November 15, 2018 - 5:59pm EST by
2018 2019
Price: 11.00 EPS 0 0
Shares Out. (in M): 21,000 P/E 0 0
Market Cap (in $M): 23,000 P/FCF 0 0
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 23,000 TEV/EBIT 0 0

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We believe that investing in nickel today represents asymmetric risk/reward. Below is a brief recap of the nickel market, why we are positive and what we see as the risks to our thesis (as well as the reasons they don’t overly worry us today).


The global nickel market is roughly 2.1m tonnes per year in size. At the current nickel price, that represents an annual value of roughly $24b.




In terms of supply, the primary countries producing nickel are the “old guard” of Russia, Canada and Australia as well as the “new guard” of Indonesia, the Philippines and New Caledonia. Between these 6 countries, one accounts for roughly 70% of global nickel supply. The primary listed companies producing nickel are Norilsk Nickel, Vale, Glencore, Sherritt, Eramet & BHP.


It's important to spend a moment on the main types of nickel that exist and the differences between them.


Nickel is produced primarily from two types of deposits - laterites and sulphides. Sulphide nickel deposits currently produce roughly 0.75m tonnes of nickel per year while laterites provide the other roughly 1.1m tonnes. Very high-level, sulphide deposits are much more concentrated than laterite deposits (which have a lot of iron and/or magnesium mixed in) and as a result the processing step(s) needed in order to produce Class 1 nickel (which means nickel of > 99.8% purity, as defined by the LME) is relatively inexpensive (compared to laterites).


The weight of global production between sulphide and laterite nickel ores has changed over time and continues to do so as a result of a scarcity of finds of new sulphide deposits as well as a natural decline in existing sulphide deposits. Total sulphide output has only grown at a roughly 2% CAGR over the past 20 years, well below total nickel production and has fallen from roughly 0.8m to 0.75m tonnes from 2015 to 2017 (implying a roughly 3% annualized decline during this recent period).




Roughly 2/3 of nickel is used is to produce stainless steel (“SS”). SS is then used for catering and household equipment (roughly 35% of total SS demand), industrial applications (roughly 25%), building and construction (roughly 15%), transport (roughly 10-15%) and then a mix of other diverse applications. The main other uses of nickel are for alloy steels, plating (basically using a thin nickel layer for decoration, corrosion-resistance or wear-resistance or to build up worn or undersized parts for salvage), foundries and batteries.


On a second-use basis (i.e. looking through to the final consumer), nickel usage breaks out as roughly 25% in engineered products (food processing equipment, catering equipment, chemical processing equipment, heat exchangers), roughly 20% in metal goods (cutlery, tableware, medical devices), roughly 15% in tubular products (the O&G industry is a core end user here), roughly 15% in transportation (auto, railway, shipping, aerospace, containers), roughly 10% in electronics and roughly 10% in construction (lifts, escalators, HVAC, chimney liners, sinks).


Since the 1960s, usage of nickel in SS has grown at a roughly 5% CAGR while usage of nickel in other applications has grown at a roughly 2.5% CAGR. Importantly, SS demand is less volatile than for many other commodities. Over the two years from 2007 to 2009, global SS consumption declined by roughly 5% - hardly a total collapse in demand despite the then-bleak macro backdrop.


Why are we bullish?


1) The nickel market is heavily in deficit


Nickel inventories at the LME & SHFE have declined from a peak of 500k mid 2016 in 225k today. That’s a total reduction of 275k over a period of just over 2 years, implying annualized draws of roughly 125k (though the more recent annualized rate has been roughly 175k). Given current inventories of 230k, the recent annualized rate implies that the world could run out of inventories in roughly 1.25 years.


This estimate of the current size of the nickel market deficit is corroborated by the latest Glencore state of the market slide deck (here), which shows an average market deficit of roughly 165 kt over the period from 2017 & 2018.


2) CapEx has been slashed, portending a future of limited (sulphide) production growth


Getting aggregated industry CapEx statistics is tricky without something like WoodMac but we can get a decent idea by looking at the largest companies.


In November 2017, Vale (the largest nickel producer in the world) announced they were cutting their nickel CapEx budgets for 2017 and 2018 by 40% and 53% respectively. This came alongside heavily downgraded nickel production forecasts. In 2015, they were targeting 318kt of nickel in 2019. In 2016, that had fallen to 316kt. In 2017, after putting three separate mines on care and maintenance, that number came down to 263kt (where it is now expected to stay until 2021). So the second largest nickel producer in the world has cut production guidance by 18% over a two year span and then said production won’t grow for another 3 years. That 55kt cut is equivalent to roughly 2.5% of global supply.


Norilsk Nickel (the 2nd largest nickel producer in the world) has stated their “stay in business” CapEx number is somewhere in the $700-900m range with their “keep production flat” number guided at around $1.5b. In 2012 they spent $2.7b of total CapEx, implying roughly $1.2b of growth CapEx. From 2015 to 2017 they averaged roughly $1.8b of total CapEx, implying roughly $0.3b of growth CapEx. In 2017, they produced 210kt of nickel, down from 228kt in 2014 and below the 230kt they had targeted production three years out back then.


