Thematic Investing: The disruptive world of Lithium. Phone October 2016

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1 Phone Thematic Investing: The disruptive world of Lithium 25 October 2016 In our view, the long-term drivers of lithium look very promising. In this report we look at investing in lithium through the prism of electric vehicles. In our view the increased penetration of electric vehicles (EV) is inevitable given government incentives/polices, global move to clean technology and technological advances in electric automobiles. With lithium batteries increasing the economic viability of electric cars, we believe the demand for lithium will significantly increase with the increasing penetration of electric cars. We must caution investors that this thematic is unlikely to play out over the short term, but is more of a medium term story. However, there is no reason why the price of lithium and investments exposed to this thematic couldn t re-rate ahead of this timeframe should investors become more comfortable with the story (markets are meant to be forward looking!). EVs growth on the rise. In our view, whilst at least 50% of current demand for lithium comes from traditional uses, increasing global demand for electric vehicles, especially driven by Chinese consumers will likely be responsible for increased lithium demand. The electric vehicle global market has grown 10x in the past five years. This excludes Tesla s Model 3 pre-orders of ~370,000 cars as of May 2016, which equate to ~30% of total electric vehicles already on the road. Moreover, in 2015, China became the largest electric vehicle market in the world where ~330,000 units were sold, or +343% increase over the previous year. China now aims to put another 4.5 million EVs on its roads by 2020 which equates to demand for ~44,000 to 117,000 tons of lithium over the next five years, assuming a required ~ grams of lithium per kilowatt hour, and average battery capacity of 65 kwh (average battery capacity for passenger vehicles is ~30 kwh, and ~100 kwh for electric buses). Governments long-term EV targets and incentives. 14 countries have committed to quantitative electric vehicle stock objectives by establishing regulatory incentives, with 13 million electric vehicles expected to be on the road by For instance, China electric vehicle sales are increasingly driven by government subsidies and purchasing quotas on traditional vehicles in Tier I cities. Subsidies for commercial and passenger electric vehicles can be as high as 60% of the selling price of a commercial vehicle, or ~40% in the case of passenger vehicles. Wood Mackenzie expects electric vehicles (including PHEVs) to reach ~13% of new light vehicle sales globally by How to play the thematic. We highlighted two investments by which investors can gain exposure to the lithium thematic Galaxy Resources (Speculative Buy and Global X Lithium ETF (Neutral) (please see separate reports). Galaxy provides investors exposure at the exploration & mining stage, while Global X Lithium ETF provides exposure to the full lithium cycle.

2 Primer on Electric Vehicles and Lithium Key macro concerns regarding the lithium market include: 1. At what rate will lithium demand grow at given the outlook for electric vehicle (and energy storage) adoption? 2. What lithium products are required by battery manufacturers? As well as what are their relative merits and how they are produced? 3. How and where lithium is mined and what are key drivers for lithium supply? The disruption of electric and hybrid vehicles Electric vehicles versus Internal Combustion Vehicles In our view, whilst at least 50% of current demand for lithium comes from traditional uses, increasing global demand for electric vehicles, especially driven by Chinese consumers will likely be responsible for increased lithium demand. An electric vehicle is a vehicle that utilises electric motors (capable of utilizing stored electrical energy) and technically covers automobiles, rail, air, sea and space vehicles. Indeed, the electric vehicle global market has grown 10x in the past five years. This excludes Tesla s Model 3 pre-orders of ~370,000 cars as of May 2016, which would equate to ~30% of total electric vehicles already on the road. Moreover, in 2015, China became the largest electric vehicle market in the world where ~330,000 units sold, or +343% increase over the previous year. China now aims to put another 4.5 million EVs on its roads by 2020 which equates to demand for ~44,000 to 117,000 tons of lithium over the next five years, assuming a required ~ grams of lithium per kilowatt hour, and average battery capacity of 65 kwh (average battery capacity for passenger vehicles is ~30 kwh, and ~100 kwh for electric buses). Indeed, attributes of lithium ion based batteries make it superior to competing technologies and hence a desirable alternative for energy storage, especially in vehicles (such as electric and hybrid vehicles) and consumer electronic devices (such as smartphones, laptops, power tools, cameras) where weight and durability are crucial factors.

