Blue Planet Studio
As Lucid Motors (NASDAQ:LCID) edges closer to commencing sales of their new vehicle, I am looking into the company more seriously than I ever have before. Given the exigencies of today, I am trying to take a long-term view of where Lucid will be over the next decade, instead of trying to follow the gyrations of our currently dislocated market.
While several other authors have already examined the details of Lucid’s business plan and its technological approach, I want to take somewhat of a more bird’s eye view of how Lucid and other EV makers fit into an increasingly tight and, just as importantly, complicated lithium market.
In brief, I am increasingly convinced that new structural elements are creeping into the lithium market that will make it very difficult for any EV maker to reach their profit targets even if all their growth targets are hit. Lucid and every other EV producer are about to become each other’s worst enemies.
An Old Story
Forgive an unusual opening, but I promise this has a point. Lucid actually reminds me of a story a professor told when I was studying economics.
Plus One Seller
Imagine a market where 99 buyers of copper all value it at $10 per pound, and 100 sellers all value it at $3 per pound. How much will the copper sell for at market?
The trick is many new students of economics try to figure out where in the middle to put the answer, when the true answer is the market-clearing price is $3 per pound. If any of the sellers tries to sell it for more than that, they will be underbid by whichever of the 100 hasn’t found one of the 99 to partner up with. Because there are more sellers than buyers, competition among the sellers pushes the price all the way down to the sellers’ marginal value.
Plus One Buyer
Now, imagine two new buyers come in. Now there are 101 buyers at $10 and 100 sellers at $3. What price? Again, the trick is not to assume there must be a middle ground. Bidding wars among the buyers, one of whom is going to be left without a dance partner, will push the price all the way up to $10 per pound, the buyer’s marginal valuation.
It’s a vastly oversimplified illustration of supply and demand dynamics, of course, but it holds a kernel of truth that I think is relevant. This sort of what my professor called “mass inversion of profit” is most commonly seen in markets where there is a long runway of potential demand for a limited-supply resource… like lithium, for example, where 74% of the global supply and rising goes to batteries that power what is still only a small fraction of the global car fleet.
The Moral Of The Story
Apologies for the stroll down memory lane, but Lucid’s impending launch of its first model, the Lucid Air, made me think of that story. Lucid is the latest of several new kids on the block in the EV (Electric Vehicle) sector that is aiming to emulate the success of Tesla (TSLA) which launched the product category almost single-handedly and rode it to a $750 billion market cap.
The moral of the story really has to do with those last two buyers, the ones who come in late and shift the balance of power from the buyers to the sellers. They are drawn into the market, of course, by the fact that something they value at $10 can be procured for only $3, suggesting to them that they have a great opportunity for profit. But of course, the paradox is that the very act of entering destroys the (merely illusory) opportunity for profit. It’s about as close as economic theory comes to a Shakespearean tragedy.
Lucid’s Place In The Story
The prevailing view of Lucid reminds me somewhat of that situation. Tesla’s profit and the expectations for (far) higher profit that drive its market cap are largely a reflection of the relatively small size of the current pool of EV production. So far, lithium production has been able to keep pace with EV production, meaning that the latter, rather than the former, is the limiting factor, to which the profits from selling to EV customers accrue. Those taking a bullish position on Lucid are more or less expecting Lucid to tap into the same profit stream and exploit it in more or less the same way.
But like I said, a lot of new companies are jumping in. Even without knowing exactly when the tipping point will be crossed, it now appears likely that a lot of capital is about to be directed at expanding sales of lithium-powered EVs but it is less clear that lithium production is going to expand enough to keep pace. I don’t think Lucid will ever actually fail to procure the lithium it needs, but Lucid and others like it may shift the balance of the markets away from buyers of lithium and towards sellers of it, such that their profit potential diminishes considerably more than their lithium supply. And that fundamental shift has the potential to linger for the longer term, perhaps even a whole decade.
Winners And Losers Both Lose
And, it should be emphasized, this remains true even if Lucid is ultimately still able to procure the lithium it needs. To follow on from our previous example, suppose Rivian (RIVN) and Lucid each are one of the “last two” buyers. With only one seller free one of them will not procure lithium at all, but even the one who does will not see any profit from it because the loser will bid the price up.
This wipes out profit for the winner as well and for the 99 that Tesla, GM (GM) and whoever else was buying far more profitably before that. While lithium batteries and EV purchases may still produce profit, the car manufacturers are merely middle-men for the profit, which passes through them from the car buyer to the lithium miner. Lithium miners are the big winners.
Lithium Supply Dynamics
Of course, presumably they will ramp up supply in response. This is one of the limiting fallacies of my old story; in the real world, supply is rarely so perfectly inelastic that it fails to respond to a tripling in price. Rising supply should cancel out some of this effect and allow profits to resume.
But for our purposes, the question is will supply expand enough to preserve meaningful profit for non-lithium miners?
In 2021, EV sales represented 8.6% of car sales, while lithium reserves represented 165 years of 2018 consumption at that time. More recent estimates are a little more difficult owing to COVID. With batteries already representing 74% of total lithium production, multiplying by a factor of 10x or more will cut reserves down to 20 years’ worth. For comparison, the world currently has almost 50 years’ worth of oil reserves, so in this scenario supply is already running very close to the limit. But to this we must add global growth in automotive sales – a lot of countries are just now beginning to urbanize and develop – so those 20 years are probably more like 10-15.
Still, that is almost doable. Almost. But putting that aside, there is also another entire source of demand for lithium batteries: homes.
The Other Lithium Explosion
There is little doubt in my mind that home demand for lithium energy storage will be at least as high, if not even higher, than automotive demand. The reasons for this are two-fold.