BHP doesn’t break out nickel CapEx but hasn’t mentioned nickel in their “greenfield CapEx” blurb for the last five years. If we look at their nickel division on a constant perimeter, production has fallen from roughly 100kt to in FY14 to roughly 90kt in FY18 (and guidance is for flat production in FY19).


For what it’s worth, the WoodMac number for global nickel “expansion CapEx” has come down from $8-9b in 2011/2012 to just $2b in 2017.


Given that three of the largest nickel producers in the world (together accounting for roughly 30% of global production and a much higher percentage of global sulphide production) have let their production levels atrophy over the past 3-5 years, we think it is clear that the industry has gone through a period of significant curtailment of growth CapEx.


3) The current low price environment continues to fail to incentivize greenfield or even brownfield projects, prolonging the CapEx moratorium and setting us up for an even greater supply deficit in the future


The current ($11.3k per tonne) nickel price fails to cover cash costs for a significant portion of global production, let alone incent new supply. We are currently sitting at roughly the 75th percentile of the global nickel C1 cost curve.


Back in February 2018, when the nickel price was modestly above current levels ($11.8k/t then vs $11.3k/t today), WoodMac estimated that the IRR on nickel expansion projects based on spot prices at the time was 1%, as compared to LT returns on nickel projects of 9%.


4) The need for Class 1 nickel to go into EV batteries could potentially be an enormous tailwind to demand growth and if it comes about


Very simply, there are roughly 100m cars producer per year today. If you extrapolate the LT trends, that number will probably be close to 115m by 2025. If 10% of global cars produced are BEVs by then (somewhere towards the lower end of most estimates at this point), that would still represent > 10m new BEVs per year. To get there, we are clearly not starting from a base of zero today. Through October this year, global total passenger EV sales hit 1mn (+66% YoY). Roughly 50% of sales came from China and roughly 25% from Europe.


There are different battery chemistries being experimented with but the important point for the thesis here is that they consistently seem to be moving in the direction of more rather than less nickel per unit (often at the expense of the more-expensive cobalt which OEMs are keen to reduce their dependence on given both its high price (roughly $50k/t today) and its concentrated, politically-unstable supply base). If you read commentary from the large battery producers, they are almost all in the process of moving away from NMC 111 (1 part nickel, 1 part manganese, 1 part cobalt) towards NMC 532 (5 parts nickel, 3 parts manganese, 2 parts cobalt) and potentially even NMC 811 (8 parts nickel, 1 part manganese, 1 part cobalt).


If you put together (a) consensus estimate of the future mix of battery chemistries with (b) an estimate of the weight of raw material needed per battery and (c) the assumption of 10m new BEVs per year by 2025, you end up with estimates of BEV-related demand for nickel in the 400-500kt range. The midpoint of this range represents roughy 20% demand uplift on the current nickel demand base, implying that this source of demand alone could power a +2.5% total nickel demand CAGR over the coming 7-8 years (and realistically much longer, given that if BEVs are cost-effective enough make it to 10% penetration, they are extremely unlikely to stop there). To sense check these numbers McKinsey did some similar math (here) and estimated that nickel demand for use in batteries could rise from 33kt today to 570kt by 2025.


As described earlier there are two principal sources of raw nickel, one of which is relatively cheap to convert to Class 1 nickel (sulphides) and one of which is not (laterites). The reason that the divergence in production growth between the two is important is that the largest potential driver of demand growth over the next decade (EV batteries) will require exclusively Class 1 nickel - so you are seeing shrinking production from sulphide deposits, right at the time that demand for higher quality nickel could be on the verge of exploding.


5) Despite this structural tailwind, the speculative hype & froth around EVs appears to have largely come out of the price in recent months as the market has refocused on short-cycle China/macro risk


Based on LME disclosures about open interest by type of counterparty (which are slightly messy because they changed the classifications earlier this year) we appear to be below the LT average for net speculative length in the nickel market, suggesting that the trade has largely de-crowded since earlier this year.


Given no change to the above thesis since then (if anything nickel inventories drawn more aggressively than almost anyone forecast, global growth has remained robust (for now), BEV momentum has continued to build with a host of competitors to Tesla rolling out models and seemingly committing to BEVs for the LT, we’ve continued to see little if any greenfield CapEx sanctioned, etc.) We think the logical conclusion is that the entirety of the base commodities space has been sold down, largely over concerns around Chinese macro trends.


This strikes us as throwing the baby out with the bathwater. Within total global nickel demand, roughly 14% ends up in some form of Chinese construction (across both infrastructure and private) which compares to roughly 27% for both copper and zinc.