3 Figure 9: Global electric vehicle growth over the last 5 years by country Source: IEA, Global EV Outlook 2016 Figure 10: Global electric vehicles growth over the last 5 years by type * PHEV = plug-in hybrid electric vehicles; *BEV = battery all electric vehicles Source: Wood McKenzie Types of electric vehicles. Electric vehicles can be grouped into three main categories: 1) Electric Vehicles (EV): are entirely electric vehicles with a main electric propulsion mechanism and possibly a smaller gasoline engine to support battery recharge or provide engine power upon battery depletion. Electric vehicles consume ~10-20 kg of lithium per vehicle. 2) Hybrid Electric Vehicle (HEV): are electric vehicles which combines an internal combustion engine (ICE) and electric power for propulsion. Hybrid electric vehicles consume ~0.5-2 kg of lithium per vehicle. 3) Plug-in Hybrid Electric Vehicles (PHEV): are electric vehicles which allow the vehicle s battery to be recharged by plugging the vehicle into an electric system. Plug-in hybrid electric vehicles consume ~ kg of lithium per vehicle.

4 Figure 11: Types of electric vehicle transportation Source: FMC, SignumBOX, IDTechEx, Boston Power Power storage. An area of growth not discussed thoroughly in this report is the use of lithium in renewable energy and energy storage. signumbox expects power storage applications to grow to 7.5ktpa LCE by Figure 12: Grid, Solar, and Nuclear Applications Sources: FMC, Sandia National Laboratory, CSP Today, Altran, Greenpeace, IEA Decline of EVs from 1910s. The first electric car powered by batteries was built in By the 1890s, there were actually ten times as many electric cars sold as gasoline cars with ~40% of total cars in the US being electric around the 1900s. However, according to Wood McKenzie, the emergence of gasoline-powered cars was the result of: 1) mass production with improved modern assembly lines for gasoline-powered cars resulting in reduced costs of production; 2) a significant number of oil exploration discoveries; 3) improvements and increasing prevalence of petroleumbased infrastructure over charging infrastructure (which is crucial for

5 electric vehicles with significant distance/range restrictions); and 4) superior driving distance possible for gasoline-powered cars. Figure 13: The revival of EVs to rival traditional internal combustion engine (ICE) vehicles Source: Wood McKenzie Continual re-emergence of EVs since Though internal combustion engine-based vehicles have been increasingly reliable and affordable, the continuing resurgence in electric vehicles in our view, is the result of: 1) Sustainability and environmental agenda: increasing acceptance of climate change science, awareness of sustainability, and increasing acceptance and attraction in operating a cleaner energy vehicle beyond environmentally conscious consumers have contributed to an increase in electric vehicles on the road. This trend has been reflected in policy and regulation as regulators look to force automakers to improve mileage per gallon. In the US, for instance, regulators have compelled automakers to improve mileage from 30 miles per gallon (mpg) to 38 mpg by 2020 and 54.5 mpg by European regulators likewise, have compelled automakers to improve mileage from 42 mpg to 58 mpg by Although the 2025 targets for Europe may change, the currently contemplated target is 71-81mpg. As such it is inevitable that the marginal cost of conventional internal combustion technology will increase significantly. Indeed, US and Europe electric vehicle sales have been driven by regulatory changes, in our view. Whilst, in contrast, China electric vehicle sales are driven by government subsidies and purchasing quotas on traditional vehicles in Tier I cities. Subsidies for commercial and passenger electric vehicles can be as high as 60% of the selling price of a commercial vehicle, or ~40% in the case of passenger vehicles.