First, the same climate change and Ukraine War-induced pricing pressures that are producing such runaway growth in EVs are also producing similar levels of growth in renewable energy. Since the sun doesn’t always shine and the wind doesn’t always blow, battery storage in the electricity industry is becoming a little less vital than in the automotive industry.
In fact, however, it is actually becoming more so, and not only because most developed nations now mandate their grids to increase penetration of renewable energy. Climate change itself is making those grids increasingly unreliable, regardless of which power source fuels them. While renewable energy can sometimes fall short and leave a grid in the lurch, as it recently did in Texas leading to an emergency conservation order, it is just as common for a grid to be threatened by a forest fire or a fallen tree or some other failure of the grid itself, not the fuels powering it.
And what’s more, these failures are probably going to be defined – by governments, as well as investors – as more serious, and more worthy of being addressed by a limited global lithium supply. While a car with no recharge or a dirty oil-based fuel source is merely disconcerting for future troubles, a failure of electricity can be a good deal more dangerous, and in some cases even immediately lethal. Heat is killing 1000 people a month in Spain and Portugal right now. The worst ever heat crisis killed 70,000 in Europe in 2003, and this was when electric grids were a good deal more reliable.
In response to this, more and more jurisdictions in developed nations around the world are advising anyone vulnerable to an electricity outage to secure a backup power supply for their home. With oil prices at such high levels and urban regulations often limiting storage of flammable fuels in residences anyway, that usually means one thing: batteries. Essentially, anyone who needs regular access to a working medical device, anyone with a prior record of heatstroke, and finally pretty much everyone over middle-age is being told to buy a battery. This is a considerable portion of all the households in America, Europe and Japan, tens if not hundreds of millions, who are suddenly going to be bidding against car manufacturers for lithium. And with their lives potentially on the line, they’re probably not willing to be outbid.
It is just not clear to me how the lithium market can possibly absorb this kind of demand. Even assuming that only 30% of households need batteries and they only need 15 kWh of capacity, with a ten-year lifespan, in the US alone that would be enough to take home battery sales above current EV sales in terms of lithium capacity. To this must be added that businesses also will want backup sources as the grid’s reliability continues to fall, and also the fact that losing electricity is annoying, so anyone wealthy enough to buy a battery will probably buy one.
And then, there’s the not inconsiderable danger that regulators will simply order battery producers to prioritize vulnerable households if supply becomes too tight.
Market Imbalance
Projections about the future are always uncertain of course. Just to be clear, though, the supply shortages I am talking about are not merely theoretical.
In fact, lithium demand began outstripping supply as early as 2015. This is not surprising since, after being used in small amounts to produce consumer electronics like iPhones, Lucid, Tesla and other companies like GM and Ford are now building massive lithium-ion batteries for cars. While an iPhone has a 7.04 watt-hour battery, a Tesla has more like a 70 kWh battery – one Tesla can power 10,000 iPhones.
With the whole world selling 1.5 billion smartphones per year, some with smaller batteries than iPhone, it only takes 150,000 EV cars to equal the size of the whole smartphone industry. Tesla alone crossed that threshold – a year later than expected – in 2018. It fell just short of a million last year and should break well above it this year.
Now Lucid wants in on the game. And so does Rivian, and all the traditional automakers. For an industry where the road to expanding a crucial resource supply is so questionable, it’s starting to get a little crowded in here.
The Bull Case For LCID
To be sure, Lucid bulls are likely not unaware of these issues, they probably merely think they are surmountable. The idea is that if Lucid can procure lithium for anything less than its break-even price, it can still make profit. And the whole point of selling luxury EV vehicles is that it tends to produce rather high break-evens. So long as break-even is above the market price, there is profit to be made.
But this is only relevant if Lucid can reasonably hope to outbid others for the lithium. To return to my analogy one last time, imagine a world where Lucid, Rivian and everyone else suddenly can value lithium/copper at $15 instead of $10, while it still only costs $3 to produce. There are still 101 buyers and 100 sellers. So what happens? The price moves up to $15 right along with EV producers’ willingness to pay.
So saying that Lucid can always just charge more and raise its break-even sort of misses the point. Supposedly it’s all about getting break-even above the market price. But if Lucid, Tesla and the others are the marginal buyer of lithium, then Lucid’s break-even price is the market price, and if it moves tomorrow the market price will move with it.
Outside-The-Box Supply Approaches
The primary way around this problem that would let Lucid and the rest keep profiting is if somehow lithium supply could be drastically expanded, beyond all the ways producers are already planning to drastically expand it. One possible source is the H2O in our oceans, where lithium is suspended in ionic form. Researchers think it may be possible to cost-effectively extract those ions, much as they already extract all sorts of other contaminants from the water we drink. However, this is merely theoretical at this stage.
I am not yet willing to hang my hat on this or any other proposed alternative lithium supply. It seems very likely to me that whatever the lithium supply is, the demand will be considerably higher, with EVs probably behind other buyers in the bidding.
Conclusion
This was, as I said at the open, a deliberately bird’s eye approach. I am not trying to describe in detail the comparisons between Lucid and all the other EV producers it will be bidding against, and I don’t really think Lucid will ever wake up and find that it literally can’t acquire lithium. Such drastic shortages, however, are not necessary to effectively flip the balance of power from resource-buyer to resource-seller, and that does seem increasingly likely to me as both the chase for EV market share and the drastic need for what are increasingly regarded as life-saving home batteries continue to grow.
Market structure, as well as market prices, is I submit a necessary component of stock analysis. My argument here is simply that the structure of the EV market is changing, and not in a way to benefit EV producers. While I know that this analysis lacks some of the detailed examination of pre-orders, market share, and technology differences that I agree are very important, I hope investors still find it useful.
Investment Summary
I am a very cautious Hold on Lucid, and will be avoiding it for the foreseeable future.
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