EV Batteries and the Cobalt Cliff: The biggest “oops” in the history of supply chain management

In early March, I described cobalt supply and demand dynamics as a giga-risk for lithium-ion battery manufacturers. I subsequently took my analysis a step further and suggested that electric vehicle (EV) manufacturers including Tesla (TSLA), General Motors (GM), Nissan (NSANY) and Porsche (POAHY) might soon find themselves coping with the biggest “oops” in the history of supply chain management.

While my statistical data was unassailable, I had a hard time answering the most common question readers asked, “how could so many major companies make the same supply chain blunder and bet their futures on adequate supplies of a by-product?” Since I wasn’t satisfied with my responses, I’ve spent the last two weeks searching for hidden flaws in my hypothesis and considering the likely short- to medium-term impacts of the Cobalt Cliff.

The bad news is I haven’t found any flaws in my hypothesis. The worse news is I’ve concluded the short- to medium-term impacts on EV manufacturers will be catastrophic:

  1. The world’s miners will not produce enough cobalt in 2016 to satisfy historic battery industry demands;
  2. There is no reason to believe that cobalt production rates will increase at a pace that’s sufficient to satisfy anticipated incremental demand from EV manufacturers; and
  3. When it comes to free-market competition for available cobalt supplies, EV battery manufacturers will be the most cost-sensitive class of users.

Cobalt Resources and By-product Status

Cobalt is an unusual metal because the known terrestrial resources are about 25 million tons and the identified sea-bottom resources are another 120 million tons. With rare exceptions, however, cobalt is produced as a minor by-product of nickel and copper mining. As a result, global cobalt production moves up and down as nickel and copper miners respond to global demand for their primary products. Since less than 6% of global cobalt production comes from primary cobalt mines, the industry cannot respond to increased cobalt demand because no rational nickel or copper miner will put additional pressure on prices for its primary products because it wants to sell a little more cobalt. Glencore and other international mining conglomerates are suspending operations at marginal nickel and copper mines around the world. Therefore, cobalt production is expected to spike downward in 2016 and remain low until nickel and copper prices recover. I don’t have enough data to accurately predict the magnitude of the downward spike, but 5,000 to 10,000 tons seems certain and far larger declines are a distinct possibility.

Country of Origin

The following table summarizes and compares the US Geological Survey’s published cobalt ore production estimates for 2006 and 2015 by country of origin.

cobalt_sources_USGS

A quick glance at the table shows that the substantial bulk of global cobalt production growth over the last decade came from the Democratic Republic of Congo, a country that has recently been slammed by Amnesty International for child labor abuses in the artisanal cobalt mining sector that accounts for roughly 20% of the DRC’s total cobalt production. If the DRC cracks down on artisanal miners, another 10% of global cobalt supply could be in jeopardy.

Competition with Other Cobalt Users

The Cobalt Development Institute (CDI) is a non-profit trade association composed of producers, users, recyclers, and traders of cobalt. According to Kim B. Shedd, a cobalt analyst for the US Geological Survey, the CDI is the definitive source for granular detail on refined cobalt supply and demand. The following table summarizes the CDI’s published refined cobalt supply and demand statistics for 2006 and 2014. The next edition of Cobalt Facts is expected in early April.

cobalt_sources_USGS2

Once again, a quick glance at the table shows that battery industry has accounted for 2/3 of global growth in cobalt demand since 2006. The factories currently under construction will increase global battery manufacturing capacity by almost 100%. Unless cobalt production ramps rapidly over the next 18 months or battery manufacturers are willing to pay exorbitant prices to out-bid competitive cobalt users, those new factories will end up sitting idle because you can’t manufacture batteries if you don’t have all the required raw materials.

If you go down the list of competitive uses for cobalt, it’s easy to see why most supply chain competitors are in a better position than the battery industry when it comes to protecting their supply chains. Cobalt Superalloys are used primarily in jet engine applications where cobalt cost isn’t even a rounding error compared to product value. The same is true to a greater or lesser degree for all of the other competitive uses for cobalt. The other industries that need cobalt can pay more if they have to without diminishing the competitiveness of their products. The battery industry, which uses between $5 and $29 of cobalt for each kWh of battery capacity, will rapidly find itself clinging to the ropes.

Competition Within the Battery Industry

My first article on cobalt supply constraints assumed for the sake of discussion that the lithium-ion battery industry would abandon high-cobalt chemistries like LCO in favor of low-cobalt chemistries like NMC and NCA. While I still believe that will happen over time because higher cobalt prices will make high-cobalt chemistries like LCO less attractive, the transition will be a work of several years because most devices that use lithium-ion batteries are designed for the specific performance attributes of a particular chemistry and those devices will have to be modified to use a different chemistry. During the transition period manufacturers of EV batteries will find themselves in direct completion with everybody else in the lithium-ion battery business.

My last table is a hierarchy of alternative lithium-ion battery applications from the highest value per watt-hour to the lowest value per watt-hour:

battery_hierarchy

In a normal free market, essential raw materials and components are allocated first to high value applications and then to successively lower value applications. In cases where supply is rigidly constrained, high value applications that only need a little raw material per unit of production will always be able to outbid lower value applications that need a lot of raw material per unit of production. The end result is that EV and utility-scale battery manufacturers will always end up at the bottom of the food chain with the weakest bargaining position. In substance, the only raw materials available to them will be the surplus that nobody else needs or wants.

Conclusion

Over the last two weeks I’ve spoken with a variety of experts including battery professionals, miners, the USGS and the CDI. The battery industry experts have invariably assumed that since cobalt trades on the LME, the world’s miners can and will quickly respond to increased demand with increasing supplies. The miners, the USGS and the CDI all agree that it simply can’t happen.

When I was a boy my mother taught me the first law of cooking – check your pantry first and don’t start if you don’t have all the necessary ingredients. It was my first lesson in supply chain management, and a lesson that served me well for over a half-century.

This is more than a supply chain management oops, it’s a due diligence debacle because nobody bothered to investigate the facts before writing a sentence like this gem from Tesla’s 10-K.

“We use various raw materials in our business including aluminum, steel, cobalt, nickel and copper. The prices for these raw materials fluctuate depending on market conditions and global demand for these materials. We believe that we have adequate supplies or sources of availability of the raw materials necessary to meet our manufacturing and supply requirements.”

I don’t see how anybody who spent a day investigating the facts could reasonably believe they have adequate supplies or sources of availability for cobalt. This is one of the few times in my life that I’ve sincerely wanted to be wrong.

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