6 Figure 14: Corporate average fuel economy standards by country Source: GFEI Figure 15: Summary of policy mechanisms for Electric Vehicle uptake by country (2015) Source: International Energy Agency, Global EV Outlook 2016

7 Figure 16: Examples of Chinese policies tackling traffic and air pollution issues by restricting opportunities to own conventional internal combustion engine cars by restricting availability of license plates and waivers for new energy vehicles Source: International Energy Agency, Global EV Outlook ) Improved electric vehicle features relative to internal combustion engine vehicles such as pricing (which is largely due to increasingly lower battery costs), extended range and stronger performance have resulted in making electric vehicles a more feasible purchase for consumers. Figure 17: Evolution of battery energy density and cost Notes: USD/kWh = United States dollars per kilowatt-hour; Wh/L = watt-hours per litre. PHEV battery cost and energy density data shown here are based on an observed industry-wide trend, include useful energy only, refer to battery packs and suppose an annual battery production of units for each manufacturer. Sources: IEA, Global EV Outlook 2016

8 Figure 18: Features of the Tesla Model 3 Source: Wood McKenzie 3) Increasing prevalence of charging infrastructure and facilities Growth in publicly accessible charging facilities have mirrored the growth trend of the electric car stock. The total number of electric vehicle supply equipment (EVSE) outlets available in 2015 reached 1.45 million, up from 0.82 million in 2014 or 20k in Furthermore, in the US, there are presently 21,846 alternative fuel stations (excluding private stations). Of that, 14,496 (or 66.4%) are electric stations. There are also 36,650 charging outlets in the US. Figure 19: Global electric vehicle supply equipment outlets from 2010 to 2015 Sources: International Energy Agency analysis

9 Figure 20: Geographical distribution of the 2015 stock of electric vehicle supply equipment outlets by charger type Note: Private chargers are estimated assuming that each EV is coupled with a private charger. Sources: International Energy Agency analysis Figure 21: stations) 21,846 alternative fuel stations in the US (excluding private Source: US Department of Energy\ Lithium-ion has secured its position as the chemistry of choice for electric vehicle batteries Lithium-ion batteries is a generic term for batteries where electric and chemical properties depend on lithium. Lithium-ion battery cells are comprised of four main components: (1) cathodes; (2) anodes; (3) separators, and (4) electrolytes, which are inserted into various container types (cylindrical and prismatic containers). Cathodes, anodes, and separators take the form of sheets, and are either wound or stacked to form alternating layers of cathode separator anode, with ions flowing between the cathode and anode sheets via an electrolyte solution. Lithium-ion batteries are primarily utlised in consumer electronics applications due to their high energy density and lifecycle. Their high

10 potential power output also makes them well-suited to particular automotive applications. Figure 22: Types of Lithium-ion batteries (LIB) Source: CEMAC Lithium-ion has secured its position as the chemistry of choice for electric vehicle batteries because: (1) higher charge density: as lithium has the highest electrochemical potential of all metals; (2) lightweight: as lithium has a low atomic mass; (3) rapid recharge: short charge times; (4) longevity: high cycling ability (the number of charge-discharge cycles that can be achieved without capacity drops); (5) efficient discharge rate (columbic efficiency); and (6) long storage: low self-discharge that is less than half of NiCd and NiMH chemistries.

11 Figure 23: Lithium-ion has secured its position as the chemistry of choice for EV batteries Source: Wood McKenzie Cost of batteries. The purchase cost of an electric vehicle is the greatest barrier to mass-market adoption with the highest cost in manufacturing of electric vehicle being the battery. No doubt, processes for manufacturing have become more efficient with recent technological advancements, whilst the cost of battery raw materials have increased. According to Wood McKenzie, at a US$100/kWh battery pack cost, electric vehicles are expected to become competitive with traditional ICE vehicles. Figure 24: Breakdown of Battery costs (2016) Source: Wood McKenzie

