Advanced Energy TrendWatch – Q3 2017

Introduction

I devoted 75% of last quarter’s Advanced Energy TrendWatch report to companies in the electric vehicle (EV) supply chain. This quarter, I’m devoting 100% of the issue to them.

Until the crude oversupply situation is resolved, oil company shares are going to trade sideways. And the standoff between OPEC and U.S. producers won’t be changing anytime soon.

Frankly, there are far more interesting and profitable places to invest. As the EV market continues to disrupt the transportation sector, there are plenty of companies in the supply chain that have the potential to be 10- or 20-baggers.

And I’d like nothing more than for you to be able to participate in those kinds of gains. So let’s get started…

The Exploding EV Market

Longtime readers of my reports, please bear with me for a moment. For those of you who are new to my service, let me tell you a little about myself.

I have a degree in electrical engineering, and I spent my first 25 years after college in the semiconductor business. I was able to retire at 47 when my company’s stock went from $0.90 per share to more than $54 per share.

I spent several years in the telecommunications business, growing a small $8 million company to $14 million in two years. Then the owner decided his burger-flipping stepson could do my job (VP of engineering and service).

The company went bankrupt two years after I left. Payback can be sweet, although I felt bad for the 90 people who worked under me who lost their jobs because of a stupid mistake.

For the past 11 years, I’ve been the Energy and Infrastructure Strategist at The Oxford Club. I’ve managed my own investments for the last 43 years (I’m 64).

Having spent 25 years watching technology change nearly every investment sector, I’ve developed three laws describing how that happens…

Fessler’s Three Laws of Technology

1. Technology marches on.

Politicians and the media believe technological growth stops periodically. Engineers and scientists know it doesn’t.

And advances in technology are recession-proof. For example, during the Great Depression, we saw the inventions of traffic signals, frozen food, Band-Aids, aerosol cans, electric razors, Scotch tape, car radios, penicillin and jet engines.

2. When it comes to technology, changes happen much faster than anyone expects they will.

Just look at any 10-year forecast for solar energy adoption, EV sales or energy storage prices. Two years from now, they will all turn out to be conservative – by a lot.

3. New technology is almost always disruptive and transformative.

For example, where would you be without your mobile phone? Energy storage is shifting to a commercially viable market this year. And EVs are disrupting the transportation sector.

My longtime readers know I’ve been fascinated by EVs for nearly a decade. My wife and I have owned two of them over the last four years.

Our driving experiences with them have been hassle-free. While low to almost no maintenance is a big incentive for owning an EV, it’s certainly not the only one.

I calculated that my wife saves 1 1/2 days per year by not having to stop and put gas in her car.

With an EV, your “gas station” is hanging on the wall in your garage. You can easily program your EV to recharge while you sleep.

Some homes are equipped with dual-rate electric meters. If your home has one of them, you’ll pay even less to recharge in the evening when rates are lower.

For longer trips, the number of EV chargers available for public use continues to increase dramatically.

Low-Priced EVs: It’s All About Battery Cost

Most of the new EVs that are hitting dealer showrooms this year and next will come with batteries with a range of 250 to 300 miles. Batteries account for roughly one-third of the cost of the typical EV.

But those costs are dropping every year. Over the last six years, EV battery costs have fallen 80%. As a result, buying an EV is becoming less of a wallet breaker.

This year, Tesla will begin mass production of its long-awaited Model 3 sedan, the company’s most affordable car to date. Another inexpensive EV offering is the Chevrolet Bolt.

Government incentives at the federal and state levels, new models, and big investments in research and development by manufacturers are all fueling EV growth. But the biggest factor is lower prices thanks to cheaper batteries.

In 2016, worldwide plug-in vehicle sales totaled 773,600 units. That was a 42% jump over 2015 sales. But here’s the real statistic we need to pay attention to: Plug-in vehicle sales grew 20 times faster than the overall market.

Plug-in vehicle sales have more than tripled since 2013. As you can see from the graph below, the growth curve is starting to steepen…

Even though EVs make up just 0.86% of the world’s new car market, the EV sector is growing at a rapid pace. December 2016 was the highest month ever for EV sales, with 102,500 units sold.

In May 2017, global total sales for EVs reached 84,000 units. That was a 50% increase over May 2016’s sales.

China is growing like crazy, with May sales up 49% year over year.

That’s good news for the industry and even better news for us as investors.

So what’s the best way to invest in the EV market? Well, you could buy shares of Tesla (Nasdaq: TSLA). It’s the closest company to a pure EV play.

However, Tesla shares are expensive. And I’m interested in companies that still have a lot of room to run.

