SQM’s Low-Cost Lithium Should Remain Profitable as EV Adoption Rises Despite Volatile Prices

Strategist

Seth Goldstein

Through its access to high-quality mineral deposits, Sociedad Quimica y Minera de Chile is a large, low-cost producer of lithium, iodine, and nitrates used in specialty fertilizers. SQM’s crown jewels are its geologically advantaged lithium and caliche ore assets. SQM’s low-cost lithium deposit in the Salar de Atacama boasts the highest concentration of lithium globally and benefits from high evaporation rates in the Chilean desert. As electric vehicle penetration increases, we expect high-double-digit annual growth for global lithium demand, one of the best growth profiles among commodities.

SQM is a top three lithium producer globally. The company is in the midst of expanding its Chilean lithium carbonate production capacity to at least 300,000 metric tons from 70,000 in 2019. However, beginning in 2025, SQM will transfer its Chilean lithium production resources to a joint venture with the state-owned Codelco, where SQM will have just under a 50% equity stake, effectively giving SQM 150,000 metric tons of capacity once the expansions are complete.

SQM is constructing the Mount Holland lithium project in Australia through a joint venture with Wesfarmers, which will be a fully integrated spodumene-based lithium hydroxide producer. We expect the project to enter production in the mid-2020s. Unit costs should sit on the lower half of the lithium hydroxide cost curve. The company also plans to acquire Azure Minerals in a joint venture bid with Hancock Prospecting. Azure is developing a lithium resource in Australia. Azure's resource is at roughly the same stage as Mount Holland when SQM bought into the project. SQM already has a 19.99% equity ownership stake in Azure.

SQM is also a market leader in potassium nitrate, a specialty fertilizer used in high-value crops, including fruits and vegetables, and is also a small player in commodity potash. Specialty potash demand should benefit from the shift in emerging-market diets to higher-value foods.

SQM is also the world's largest producer of iodine, used in X-ray contrast media, pharmaceuticals, and LCD films. Iodine demand should grow in the coming years as healthcare spending rises with aging populations.

Business Strategy & Outlook

We award SQM a narrow economic moat rating based on its cost advantage in the production of lithium, iodine, and specialty fertilizers, stemming from its salt brine and caliche ore assets in northern Chile. The salt brines in the Salar de Atacama are the lowest-cost source of lithium globally because of the high concentrations of lithium. Likewise, caliche ore is one of world’s largest and lowest-cost sources of nitrates and iodine.

Globally, lithium carbonate is produced from either lower-cost evaporation of brine or higher-cost mining of spodumene minerals. SQM has a cost advantage in lithium carbonate production due to its lucrative brine assets in the Salar de Atacama in Chile, which produce lithium at the lowest cost globally excluding royalties.

Two factors make the Salar de Atacama the lowest-cost source of lithium in the world: dry conditions and high lithium concentration. The Salar de Atacama is one of the driest places in the world and the largest salt flat in Chile. It has an extremely high evaporation rate and low rainfall. Snow from the Andes Mountains melts and flows underground into pools of brine, which have the highest concentration of lithium globally. This high concentration makes the company one of the lowest-cost lithium producers even among brine-based producers. The company pumps the brine above ground into a network of large evaporation ponds. Water evaporates from the ponds over the course of approximately 18 months, leaving behind concentrated lithium brine, which is then processed into lithium derivatives, including lithium carbonate and lithium hydroxide for batteries. SQM has a long-term contract through 2030 with the Chilean government to extract 414,369 metric tons of lithium, or roughly 2.2 million metric tons of lithium carbonate equivalent. Additionally, SQM’s joint venture operation in Australia will become a low-cost lithium hydroxide operation when the spodumene mine and accompanying lithium hydroxide conversion plant fully ramp up by the mid-2020s.

