Price hedge required for banks to back lithium

Price hedge required for banks to back lithium

Gilbert + Tobin Energy + Resources Group Partner Justin Little discusses the reluctance to date of main stream banks to provide project level debt finance support to lithium and other battery materials projects in Australia.

Government policy intervention in international markets has been an essential driver in the take-up of electric vehicles to date, particularly in European markets. Other populous jurisdictions are also joining the war on emissions and laying the framework for global automotive manufacturers to rebalance their fleets in favour of plug-in electric or hybrid vehicles.

The Australian experience so far has been rather different – we are a country where the top three volume selling vehicles are still diesel-powered dual cab utes. While we have certainly lagged major developed (and developing) markets in the acceptance of EVs as a real alternative to one or more of the family cars, we can perhaps be forgiven for a couple of reasons.

We suffer from a significant case of range anxiety in this country, exacerbated by romanticism around our long-distance driving prowess. We want an EV that can facilitate our grand tour across the Nullarbor Plain. However, the local landscape appears to be changing, at least in terms of the appetite for federal policy support of the sector. In March this year, Bill Shorten unveiled Labor's new EV policy ahead of this month’s election – a target for EVs to make up 50 per cent of all new car sales in Australia by 2030.

The attitude of motorists will take longer to modify. However, expect this to quickly reach a tipping point once price parity is achieved, and both federal and state policy settings graduate from soft target outlines to actively disincentivising the continued purchase and operation of internal combustion engine vehicles.

As the latest formulations of lithium-ion batteries, commonplace at the heart of most EVs, offer higher voltage options and quicker recharging solutions we may even overcome range concerns. After all, no one leaves home each day with a full tank of fuel and very few of us, in the metropolitan region at least, drive more than 100 kilometres per day.

The natural behaviour of an EV owner would be to charge the vehicle overnight at home each day – meaning intermodal charging stations would only come into play a couple of times per year, when the average driver sets off on longer journeys down the nation’s highways.        

The emerging hardrock lithium production hub of Western Australia, driven by the global opportunity to feed into the EV battery manufacturing sector, has also organised as one to capitalise on a rare opportunity to participate in the value chain of battery chemicals beyond being just a source of unrefined commodities.

The ambitions of global companies including China's Tianqi Lithium, Chile’s SQM and the United States’ Albemarle to partner with local lithium producers to build and commission downstream refineries in WA for the production of the essential battery precursor chemical of lithium hydroxide has been heavily championed by the State Government.

The Commonwealth Government has also backed in the battery chemical production hub in Perth, with the announcement in April that the mining capital will host a $53 million Future Battery Industries Cooperative Research Centre. Premier McGowan believes the CRC will help create jobs and make WA a “one-stop shop” for battery materials.

With seemingly everything in favour of Australian mining and refinery projects leading the globe in the ethical supply of battery chemicals, why have proponents encountered significant resistance from mainstream banks in Australia when seeking development capital?   

Industry experts from Gilbert + Tobin have been trusted advisers across aspects of almost all major lithium project developments in Western Australia in the past two years, and are uniquely placed to analyse the risks associated with these large-scale investments. One such risk is the fluctuations in the spot and longer-term contract prices reported for lithium spodumene concentrate, and to a lesser extent carbonate and hydroxide, as the market factors in significant new supply of these materials from the very same mining and refining projects in Western Australia.

Project revenue risks and long payback periods on the scale of debt being sought – several hundred million dollars, for example – has in the past proved a barrier to mainstream banks in this country, according to G + T Energy + Resources Group Partner Justin Little. As a result, none appeared willing before now to be the first mover in adding these risks to their balance sheets. But some Australian majors have recently been showing greater appetite for potentially financing lithium projects.

“The uncertainty over future cash flows in the absence of published index prices for spodumene concentrate has led banks to hold back from major lithium project investments, due in the main to a lack of confidence in their ability to hedge in an ‘opaque’ market,” Mr Little said.