12 Figure 25: Battery pack cost projections by manufacturers ($/kwh) Source: Wood McKenzie Opportunities to lower costs include: (1) increasing competition from battery producers; (2) More manufacturing capacity coming online creating economies of scale ; (3) development of next generation technologies; (4) Increasing cleaner policies (resulting in less carbon and lower air pollution) which incentivise a trend toward electric vehicles; (5) Ability to arbitrage stored energy into power market, by selling back stored electricity to local utility. Risks to delay cost reductions include: (1) Increasing costs for battery raw materials with rising demand for electric vehicles; (2) Lithium-ion components are not commoditized or standardised with each component being specific to each batteries design/use; (3) Rising lithium-ion batteries demand from other sub-sectors such as power storage and consumer electronics. From exploration and mining to batteries What is Lithium Lithium is a metal with the lowest molecular weight, but highest electrochemical potential and largest specific energy per weight of all metals. These properties (power density and high energy) make lithium relative to other metals, ideal for use in lightweight batteries. Raw lithium itself is rarely used but instead processed into different chemicals for a variety of uses. Two chemicals used for rechargeable batteries are lithium carbonate (Li2CO3) and lithium hydroxide (LiOH). The end result of a battery begins with exploration and mining of lithium, and processing.

13 Figure 26: From resource exploration and mining to lithium-ion batteries *Note: lithium brine deposits are accumulations of saline groundwater that are enriched in dissolved lithium Source: CEMAC, Wood McKenzie Lithium Mining and Processing Battery grade lithium hydroxide and carbonate can be produced from both mineral deposits and brines, with lesser processing required for brines than mineral deposits. Indeed, lithium in meaningful quantities is found in one of two ways: 1) Mineral deposits (ores): are essentially hard rock minerals predominately located in Australia, and extracted via standard open pit or underground mining operations. The ore is crushed before undergoing a standard separation processes to isolate lithium from waste materials (for conversion to lithium chemicals). 2) Brines deposits: are predominately found in the lithium triangle, in Chile and Argentina (~58% of global reserves). Lithium salts exist at or slightly below the surface and as water evaporates, the mineral becomes concentrated in water. Brines are generally more economical to extract than mineral deposits. Lithium extraction involves solar evaporation to recover lithium from subsurface brines. Water is pumped from reservoirs into evaporation ponds which then crystalise with other salts. Thereafter, the lithium chloride solution is pumped to a recovery plant, washed with soda ash to precipitate lithium carbonate. It is then dried and sold to downstream customers who undertake further processing.

14 Figure 27: SQM s lithium solar solution production Source: SQM Supply According to the US Geological Survey, lithium resources discovered equate to 40 million tonnes and reserves equate to 14.0 million tonnes, with ~85-94% of the commercially viable concentrations at a limited number of locations in Australia, Chile, Argentine and China. Two brine deposits in Chile account for ~43% of global production whilst 30% of supply comes from a hard-rock mine in Australia. Lithium supply in 2015 was ~ kt. Figure 28: Lithium supply by country (2014) (Total in 2015 ~150kt) Source: Roskill

15 Figure 29: Current Global Primary Lithium Production Source: Wood Mackenzie; Thomson Reuters Datastream Long lead times from exploration to production. Meeting demand growth in the long term will be a challenge for miners, as lithium operations have significant lead times to develop and ramp-up production. As an example, Orocobre developed the first greenfield brine project the Salar de Olaroz project in Argentina in over 20 years. It took ~8 years from initial exploration and first production. No other major mined commodity has managed to double in scale within the timeframe required for lithium to meet current demand requirements; even bauxite, the least capital intensive of all mined commodities took nine years to double in scale between 2004 and We do not expect any new brine resource to come online before In Chile, arbitration continues with CORFO with no resolution in Atacama for SQM. In Argentina, SQM continues to push Lithium Americas but no additional supply is expected before 2019, and FMC has plans for a hydroxide expansion but there are questions over its brine source. In China, no significant production is expected. In Nevada, US, development continues but again no additional supply is expected in the short term. Brine supply to come online between include Orocobre s ~10kt LCE and Albemarle (La Negra) ~20kt LCE. We expect the gap to be supplied by Australian spodumene (from Galaxy Resources and Neometals). Figure 30: Significant lead times to develop the Orocobre example Source: Wood Mackenzie