As I’ve done with other industries, I like to find what I call pick-and-shovel plays. These companies are further back in – or even at the beginning of – the supply chain.

Investing in a company that makes EV chargers would be a perfect pick-and-shovel play. However, there is really no pure play on a charging company that I like.

I’ve spent a lot of time studying the EV charging market. The problem is that most chargers are supplied with the vehicles and are made by the vehicle manufacturers.

The only remaining chargers are made by companies that have other businesses too. But the best way to play the coming EV boom is not by investing in charger manufacturers.

Every EV needs battery packs, and it seems every EV manufacturer has its own proprietary battery cell configuration.

But that doesn’t matter because the current battery chemistry for all EVs is lithium-ion.

Prior to its use in EVs, computers and cellphone batteries, lithium was relatively unknown.

Back in 1800, Brazilian naturalist José Bonifácio de Andrada e Silva was exploring Utö Island off the coast of Sweden. He discovered a whitish-gray mineral that’s now called petalite.

A couple of decades later in 1817, a Swedish chemist by the name of Johan August Arfwedson noticed that petalite contained an element that was unknown to the scientific community.

While he couldn’t completely isolate the element, Arfwedson named it lithium, which comes from the Greek word lithos, meaning “stone.” He later demonstrated that lithium was also present in two other minerals, lepidolite and spodumene.

Lithium wasn’t completely isolated until William Thomas Brande did so in 1821. Lithium production in commercial quantities started in Germany in 1923.

Its first major application was in high-temperature lithium grease for aircraft engines during World War II. Lithium grease has a much higher melting point than normal grease does.

Between the 1950s and the mid-1980s, the U.S. became the largest producer of lithium.

Nuclear fusion weapons produced during the Cold War dramatically increased the demand for lithium, as it was used as a form of fuel inside hydrogen bombs. Other uses for lithium included lowering the melting temperature of glass. This was the dominant use of lithium until the mid-1990s.

Once the development of lithium-ion batteries happened, the demand for lithium began to take off. By 2007, lithium-ion batteries had become the largest use of lithium.

As you can see from the chart below, the demand for lithium is starting to skyrocket. This is primarily due to the demand from EV manufacturers…

Here’s how lithium use breaks down, according to the U.S. Geological Survey…

• Batteries: 35%
• Ceramics and glass: 32%
• Lubricating grease: 9%
• Continuous casting mold flux powder: 5%
• Air treatment: 5%
• Polymer production: 4%
• Aluminum production: 1%
• All other uses: 9%.

Lithium hydroxide is one form of lithium used to produce the part of the battery called the cathode. Lithium carbonate is another.

But lithium isn’t the only element used in lithium-ion battery cells. Let’s take a closer look at the batteries in use in today’s EVs.

Current EV Battery Chemistry

With the ramp-up in EVs, lithium and cobalt, the other main battery component, have been thrust into the limelight.

There are currently 12 battery “gigafactories” in the works around the world. These are not unlike the one Elon Musk is building in Nevada for his Tesla cars and energy storage units.

And Tesla plans to produce 35 gigawatt-hours (GWh) of batteries by next year. That’s equal to the entire global production in 2013.

In 2015, battery demand increased 45% year over year. Those batteries accounted for 40% of the worldwide lithium demand.

But three years from now in 2020, lithium-ion EV batteries will consume 75% of the worldwide lithium demand. The chart below shows just how much growth is ahead for EV batteries…

Deutsche Bank projects that the compound annual growth rate of lithium demand from EV batteries will be 23%, at least through 2025. That’s a lot of lithium.

Musk says he believes 200 gigafactories will be needed to totally transition away from gasoline- and diesel-powered vehicles and toward all-electric ones.

Musk also believes that mass production will reduce the cost of EV batteries by more than 30%. So what’s inside the current EV lithium-ion battery? Let’s take a look…

Here’s the size of the battery in a Tesla battery pack. It is called an 18650 cell, named after its dimensions (18 millimeters in diameter by 65 millimeters high)…

Tesla’s P85D battery pack (85 kilowatt-hours) consists of 16 battery modules, each with 444 of the 18650 cells. That’s 7,104 cells.

Why does Tesla use such small cells? Because these cells have an extremely high energy density. They have been in use for years, and their charge/discharge characteristics are well-known.

In addition, these cells have no memory. That means they don’t need to be periodically discharged.

So what’s inside an 18650 cell? Each cell is a 2-ampere-hour battery. It contains lithium, graphite and one other element.

This element is even more scarce and costs far more than lithium does. I’m talking about cobalt…

As you can see, cobalt prices have soared over the last year. Since hitting a low on February 1, 2016, cobalt prices have increased 165%. Let’s look into cobalt a little more.

