Metals Commentary: China's electric vehicle slowdown could dampen cobalt prices

China's electric vehicle (EV) sales have declined year-over-year for the second straight month, on the heels of uncharacteristically slow growth this spring, indicating that contractions in cobalt supply may be partly offset by lower-than-anticipated battery demand.

China announced in March that it planned to end a key subsidy for smaller EVs with a driving range below 250 km, and to halve the subsidy for longer-range vehicles. The policy update sparked a burst in new energy vehicle (NEV) spending, as consumers rushed to take advantage of the subsidies before the June 26 deadline. Sales jumped 85% year-over-year in March, according to the China Automobile Association of Manufacturers.

However, the growth slowed in April, and again in May to just 1.8% growth year-over-year. Sales dipped below 2018 levels in July, after the subsidy cuts, and in late September, the Association reported a 15.8% decline year-over-year in August NEV sales.

This trend could impact cobalt demand and pricing. Batteries - particularly in EVs - account for more than half of global cobalt consumption, and China is the biggest player.

In 2018, the global EV fleet topped 5.1 million, according to the International Energy Agency (IEA)'s "Global EV Outlook 2019" report. China accounted for almost half of that number and dominated the light-commercial and medium-truck EV markets. The country has more than doubled its annual NEV sales in each of the past three years, and was responsible for 80% of world electricity demands for EVs in 2018.

China seems here to stay as a power player in the EV global market, as the country is widely expected to provide the single biggest share of EV growth between now and 2025. The IEA's conservative forecast of over 11 million in annual EV sales by 2025 anticipates that at least half of those sales will happen in China (compared to 1.1 million sold in China in 2018). Similarly, Bloomberg New Energy Finance expects China will account for 48% of the global passenger EV sales market in 2025, according to its "Electric Vehicle Outlook 2019."

The country would need to increase annual sales to at least five times 2018 levels to meet 2025 expectations, but its recent year-over-year declines are moving the numbers in the wrong direction.

China's subsidy changes were not entirely unexpected, and were not guaranteed to temper the rapid sales growth China has posted in recent years. Fitch Ratings said in an April 2019 note that it expected China's NEV market demand would find support in 2019, after the subsidy changes, by "increasingly attractive product offerings, as well as wider commercial use of passenger EVs," and a three-month transition period in which local subsidies remained in place before being phased out. After all, China has other policies in place to encourage adoption of NEVs.

Cobalt briquettes at Cobalt 27 Capital's Rotterdam warehouse.?EUR,Credit: Cobalt 27 Capital.

However, China's NEV market has begun to look less like the limitless boom of recent years, and more like its internal combustion engine (ICE) sector, where sales have declined steadily since mid-2018. The slumping ICE market - which had not posted a decline in sales in decades before 2018 - has been suffering under incentives for NEVs, as well as the broader economic impacts of the tariff battle between China and the United States.

Ironically, the decline in ICE sales could indirectly lessen incentives for NEV adoption in China. The slashed subsidies were just one mechanism of support for NEV growth in China. The most important NEV policy today, according to Bloomberg NEF, is China's NEV credit policy.

This policy requires that each auto retailer have NEV credits worth 10% of its ICE sales (12% next year), which it earns by producing NEVs or by purchasing credits, largely from pure-play, EV makers. As ICE sales decline, the credit requirements also lessen, reducing the number of credits carmakers buy from domestic NEV firms.

All these factors could result in higher prices and lower NEV production. Already, the declines in NEV production have outpaced the decline in sales, according to the China Automobile Association of Manufacturers.

There are still incentive programs within China - and the NEV Credit Policy is stringent at any level - but if the decline in NEV sales year-over-year continues in the coming months, China will be left with a lot of ground to make up from its 1.1 million in 2018 NEV sales to the more than 5 million in annual sales anticipated in 2025 forecasts.

A slowdown in the biggest cobalt consumer's EV market could mean that the sector's anticipated cobalt demands of 170,000 tonnes in 2030 - or more than 250,000 tonnes, under ambitious forecasts from the IEA and World Economic Forum - might not materialize as quickly as predicted in the near-term.

Demand is further reduced by China's preference for NCM811, and similar batteries. (NCM811 stands for nickel-cobalt-manganese at a ratio of 8:1:1, which includes more nickel and less cobalt than traditional batteries.) Despite being the most expensive input for batteries, cobalt is proving frustratingly difficult for battery makers to replace, given its power by volume and fire-prevention capabilities. So, while it continues as a necessary input for batteries for the future, companies and scientists are working feverishly to minimize their reliance on cobalt.

Cobalt pricing on the London Metal Exchange (LME) seems to reflect these dampening influences on demand.

Cobalt fell from a high of US$95,000 per tonne in March 2018 to just US$25,000 per tonne at the end of July 2019, largely in anticipation of a 2019 cobalt surplus, due to new capacity coming online. However, Glencore's (LON: GLEN) suspension of its Mutanda mine and its ongoing issues at Katanga effectively eliminated the cobalt surplus for the next couple of years, and the price has barely rebounded.

The Anglo-Swiss miner and commodities trader decided to mothball its Mutanda mine in August after the Democratic Republic of the Congo (DRC) government opted to uphold the previous government's imposition of higher taxes and domestic ownership rules. The Mutanda mine produced 27,000 tonnes cobalt in 2018 (20% of the world's supply of the metal).

Glencore said in its half-year 2019 earnings report that while subsidiary Katanga posted higher production in 2019 year-over-year, it continues to stockpile most of its production on-site. Katanga is working on technical fixes to lower the high levels of uranium in the cobalt. It was able to sell just 1,200 of 6,200 tonnes produced in the first half of 2019.

These developments at Glencore's mines hold back the expected surplus for the next two years at least, some analysts say. The duration depends on DRC policies - as most of the world's cobalt lies under DRC land - and Glencore's ability to remove the uranium from its cobalt. It is unclear when new cobalt supply will become available.

An absent cobalt surplus could understandably raise prices on the LME. Instead, the weeks since Glencore's announcement have seen only a slight rebound in cobalt prices, climbing from US$25,000 per tonne in late July to US$36,000 per tonne by mid-September (slightly more on Fastmarkets).

It may be that market players expect DRC to back off its policies when faced with significant tax revenue losses due to Mutanda's suspension, or that they believe cobalt pricing can reach a level that makes Mutanda economically feasible, in spite of DRC policies. Whatever the case, a prolonged slowdown in China's NEV sales could dampen cobalt-price increases during the production stall.

And, whenever the supply-side issues are resolved, producers may find themselves without the cobalt-hungry EV market they were anticipating in China, which could keep cobalt prices well below 2018 - or even 2019 levels - for the next few years.