Over capacity leads to oversupply – now waiting for more producer response and demand to catch-up

The lithium market is going through a significant weak patch where prices have tumbled. While prices are not as eye-watering low as they were in 2019 and 2020 (battery grade Lithium carbonate, cif China, Japan Korea, hit a low of $6.75per kg in 2020), they are low enough ($14.75/kg) to cause some producers pain, with some reining in supply and Capex as a result.

The price weakness has come about as too much lithium production capacity has come on stream in too short a space of time, leading to oversupply. The situation has been made worse as demand growth slowed in 2023, compared with the very high levels of growth seen in 2022.

China’s battery-electric vehicle (BEV) sales increased 84% to 5.4 million units in 2022, with plug-in hybrid vehicles (PHEV) increasing by 152% to 1.5 million units. In 2023, preliminary data suggests BEV sales grew 25% and PHEVs grew by 85%- so still strong growth, but below that of 2022.

The fact growth rates slowed, combined with the increase in supply that the high prices in 2022 and early 2023 encouraged, led to the market suffering a double whammy – too much supply and weaker than expected demand. This led to the build-up of inventory as seen in the chart below.

Implied inventory on the way back to normalized level

My colleague Chandler Wu’s inventory model tracks different inventory patterns on the supply chain by comparing production, sales and import/export in each node of the supply chain from salts producers to EV dealerships on monthly basis. It also evaluates the inventory pressure by comparing to current demand. All patterns of inventory are reverse engineered into lithium carbonate equivalent (LCE).

2020 – 2022 - Active restocking period: Price up /Inventory up

In response to the demand recovery and rapid price gains in 2021 and 2022, companies along the supply chain built up inventory to protect themselves from further price rises. The CAM manufacturers were particularly aggressive at building inventory. It was not just about protecting against rising prices, but they were also seeing strong demand for batteries as EV sales were expanding rapidly and therefore, they needed higher inventories to cope with potentially another strong year of growth in 2023 – which later turned out not to be the case.

January to April 2023 - Passive restocking period: Price down /Inventory up

Purchasing strategies did not react quickly enough to the price drop in the first four months of 2023, which saw them continue to purchase material, while their sales were falling, as a result further inventory accumulated.

April 2023 to present - Active destocking period: Price down /Inventory down

As normal in falling markets, manufacturers, if they cannot hedge their inventory, tend to destock, which hits demand even harder, creating a downward spiral in prices and demand. But, rest assured destocking can only go on for so long.

The market is now in a situation where demand needs to once again rise to a level where it absorbs the extra supply that is available due to the increased production capacity. While supply is expected to grow this year, this low-price environment should see production growth slowdown, especially as more production cuts are expected.

Slower production growth, combined with still robust demand, should lead to a reduction in surplus inventories and a redistribution of inventory along the supply chain as sectors restock. As the chart shows, CAM manufacturers have been destocking at a fast pace, once battery inventories return to normal level then orders should start to flow upstream again.

Commodity markets routinely go through boom/bust cycles and lithium and the other battery raw materials are proving to be no different, but the price volatility has been particularly severe. We think this is because we are still in the relatively early stages of the new electrification era, the market is in a hurry to grow, companies are in a hurry to secure market share and in doing so too much capacity has been built. This capacity will be needed before long, but for now its created oversupply.

But, as the chart shows inventories are falling, especially at CAM manufacturers and given the size of the overall market is growing and therefore more inventory in tonnage terms is needed, the months of inventory number is falling and is almost back to where it was before the inventory build got underway.

While prices overshot on the upside in late-2022, there is still a danger of them overshooting on the downside now, but with some producers starting to rein in production and with destocking only able to run for so long – either restocking, or a return to hand to mouth buying, are expected to provide some respite in the gloom before too long. We expect orders to start flowing upstream again either towards the end of the first quarter or early in the second quarter.