Lithium-Ion Batteries Should Be Renamed

Because of their name, the average person thinks lithium-ion batteries contain mostly lithium. They also believe that an increase in EVs is going to create a supply crunch for lithium.

Neither is a true statement.

Lithium-ion batteries contain about 2% lithium, and though worldwide demand has increased, cobalt is actually the metal that will be in short supply as early as 2018.

Most lithium-ion cells contain anywhere from 15% to 33.3% cobalt. The batteries really should be called cobalt-nickel batteries.

Each 18650 cell in a Tesla battery pack has three major parts. The anode is made from graphite. The second part of the battery is an electrolyte solution containing lithium salts.

The third part of the battery is the cathode. It contains a number of different chemicals, but most designs contain some cobalt, as you can see from the figure below…

Notice the Tesla cathodes contain anywhere from 15% to 33.3% cobalt. Apple iPhone cathodes comprise 100% cobalt.

Both lithium and cobalt are critical for EV battery production. The problem is that EVs are about to take off like wildfire – much faster than any of the industry analysts are predicting.

Why the Costs of These Elements Will Drive EV Battery Prices

Most of the world’s lithium is produced from brines that come from two of the countries that make up the “lithium triangle”: Argentina and Chile. Though Bolivia also has huge deposits of lithium, it is not currently developing them.

The world’s supply of cobalt is a completely different story. The main supplier has been the Democratic Republic of the Congo (DRC), which produces 65% of the world’s cobalt supply.

The problem is that the DRC has been accused of using child labor in its cobalt mines. As a result, many battery producers have shunned cobalt coming from DRC mines.

But the DRC is by far the largest cobalt producer, dwarfing production coming from other countries. Check out the graph below to see which countries are scrambling to get cobalt mines in operation to challenge the DRC’s dominance…

China is following the DRC as a dominant player in the cobalt market. It now has about 60% of refined cobalt production under its direct control.

China wants to grow its lithium battery production by six times by 2020, and it’s ramping up its megafactory production.

In 2016, the country produced 28 GWh of lithium-ion batteries. It wants to increase production to 174 GWh by 2020.

Goldman Sachs analysts believe the cobalt market could mushroom to $244 billion by 2025. They may be onto something.

Based on the increasing demand from EVs, cobalt demand is expected to rise exponentially. See the chart below from Bloomberg…

In 2016, the cobalt supply was about 100,000 metric tons. However, demand was rising, and it opened a 1,500-metric-ton deficit.

According to the CRU Group, that deficit could triple this year. By 2020, the cobalt supply deficit could reach 5,340 metric tons.

The good news is there are a number of undeveloped, viable cobalt deposits in other parts of the world that can come online relatively quickly. We already have one potential cobalt supplier in our portfolio: eCobalt Solutions Inc. (OTC: ECSIF).

But I’ve found two more that are equally as exciting. What’s more, I think all three companies are poised for huge gains, even though right now they are trading for pennies.

I’ve never been too interested in junior mining companies. But EVs are completely disrupting transportation, and that change is causing a ripple effect in the mining sector.

Investing in lithium and cobalt miners means we don’t have to worry about who succeeds in making good EVs and who doesn’t. The sure bet is pick-and-shovel plays that provide raw materials in the EV battery supply chain.

And cobalt miners are going to make a killing over the next five to 10 years. I believe the two companies we are adding in this quarter’s report are in excellent positions to capitalize on the upcoming cobalt shortage.

Let’s get to it.

Cobalt From Down Under

Most cobalt isn’t mined directly. It’s produced as a byproduct of copper and nickel mining.

Australia has about 15% of the known reserves of cobalt. That’s one of the big reasons we’re focusing on companies intent on developing Australia’s cobalt reserves.

Australia is a very mining-friendly country. Most of the areas where mining takes place are in the middle of nowhere. Let’s take a look at our first company…

Clean TeQ Holdings Limited (OTC: CTEQF) produces metals that are geared toward disruptive changes in the global energy and transport markets.

Its current focus is to develop the Syerston Project, which aims to produce cobalt directly, not as a byproduct.

The company has a proprietary ion-exchange extraction method in addition to its cobalt purification processing technology.

As a result, Clean TeQ believes it will be one of the largest low-cost cobalt suppliers for the EV battery market.

Chinese mining company Pengxin International Mining purchased a 16.2% stake in the company for AU$81 million. In addition, Robert Friedland, an American-Canadian financier, owns a 19.9% stake.

And if Friedland owns part of the company, you can bet Clean TeQ is onto something.