On a cash-cost basis, SQM's lithium carbonate produced from the Salar de Atacama is the lowest in the world. However, the government of Chile also implements one of the highest royalties globally, in a progressive scheme that, at the highest bracket, sets a 40% rate on prices over $10,000 per metric ton. At $20,000, which is our current view of the marginal cost of production, this amounts to a 27% royalty rate. Due to the royalty expense, neither SQM nor Albemarle, which also operates at the Salar de Atacama, are the lowest-cost producer if lithium prices are at $20,000 per metric ton or higher. However, for a cost advantage moat source, we look at an operation’s ability to generate an excess return on invested capital when prices are at the bottom of a cycle. When lithium prices are below $14,000 per metric ton, the royalty is greatly reduced, and the geological advantage puts the Salar de Atacama, both SQM and Albemarle, firmly at the bottom of the cost curve. As a result, we view Albemarle’s Chilean brine as having a durable cost advantage in place.

SQM’s caliche ore is the lowest-cost source of iodine globally due to its high concentration of iodine. Over half of the global supply of iodine comes from caliche ore in Chile, where SQM is the largest producer. Another major source of iodine supply comes from recycling of LCD screens, which is mostly done in Japan. High-cost sources of iodine come from extraction of underground brines as a byproduct of oil and gas production. 

SQM’s specialty fertilizer, potassium nitrate, is made by taking commodity potash produced as a lithium byproduct from the Salar de Atacama and low-cost nitrates that are produced as a byproduct from its caliche ore. The company's cost position in potash, which makes up the bulk of the remaining gross profit, is average—not as low-cost as Nutrien, for example, but considerably better than high-cost producers in Europe. Because of the high concentrations of potassium in the brines and nitrates in the company's caliche ore, SQM also holds a cost-advantaged position in specialty fertilizers. Altogether, we estimate that the vast majority of SQM's gross profits come from products that have a distinctive cost advantage—namely lithium, iodine, and specialty fertilizers.

All in all, we are confident SQM is likely to generate an excess return on invested capital for at least the next decade.

Narrow

Economic Moat

Sociedad Quimica Y Minera De Chile

Sociedad Quimica y Minera de Chile SA engages in the production and distribution of fertilizers, potassium nitrate, iodine, and lithium chemicals. It operates through the following segments: Specialty Plant Nutrients, Iodine and Derivatives, Lithium and Derivatives, Industrial Chemicals, Potassium, and Other Products and Services. The Specialty Plant Nutrients segment produces potassium nitrate, sodium nitrate, sodium potassium nitrate, and specialty blends. The Iodine and Derivatives segment manufactures iodine and iodine derivatives, which are used in a wide range of medical, pharmaceutical, agricultural, and industrial applications. The Lithium and Derivatives segment covers lithium carbonate for electrochemical materials for batteries, frits for the ceramic and enamel industries, heat-resistant glass, air conditioning chemicals, continuous casting powder for steel extrusion, primary aluminum smelting process, pharmaceuticals, and lithium derivatives. The Industrial Chemicals segment comprises industrial chemicals including sodium nitrate, potassium nitrate, and boric acid. The Potassium segment produces potassium chloride and potassium sulfate. The Other Products and Services segment deals with other fertilizers and blends. The company was founded on June 17, 1968 and is headquartered in Santiago, Chile.

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SQM navigates Lithium market challenges with strategic resilience and growth

SQM's Q1 performance reflected challenges in sales volumes offset by higher prices, with a positive outlook driven by recovering Lithium market conditions and strong EV sales.
The company's strengths lie in its proactive approach to capacity expansion, flexible pricing contracts, and sustainability efforts, positioning it well for future growth.
While facing challenges in project developments, negotiations, and market dynamics, SQM can leverage opportunities in EV market growth, new projects, and sustainability trends.
Overall, SQM's strategic focus on Lithium market dynamics, customer relationships, and sustainability bodes well for its resilience and growth potential in a competitive market.

SQM reports record Lithium sales and strong Iodine market performance

SQM's Q2 2023 earnings call highlighted exceptional performance in Lithium and Iodine businesses, with record sales volumes and high market prices. Despite facing challenges with project delays, the company remains well-positioned to benefit from the booming EV market and increasing lithium demand globally. Strategic partnerships and strong financial contributions underscore SQM's resilience and growth potential.

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