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Capital capacity vs Capital requirement: the misunderstanding that threatens the viability of the EV event

Avatar photo   By: Matt Fernley

Posted on - 23 Sep 2022

This article is based on research presented in the August issue of Battery Materials Review and in my presentation to the Fastmarkets European Battery Raw Materials Conference in Barcelona (and thanks to Fastmarkets for the invitation to present!).

I don’t normally publish the full analysis from a feature article in Battery Materials Review in the public forum, preferring to keep our insights for our paying subscribers but, in this instance, I believe that the topic is vital to digging the EV transition out of the hole it’s currently in, so I am publishing it.

What is capital capacity?

Capital capacity is a term that we’ve coined to explain the ultimate amount of capital that an industry segment should be able to access. Capital capacity for an industry is basically the sum of the capacities of the companies in that industry.

For an individual company, we’re realistically primarily talking about debt and equity funding (with a focus on equity), but there are other funding sources including royalties/streams, government grants, earn-ins and offtake prepayments and a plethora of new funding instruments starting to come to the market.

We track (and publish data on) capital raised for key battery raw materials segments, midstream, cell manufacturing and EV manufacturing on a monthly basis in Battery Materials Review. But we also track the origin of those funds.

And you can see from the chart above that equity funding has been the primary source of capital in the battery raw materials industry over the past four years and so it remains in 2022, even considering the current volatility of equity markets.

While debt funding is a more common form of funding for producing operations in manufacturing and, indeed, in raw material extraction, it’s often a risky instrument for development projects, and even more so in battery raw materials. In basic terms debt is risky for development projects because of the potential for development timeline overruns and hence cost-overruns. A substantial proportion of failures in raw material projects come about because companies run out of money in the construction phase. In battery materials it is even more fraught because of the complexity of the industry. There have already been a number of failures in development battery raw material projects that have been caused by taking on too high a debt load.

So industry best practice for development projects is not to over-leverage.

A listed company can likely access development capital in the form of equity and debt to a level of 80-90% of its market capitalisation. Companies will not want to access more than 50% of their capitalisation as equity otherwise existing shareholders will be diluted too much, and they will (as best practice) not want to borrow more than 50% of their market value as debt.

So, when we estimate the capital capacity of a listed company, we’re effectively talking about its market value (ie equity capacity + debt capacity + other funding sources).

But not all companies are listed, and for unlisted companies in production we assume a capital capacity in line with the value of their revenues (most companies in this sector would be valued at c.1x EV/Sales (it can be a higher multiple for downstream segments like cells and EV manufacturing). For development companies we make an assumption on valuation.

Once we have established the capital capacity of individual companies we then calculate capital capacity for an industry segment by adding the capital capacity for all the individual companies together.

Capital requirement

The capital requirement for the EV event is also easy to calculate. It’s simply the eventual capacity of EVs, cells, battery raw materials needed, multiplied by the cost of that capacity.

We’ve done our own work on calculating the cost of new capacity because we believe most of the work in the market at the moment substantially understates the cost of new assets:

For instance a cell factory in Europe costs nearly three times more in US$/kWh than a comparable factory in China.

A lot of work on battery raw materials blends Brownfield and Greenfield development costs. While there are Brownfield expansions, the bulk of new supply will come from Greenfield.

Most work on battery raw materials only considers construction capex and doesn’t include any allocation for funds spent on exploration and evaluation, and also doesn’t consider funds raised for exploration projects that don’t make it to construction.

Similarly most analysis doesn’t factor in requirements for R&D in the EV segment and in the cell manufacturing segment.

Most industry analysis doesn’t factor in the likely impact of inflation on capital costs.

What to expect in a healthy industry?

In a healthy industry, the capital capacity should more than exceed the capital requirement. And, indeed, we can find the very definition of a healthy industry in cell manufacturing and EV manufacturing.

As can be seen from the adjacent chart, capital capacity in the EV and cell manufacturing sectors is multiples of the capital requirement for the next 10 years’ worth of development.

But there is a problem

But something’s not right in the battery supply chain, and to explain what’s not right I’d like to reference a chart that I publish every quarter in Battery Materials Review. This tracks the amount of capital raised or allocated for each segment of the supply chain and you can clearly see that there’s a huge disparity between the segments.

Now, if we refer to the chart earlier (number 3) we know that the capital requirement for EVs is two and a half times more than for cell manufacturing, and that’s backed up by this chart.

In fact, our quarterly data for cells and EVs focuses more on ex-China capital raised than on Chinese capital, so it makes sense that there would be more ex-China capital raising for cells since currently we are developing an ex-China industry for that, when we’ve seen the bulk of investment in China up to now.

So it’s not a surprise to see cell manufacturing in the Western World punching above its weight.

What is a surprise is that raw materials capital raising is substantially underperforming the Downstream part of the industry. Over the past four years the ex-China EV industry has raised capital at over seven times the rate of the raw materials industry, and the cell manufacturing industry at nearly four times.

That is a big problem.

Because if you look at the capital requirement chart, more money needs to be raised for battery materials than for cell manufacturing and battery materials should be raising funds at a rate of about 70% of what the EV sector is raising, not 14%!

And there’s another problem; time. Because, on average, it takes 1-3 years to build a cell or EV manufacturing plant. But it can take between five and ten years to build a new mine.

So not only are we seeing a massive structural capital shortage in the battery raw materials space, we’re also building in a time lag.

So, why is this happening?

It all comes down to the capital capacity of the raw materials segment.

A capital-constrained industry: Mining

As we discussed earlier, in a healthy industry the capital capacity of the industry should more than exceed the capital requirement for expansions. Contrast the chart I posted earlier for cell and EV manufacturing with the chart below that looks at capital capacity vs requirements for battery raw materials.