16 Figure 31: Supply growth index for the major mined metals Source: Wood Mackenzie Figure 32: Supply growth to increase ~13% CAGR Source: Benchmark Mineral Intelligence Cash cost of supply. At currently negotiated prices, the premium over the production cost achieved by miners should incentivise capacity additions. Mineral deposit operations (relative to brine deposits) have higher cost of production as costs are driven by a technically more complex and energy intensive process to reach battery grade lithium carbonate and hydroxide products. Offsetting these costs is the benefit of by-products. For instance, brine operations can additionally produce potash and borates whilst mineral deposit operations may produce tantalum and feldspar.

17 Figure 33: Lithium cost curve by company brine < mineral deposits Source: Roskill Lithium Demand Traditional use represents ~70% of demand. In 2015, the market demanded ~150kt to ~190kt, ~70% for traditional use in production of glass, ceramics, air dehumidification, dyes, chemical synthesis of pharmaceuticals. Figure 34: Lithium historical supply Source: Benchmark Mineral Intelligence But increasing prevalence of electric vehicles to boost demand Converters such as Ganfeng Lithium, Sichuan Tianqi and Albemarle/GRM are driving demand. The lithium content required by electric vehicles is significantly disproportionate to traditional use. For instance, pure electric vehicles require 8 to 40kg in lithium versus 0.002kg in smartphones.

18 Moreover, 14 countries have committed to quantitative electric vehicle stock objectives with 13 million electric vehicles expected to be on the road by Wood Mackenzie expects electric vehicles (including PHEVs) to reach ~13% of new light vehicle sales globally by Indeed, if new EVs from Tesla and other manufacturers spur wider electric car adoption, then this could have significant implications for lithium and battery raw materials. Wood Mackenzie expects total lithium demand to double before 2024, with two-thirds of that growth coming from EV demand. Figure 35: Electric vehicle penetration (% global new vehicle sales) Source: Wood Mackenzie; Thomson Reuters Datastream

19 Figure 36: Lithium demand (LCE kt) forecasts to 2020 Source: Albemarle Figure 37: Wood Mackenzie forecast lithium demand (LCE kt) to 2035 Source: Wood Mackenzie Note: supply and demand are measured in Lithium Carbonate Equivalent tonnes (LCE)

20 Figure 38: 14 countries have committed to quantitative electric vehicle stock objectives of 13 million electric vehicles on the road by 2020 Notes: * This target includes 4.3 million cars and 0.3 million taxis and is part of an overall deployment target of 5 million cars, taxis, buses and special vehicles by ** Estimate based on a 10% market share target by *** Estimate based on the achievement of the 3.3 million EV target announced to 2025 in eight US states. All indicators in this table refer to the eight US states; market share and stock share are assumed to account for 25% of the total US car market and stock. Source: International Energy Agency Figure 39: According to the IEA, meeting 2020 deployment targets requires a sizeable growth of the electric car stock. Thereafter, meeting 2030 decarbonisation and sustainability goals requires a major deployment of electric cars in the 2020s. Source: International Energy Agency Lithium-ion mega factories are coming. Over US$20 billion have been committed to establishing lithium ion battery mega factories, which have the intention of expanding cell plants from megawatt to gigawatt capacity.

21 Figure 39: Lithium-ion mega factories to come online Source: Benchmark Mineral Intelligence Lithium Prices Price support driven by long lead times for supply to come online coupled with increasing demand The prices of lithium carbonate and hydroxide are negotiated individually through contracts between buyers and sellers. Hence, there is little transparency in pricing. In our view, with long lead times for projects, prices should be supported between with some impact from supply coming online around 2020 from brine projects.

22 Figure 40: Benchmark Mineral Intelligence Lithium Pricing Forecasts Source: Benchmark Mineral Intelligence Figure 41: Benchmark Mineral Intelligence lithium price forecasts with peak of in 2017 Source: Benchmark Mineral Intelligence

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