6) Supplying the future Class 1 nickel deficit likely requires prices in the $20-25k per tonne range, a double from today


If you put together some of the pieces laid out above, you might wonder - if sulphide production is already declining, expansionary CapEx has been slashed and yet demand could be exploding thanks to BEVs, then where is the world’s Class 1 nickel going to come from?


If nickel prices rise, we will undoubtedly see more brownfield and greenfield sulphide projects sanctioned. The issue here, however, is that there are very few large undeveloped sulphide resources left in the world. Sulphide resources make up roughly 40% of current production but less than 20% of undeveloped resources with a non-negligible decline in ore grades between the producing and the undeveloped.


As of today, the next option for producing Class 1 nickel is to use a process known as High Pressure Acid Leaching (aka “HPAL”) which works as follows. You mine a laterite ore, crush it to create a fine material, mix it with water to create a slurry, preheat it and then mix it with sulphuric acid inside titanium-lined autoclaves, heat it up to 270°C and apply pressure of up to 45 atmospheres. The slurry and acid react as they flow through multiple compartments within the autoclave where solvent extraction is used to separate nickel from the solution, which is then precipitated.


If it wasn’t obvious from that paragraph, this is an extremely complex process and every single large HPAL project ever attempted has come in significantly over budget. Glencore openly states that it took them 10 years before they had their HPAL asset working properly. If we assume that the industry as a whole has benefitted from the learnings of these past cost overruns and that the capital intensity of constructing an HPAL project is now at the historically best-in-class level of roughly $60k/t, then we will still need $25k/t nickel prices to generate a 15% IRR (I think that a higher cost of capital than you might apply to a typical mine project is appropriate here given the process’ technical complexity & history of failure). If we give credence to the rhetoric from some Chinese companies which have recently claimed to be able to build HPAL plants for $40k/t, then we would need $20k/t nickel prices to generate a 15% IRR.


Importantly, like a mine, HPAL projects take considerable time to design, build and ramp up. So even if a project was approved and funded today, we would still be looking at 2 to 3 years (at best) before that project was up, running and producing Class 1 nickel.


What are the risks?


1) The miners themselves get excited so about EVs they justify spending massive amounts of CapEx to get ahead of the projected deficit and higher prices that they also foresee emerging


This is always a risk in commodity-land but (a) miners still seem to playing along with the “capital discipline + shareholder returns” narrative for now, (b) we’ve seen very limited if any evidence of greenfield CapEx ramping back up in nickel and (c) even if it did come, it would likely be years before that incremental supply came to market while in the meantime the nickel market is in a substantial deficit and inventories are falling at a rapid pace.


2) EV demand never comes through


We don’t have anything particularly smart or differentiated to say here but given what seems like (1) consumer acceptance of the Tesla product, (2) the more recent momentum behind the product from the legacy OEMs (for instance, Volkswagen claiming they will have invested $80b invested in EVs by 2022) and (3) its necessity if OEMs are to meet regulatory emissions targets (esp in Europe & China), it seems to us that the EV train has almost left the station.


3) The world finds a way to more cheaply convert laterite nickel into Class 1 nickel, reducing the price rise that is ultimately needed in order to incentive the market to close the Class 1 deficit


This is probably the biggest risk to the thesis - that HPAL goes through its own form of “shale revolution” with massive deflation in capital intensity and cash costs, thus reducing the incentive price needed to produce more Class 1 nickel. It’s clearly impossible to rule out future technological improvement or innovation (in any sphere), but it’s also hard to bake it to forecasts in any meaningful way until there is actually some tangible evidence that the technology is getting better and/or cheaper. In the meantime, I think all we can do is keep a close eye on HPAL announcements and outcomes.


4) There is still some demand destruction to come from SS producers shifting further away from Class 1 nickel to NPI or scrap


One final theory of how the future Class 1 deficit gets (somewhat) covered is that customers (mainly stainless steel producers) who are currently using Class 1 nickel but don’t really need to do so will switch to laterite-ore-based nickel in the future if they were ever to see a meaningful price gap emerge between Class 1 and lower grades of nickel. Most estimates today have 400-500kt of Class 1 nickel going into SS production and bears would argue that this could fall to 100-200kt if the economic incentives existed (i.e. if Class 1 nickel was priced at a large enough premium to non Class 1 nickel).


We’ve spoken to multiple stainless steel producers and most, if not all, of them already seem to be running their processes using as little Class 1 nickel as they can already and given the predominance of scrap as a source of nickel within the SS production process, mined nickel itself actually represents a relatively modest portion of total costs, somewhat reducing the incentive to go to the trouble of altering production processes to tweak the mix of Class 1 / non Class 1 nickel inputs.


So to sum up - rapidly drawing inventories, prices well below cash costs / incentive costs, limited speculative positioning, dearth of industry CapEx, potentially explosive demand growth. We think it's a compelling setup.



I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.


- continued inventory draws

- tighter inventories

- rising BEV penetration

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