In this chart you can clearly see that only in Lithium does capital capacity (just) exceed requirement, while in nickel and graphite it’s materially lower. I didn’t plot high purity manganese on this chart but rest assured the comparison is even more striking in that, and the relationship also holds true for cathode materials.

We have a problem here insofar as battery raw materials are relatively small sectors, which means there are no majors or supermajors. There just isn’t enough capital within the battery raw materials industry to finance the huge developments that are needed. Capital needs to come into mining from outside the industry.

Even more worrying on a regional basis

In the chart above, you can see that I’ve split capital capacity between China and Ex-China. This is because of the identified need for Europe and the US to develop more regionalised supply chains away from China.

And you can also see that if you back out China’s capital capacity then there is a real problem, because the available capital capacity is well below what will be required.

At the Fastmarkets conference I introduced a further analysis for the European battery raw materials supply chain. And it doesn’t look good. Europe doesn’t really have a domestic battery raw materials sector of its own, and that comes out very clearly in the below chart.

When we extend the analysis to the US supply chain we see a similar (though not quite as serious) phenomenon. The US was a slower starter in terms of developing its EV supply chain but has also been much more realistic than Europe about its potential raw materials supply chain, insofar as it has opened the door to allied countries such as Canada and Australia to be “compliant suppliers” of raw materials.

Nevertheless there is still a problem of capital capacity in all materials except lithium. And, even within lithium, perhaps 70% of the additional capital capacity in compliant jurisdictions is in Australia and is already locked into offtake contracts with non-US destinations (which is, to some extent, also true of nickel as well).

ESG investing trends a real concern

I just want to make a comment on the impact of ESG investors here. It’s noticeable that in this cycle considerably less funding has been available to the mining industry from generalist investors than in previous cycles. The trend of ESG investing is almost wholly responsible for this.

Now, I’ve discussed my concerns regarding the impact of ESG investment trends on the sector before so I won’t regurgitate that here, but in my view currently certain ESG investors and proponents are the biggest danger to the Energy Transition.

That’s not because ESG is a bad thing. I believe ESG is very important for the industry. But it’s because ESG investors tend to take a very black and white approach to primary extraction industries. In plain English that means that many ESG investors will not touch mining with a barge pole!

And here’s the problem. There can be no Energy Transition without considerable investment in primary extraction. Recycling won’t cut it. There’s not enough material in existence that’s available to be recycled. I’m not just talking battery materials here, but also REEs for motors and wind turbines, copper and steel for Renewables infrastructure, silicon, the list goes on.

Funding for mining has to come in from outside the industry and current trends and thinking in the ESG space are preventing many investors from doing that.

Impacts of under-investment in raw materials supply

Under-investment in raw materials supply effectively means that there will be a massive structural gap between supply and demand. In basic terms that means that prices for raw materials will remain at elevated levels for an extended period. Lithium prices have already gone up (by eight times). They could go up further, in my view. Nickel prices have gone up, but have come down a bit in recent months because of the macro economic situation. Nickel production is power-intensive. Nickel prices are likely to go up from current levels, in my view. I believe that graphite will certainly go up from here. As will cobalt, phosphate and other key materials for the battery supply chain.

EV’s look like they’ve taken off. There’s critical mass in EV demand and we’re forecasting 26m EV sales by 2025E on a materials-constrained basis. Our unconstrained EV sales forecast for 2025E (based on there being enough battery raw materials supply to satisfy demand) is 38m units. So, straight away, EV and cell manufacturers are leaving a huge amount of units on the table because of the underinvestment in raw materials supply.

But its’ worse than that. If we calculate the impact of the difference between battery raw materials prices in 2020 and 2025E, we find that the autos/cell industry will be spending c.US$200bn per year extra due to higher raw materials prices in 2025E.

Between the impact of running at lower capacity utilisations on their manufacturing facilities because there’s not enough raw materials, and the extra costs, the underinvestment in raw material supply is going to be very painful for the auto industry.

How do we solve this issue?

But, as I discussed earlier, the capital capacity of the autos and cell industry is materially higher than their requirement. We hear all the time from autos CEOs that the mining industry needs to spend more money on supply. But the problem is that it cannot.

The solution then is obvious. The autos industry must make capital available to mining development projects. It doesn’t need to acquire them – we hear auto CEOs who say that they have no experience in mining. We understand that, but the downstream industry as a whole must make funding available to the upstream.

This has been obvious to many of us in the extractive industries for some time (years). When we’ve tried to talk about it before, the autos industry has refused to engage. We’ve seen some limited engagement in the past 12-18 months. We’ve even seen three (yes, you read that right – three!) direct investments by OEMs in development projects this year. But it’s not enough.

It’s a drop in the ocean.

The solutions to this situation are very clear, in my view:

We need investment into raw material exploration and development projects from outside the industry. It makes the most sense for the bulk of that to be from the autos industry.

We need a change of strategy from the ESG investment community to embrace environmentally and socially responsible, and well governed, mining development projects and not keep bagging them.

We need governments to take part as well. Planning regulations must be streamlined to ensure that development of mining projects in the US and the EU is possible. Currently it’s horrifically difficult to build mining projects in these regions.

Only if all three of these things come to pass can we get out of this situation. The consequences of not doing so will be huge. The success of the EV event itself, and with it the Energy Transition, is on the line.

Matt Fernley is Head of Research for Westbeck Capital’s Volta Energy Transition Fund and Editor of Battery Materials Review.


Batteries Capex Capital Capacity Capital Requirement Cathode China Cobalt Debt Energy Transition Equity Europe EVs Graphite Investment Lithium Manganese Nickel REE Risks US