As the founder and executive chairman of Ivanhoe Mines Limited, Friedland is a major player in the junior mining industry. His net worth is a cool $1.18 billion.

But let’s get back to Clean TeQ’s Syerston Project. This deposit is in New South Wales, Australia, about 220 miles west of Sydney.

It contains one of the largest and highest-grade cobalt and nickel deposits ever found outside of Africa. The mine is development ready, with all of its permits in hand.

Even better, it contains the world’s largest and highest-grade scandium deposit. The near-surface deposit is well-delineated.

Clean TeQ has drilled more than 1,300 core holes to size and grade the resource. Because the deposit is close to the surface, the company can easily mine it via strip-mining techniques.

The 2016 preliminary feasibility study showed that the company can mine 2.5 million metric tons annually over the first half of the mine’s expected 40-year life span.

However, the scandium could have a much longer life span. The deposit has one of the best nickel-cobalt ratios at 6-to-1.

Other deposits in Australia have a much higher ratio of nickel to cobalt. The Murrin Murrin mine has a ratio of 15-to-1, and the Ravensthorpe mine has a ratio of 28-to-1.

At today’s cobalt prices, the anticipated output of cobalt alone would be approximately 55% of the mine’s total revenue.

Right now, Syerston’s pilot plant has already processed 20 metric tons of ore for customer sampling and testing. I believe Clean TeQ’s Syerston Project will be one of the top cobalt suppliers in 2018 and beyond.

There’s no question in my mind that Clean TeQ is going to be one of the top additions to our portfolio. And let’s face it, Friedland has a pretty good track record of picking winners.

Action to Take: Purchase shares of Clean TeQ Holdings Limited (OTC: CTEQF) using a limit order.* Our limit price is $0.56. Use a 50% trailing stop to protect your principal and your profits.

*Note: Please use a limit order and a limit price when purchasing shares of Clean TeQ. If you fail to do so, you could end up greatly overpaying for your shares and cutting into your ultimate profits. This is a junior miner, and shares can be very volatile.

We will be tracking the over-the-counter stock in the Advanced Energy Strategist portfolio, but the company also trades on the Australian Securities Exchange as Clean TeQ Holdings Limited (ASX: CLQ). If you choose to buy shares on the ASX, please use a limit price of AU$0.70.

Another Miner From Down Under

Clean TeQ isn’t the only Australian mining company with cobalt assets. Ardea Resources Limited (OTC: ARRRF) is another one.

Right now, it’s sitting on the Kalgoorlie Nickel Project (KNP). It contains Australia’s largest cobalt resource, as you can see from the chart below…

Ardea is a newly listed company, having issued 67 million shares on the Australian stock market on February 9, 2017. Shares were initially priced at $0.20.

But those shares are already at $0.59. That’s a 195% increase in a little less than five months.

But there are plenty of gains ahead for Ardea. The KNP Project contains 386,000 metric tons of cobalt and 5.6 million metric tons of nickel.

Similar to Clean TeQ, the KNP has active granted mining leases and all the required infrastructure. More than 9,000 holes comprising 400,000 meters of detailed drilling have delineated the resource.

Just like Syerston, KNP is a near-surface deposit that will allow open-pit mining. The material will allow for easy digging.

As with Clean TeQ, things are proceeding fast with Ardea’s KNP Project. By July, a new resource estimate should be available based on earlier drilling.

Between now and January 2018, the prefeasibility study will be put together. Once that’s complete, Ardea will seek a major funding partner to move forward.

Ardea is about 16 months behind Clean TeQ in terms of its project timeline. However, given the upcoming shortage in cobalt supply, I believe Ardea will be able to sell all the cobalt it can produce… and at a very favorable price.

Unlike Clean TeQ, Ardea is not a one-trick pony. The company is also exploring zinc, silver, gold, platinum, nickel and chrysoprase.

Ardea is another potential cobalt supplier. With a resource estimate that is three times the size of Clean TeQ’s, Ardea is another cobalt miner we want in our portfolio.

Action to Take: Purchase shares of Ardea Resources Limited (OTC: ARRRF) using a limit order. Our limit price is $0.45. Use a 50% trailing stop to protect your principal and your profits.

Again, please remember to use a limit order and limit price.

We will be tracking the over-the-counter stock in the Advanced Energy Strategist portfolio, but the company also trades on the Australian Stock Exchange as Ardea Resources Limited (ASX: ARL). If you choose to buy shares on the ASX, please use a limit price of AU$0.60.

Well, that’s it for this quarter’s report. I hope you find these two companies as compelling of an investment as I do. I will be keeping tabs on them in my regular Advanced Energy Weekly updates.

Good investing,

David Fessler