“With up to 30 different reporting agencies offering lithium price bulletins according to lithium content, chemical state, the location of the buyer and whether the lithium is sold on long-term contracts or the spot market, it is easy to understand why uncertainty exists in the market. 

“As it currently stands, the best current measure for a bank to rely on when assessing project finance is published off-take arrangements including the credit quality of the off-taker, the agreed price mechanism and the supply demand balance. 

“In our experience with lithium clients, we have seen this uncertainty result in Australian banks only opting to provide short-term credit provisions rather than major project investments. If banks maintain this reluctance to get involved in lithium projects prior to production, it has the inevitable consequence of pushing companies towards far more expensive offshore bond markets, large private equity groups, or pursuing funding options with customers, as many have already done.”

The London Metal Exchange recently announced that its new lithium cash-settled futures contracts will be released in Q4 of FY2019, and the exchange has asked companies that currently assess the prices of battery-grade lithium to submit proposals for the supply of a lithium index price. It is hoped over time that greater transparency from contract trading on the LME will provide a greater level of price certainty, provided of course there is sufficient liquidity in the LME lithium contracts once established.

Mr Little said in recent off-take deals Gilbert + Tobin had advised on, the difficulty had been trying to identify what an appropriate price was, with no single agreed spodumene concentrate price. Companies were all doing it differently – some used Chinese import prices, and some used Chinese export process.

He said the problem with the Chinese prices was that they tended to understate the purchase price and overstate the sale price. The real advantage of having a spodumene concentrate contract price on the LME would be the ability for mainstream debt providers to hedge pricing risk. 

“The current gap in the debt finance market has been treated as on opportunity by specialist lenders such as Swiss private equity firm Pala Investments and Australia’s Tribeca Global Natural Resources Credit Fund, who have emerged to assist the small end of the resources sector,” Mr Little said.

“We don’t expect this trend to continue in the longer term, and anticipate the debt finance dynamics around lithium and other battery chemical projects will shift quite quickly once one or more of the big four lenders in Australia commits to a major project or two in this emerging sector which we think is likely to happen.

“Foreign and local banks are currently nibbling at the hook with smaller amounts, with BNP Paribas providing small working capital facilities for both Pilbara Minerals and Galaxy Resources, while Westpac is also active in the sector.” 

Of the eight active lithium projects at various stages of development and production in Western Australia, Gilbert + Tobin has provided corporate, transactional and dispute resolution advice to operators including Mineral Resources, Pilbara Minerals, Kidman Resources and Talison.

The firm is also supporting other Perth-based lithium hopefuls with assets in other jurisdictions, including Galaxy Resources with its project in Argentina and Birimian with its project in Mali.

“There has been a lot of speculation in the lithium market, so the banks have responded with caution. It’s fine today, lithium is all the rage now, but the loan periods are seven to eight years and who knows what the lithium market will look like then – so if they can’t hedge their risk on price they just won’t lend,” Mr Little said.

“I also believe part of the reluctance from banks has been derived from not understanding the marketing of the commodity as well as other commodities they deal in, together with the potential for the current lithium rush to end up being a bit of a bubble. A better understanding around the marketing of lithium and having an LME pricing mechanism will help address these concerns.”

About Gilbert + Tobin

Independent corporate law firm Gilbert + Tobin’s Perth team are leading advisors to the energy and resources sectors – through the full lifecycle from junior explorers to multi-national, blue-chip corporates.

The Perth team includes some of Australia’s best corporate legal and litigation talent, with the depth and breadth of expertise to provide clear, decisive legal solutions to clients on all matters – routine and complex.

Gilbert + Tobin is a leader in innovation in the business of law, using new data-driven technologies to offer more efficient and cost-effective legal services.  The firm is a recognised Employer of Choice for gender equality and a member of Pride in Diversity, Australia’s leading workplace program for inclusion of LGBTI employees.

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