This article was written by Martin Hayes. All views and opinions expressed are strictly his own.
This week saw the London Metal Exchange (LME), which is still in semi-hibernation from the 16-month long Covid-induced closure of its trading floor, introduce six new contracts, largely geared towards its more environmentally responsible approach to business.
As the LME succinctly put it – offering pricing and risk management solutions for metals that support the electric vehicle (EV) transition and circular economy.
Regarding timing, it is irrelevant that the open-outcry floor will remain shuttered until September at the earliest – these new instruments, like previous debutant contracts, will trade only on the electronic platform and the inter-office telephone market.
They range from a European aluminium premium contract, a US aluminium UBC scrap offering, a brace of regional steel scrap instruments, a European HRC steel market, and lithium hydroxide. They join a growing family of base and precious and minor metals contracts, steel, alumina and various aluminium premium instruments.
All of these share the same characteristics of previous new markets launched by the LME – they are cash-settled futures, as opposed to the traditional physical delivery forward markets, such as copper and primary aluminium. Likewise, they are based at prices from reporting agencies – in this instance Fastmarkets, Argus and Platts.
Of these, the steel and aluminium newcomers join groups that have been trading for some time – with varying degrees of success. It is lithium that is the real newbie, not only on the LME, but elsewhere, as both the US and China have introduced lithium contracts in recent weeks.
So what are the chances of lithium futures gaining momentum and usage from the global industry – the producers, the vehicle manufacturers, the lithium-ion battery makers, as well as the financial markets?
This, after all, is an underlying marketplace where there has been some vicious price volatility in recent years, and where supply is going to have to increase significantly from current constrained levels to meet the rapid growth that will take place in the PEV (plug-in electric vehicle) sector in the next decade.
From 2019, demand weakness and the impact of the pandemic was the broad backdrop to a classic metal industry cycle where falling prices and de-stocking were followed by eventual cutbacks, re-stocking and a partial price recovery.
In price terms, lithium hydroxide, ex-works China, has fallen from around 175,000 yuan per tonne to 39,000 ypt, and is now currently around 88,000 ypt.
Again, as part of the metal industry cycle, there is nothing unusual in that it takes time to re-start idled production, so if there is an upsurge in demand, which is predicted for lithium, then market tightness comes into play.
There are plenty of supply-side projects, but some have been delayed and need financing, while current idle capacity will eventually ramp up – prices are above the level needed to re-start right now. But all of this takes time.
That is the here and now of the mid-2021 market, but one which is poised on the brink of a once-in-a-lifetime demand-side explosion in the global shift towards a low-carbon world. Before 2020, EV growth was largely fuelled by China. But now Europe and the US are on the brink of rapidly increasing demand growth, as EVs start to become more mainstream.
For example, China EV growth could be up by 80% this year, while Europe may register a 50% increase. Overall, it is estimated that the market will have doubled by 2025, while by the end of the decade it will need over five times current supply.
That sounds like a recipe for market volatility and rapid and unforeseen price swings – the ideal time maybe to consider risk management strategies on financial exchanges, which provide much more transparency, so the LME may be in the right place at the right time.
As has been noted, these are futures contracts, cash-settled, and traded on a RVM (realised variation margin) basis, which is typical of most financial markets these days – much more likely to entice the wider clientele familiar with this type of margining.
So, the timing looks right for lithium hydroxide futures – the question is how long contracts will take to gain user acceptance and recognition. LME aluminium, which started in 1979, took over 10 years really to become established. But these days it is not feasible to have a dormant contract sitting on the books – especially given the demand side backdrop that exists for lithium.
Potentially, too, business may be diluted and fragmented, as the LME is, in theory, in competition, joining the US-based CME, which introduced its own contract in early-May – so far it is thinly-traded - while China’s offering was earlier this month
That, however, is not a bad thing, perhaps. After all, price risk does not sleep, so it could be beneficial having three time-zone vehicles available for trading. And take-up of futures trading as a concept has much broader benefits.
It allows for better forward planning by offsetting more extreme price volatility, providing greater certainty for financial and raw material purchasing managers. More secure and settled price inputs may hasten the time when EVs really become more mainstream, and cheaper, attracting wider take up from the vast majority of car drivers.
So, the environment could benefit as well – not just the industry and brokers, A win-win situation, it seems.