disappear.

1. In some parts of the world, such as Brazil, this is complemented by the availability of biofuels and CNG competitive with petroleum-derived gasoline and diesel. Even with a carbon tax, there is no business case for a BEVs. Likewise work continues of fuel cells, which may prove a good match in countries that turn to storing intermittent "green" energy output as hydrogen. Particularly for readers in the US, it's easy to overlook the country- and region-specific variety in markets for motor vehicles.

2. Lithium-ion batteries are a poor match for utility-level energy storage, where on the battery side vanadium-flow technologies are already superior.

3. Having just visited suppliers and looked at their order books, MY2022 is basically a done deal. The validation - pilot production - volume production cycle for a new battery will take at least 5 years before it can be incorporated into a high-volume passenger vehicle. So as of early 2019 we're looking at MY2027 as the earliest date for the rapid expansion of BEVs.

Tesla and Elasticities: An Economics 101 Lesson

Mike Smitka
Prof of Economics, W&L

An elasticity is a qualitative and quantitive tool to put bounds on real-world behavior. If a change in one variable leads to a more than proportional change in another, then the relationship is "elastic." Numerically, it's the ratio of percentage changes. Here I apply it to a simple but interesting case, Tesla's $1,100 price cut.

The demand for cars is not very elastic in price. There are lots of 300+ models to choose from in the US, from a variety of manufacturers and in types ranging from compact cars such as the Fiat 500 and the Smart to full-sized pickup trucks replete with towing packages and other options. Then there are performance cars, and most popular of all, small SUVs and crossovers, such as the Toyota RAV4 and the Honda CR-V. There's very little substitutability across vehicle classes; someone looking for a pickup truck does not cross-shop the Fiat 500. The price isn't terribly important. And so demand for any single model is inelastic – it can help sway the choice against a similar vehicle.

(Mea culpa: my wife drives that latter. I prefer a smaller sedan with a stick shift, in my case a Chevy Cruze. My son drives a Subaru Forester, bought used, and we have a F-250 pickup to handle the tasks of living in the woods.)

...a 2% drop in price leads to an 8% drop in gross revenue and a 60% drop in net profit...

For the Tesla Model 3, there are (at least according to afficionados) no similar vehicles. Someone either wants one (and has the money to make that happen), or they don't. A $1,100 difference in price, or a decrease of about 2% with average sales prices (ASP) of $50,000, won't lead to many more sales – if you can't afford a $50,000 vehicle then you probably can't afford one at $49,000. It might make a big of difference if you're comparison-shopping against a similar-sized BMW or Audi. Let me ere on the high side, and assume a 1.0 elasticity. That is, the 2% drop in price will push up the quantity demanded by 2%. As a result, total revenue for Tesla will be unchanged: the drop in price will be just offset by the increase in sales.

I ignore the impact of the phasing out of Federal tax credits. As of January 1st, those drop from $7500 to $3750 so net of the just-announced price cut by Tesla, the bottom line cost to US consumers has in fact risen by $2650.

But for a company with a parlous balance sheet, what matters isn't total revenue but profits and cashflow. Now Tesla claims a gross profit margin of 24%. They don't calculate that in the same way as other car companies – despite self-proclaimed industry-best margins Tesla has never earned a full-year profit. But for the sake of argument, and to keep numbers round, let's us 25%. Given an ASP of $50,000, they then have a gross profit of $12,500 per vehicle. And they've just cut that by 8%.

The bottom line is clear: if Tesla is extraordinarily lucky, they'll maintain total revenue. But they'll earn 10% less gross profit on that revenue. With automotive revenue of $6.3 billion, and a gross margin of 25%, they've gross income of $1.6 billion. Lop off 8%, and this falls by $126 million. So assuming nothing else goes wrong relative to 2018Q4, net income falls from $210 million to $80 million, or a 60% drop in net profit. While timing may affect that – lower sales in Q1 as Model 3s sit on ships en route to Europe, and then higher revenues in Q2 as they make their way to customers – the impact is permanent.

Note that at each step along the way I have rounded numbers in favor of a better profit number for Tesla. Tesla has also cut prices for Model S and Model X over the past 6 months, without any increase in sales. I don't try to factor that in, again to provide a more optimistic case for Tesla.