It’s All Relative: RV Trading in Battery Metals Markets

Cobalt metal and cobalt hydroxide are intrinsically linked in the battery supply chain. Cobalt hydroxide, an intermediate product, is typically converted into cobalt sulfate for use in lithium-ion batteries or cobalt metal. As such, the price for cobalt hydroxide is often quoted as a percentage (payable) of the cobalt metal price, with the difference between cobalt metal and cobalt hydroxide representing the conversion costs. The economics of the spread between Cobalt Metal futures and Cobalt Hydroxide futures is shaped by several factors. Refining costs play a significant role, as the conversion of cobalt hydroxide into cobalt metal requires energy, reagents, labor and waste management, higher refining costs would typically be expected to widen the spread. Logistics considerations also influence the spread, as cobalt hydroxide is quoted as an import price into China while cobalt metal is priced on an ex-warehouse Rotterdam basis. Supply issues impacting the DRC, or the transport of the commodity to China, may influence the futures contracts differently. Market imbalances, such as a surplus of hydroxide or constrained refining capacity, can also temporarily distort the spread, creating trading opportunities.

Relative value trading strategies for cobalt metal and cobalt hydroxide revolve around these dynamics. Refiners can hedge their margins by taking offsetting positions in Cobalt Hydroxide futures and Cobalt Metal futures, ensuring that changes in refining costs do not erode profitability. Speculators can capitalize on anticipated changes in the spread, such as a narrowing due to increased hydroxide demand to support higher-than-expected EV adoption. Furthermore, integrated producers may engage in arbitrage when futures spreads deviate significantly from real-world refining margins, exploiting temporary discrepancies between financial and physical markets.

A market participant believes that logistics disruptions in African transit countries will limit the export of cobalt hydroxide from the DRC to China. At the same time, she is not bullish on the cobalt price, as the end-user market remains tepid. By going long cobalt hydroxide and shorting cobalt metal, the trader is speculating on a higher relative hydroxide price, a narrowing of the spread. Her spread position means she has only limited outright cobalt price risk.

Lithium hydroxide and lithium carbonate are two key lithium chemicals used in battery production, each serving distinct applications. Lithium carbonate is primarily used in lithium iron phosphate (LFP) batteries, while lithium hydroxide is preferred for nickel-rich chemistries such as NCM and NCA (nickel cobalt manganese and nickel cobalt aluminum). LFP batteries were historically favored for energy storage applications due to their lower cost while nickel-rich chemistries were used in electric vehicles that required high-performance batteries. Over the past years, advances in LFP technology have somewhat blurred these lines, with LFP batteries now also used in top-of-range electric vehicles. The availability of futures contracts for both carbonate and hydroxide allow market participants to trade on their relative value.

The spread between Lithium Hydroxide futures and Lithium Carbonate futures reflects the underlying economics of their production and demand. Conversion costs are a primary factor, as producing lithium hydroxide from lithium carbonate involves additional processing steps, resulting in a historical price premium for hydroxide. End-market demand also shapes the spread; shifts in battery chemistry preferences, such as greater adoption of nickel-rich cathodes, can increase hydroxide demand relative to carbonate, or vice versa. In fact, over the past year, the hydroxide-carbonate spread has turned negative. Market watchers believe that weak Chinese demand for NCM batteries has been the primary driver behind this price move. In response, producers can switch their production capacity from hydroxide to carbonate. While imperfect, the substitution potential between the two chemicals, where producers opt for one over the other based on prices and conversion availability, should be expected to keep the two products relatively close to each other.

Market participants can leverage these dynamics in several ways. Battery manufacturers and producers can hedge their exposure to fluctuations in the relative prices of hydroxide and carbonate. Speculators can anticipate shifts in demand for either chemical based on technological developments or policy changes. Additionally, producers with the capability to convert between the two chemicals can exploit discrepancies between futures prices and physical conversion costs, engaging in arbitrage as the futures spread between the two products moves back towards fair value.

A market participant believes that demand for LFP batteries will displace NCM units. While she acknowledges the potential for additional conversion capacity to accommodate that extra carbonate demand, she believes that the market is underestimating how long it will take for capacity to come online. Therefore, she takes a long position in Lithium Carbonate futures and a short position in Lithium Hydroxide futures.

The spread between spodumene and battery grade lithium products stands for the broader economics of lithium processing, with the spread between the raw input good (spodumene) and the battery grade chemical price representing conversion and refining costs. Reflecting this close relationship, some spodumene is priced based on the lithium chemical price, just like cobalt hydroxide is sometimes quoted as a percent of the finished cobalt metal. Further to that, it’s important to also consider that spodumene is not the only feedstock for lithium production. Brine from the South American lithium triangle accounts for more than half of global lithium feedstock.

Converters can hedge against adverse price movements in of lithium chemicals relative to spodumene, managing cost uncertainty. Speculators may profit from shifts in the spread caused by changes in the relative supply/demand balance, considering local supply factors (spodumene is priced CIF China with the vast majority of spodumene supply coming from Western Australia), inventory levels for feedstock and finished chemical, and market sentiment.

The spread between lithium carbonate and spodumene is currently narrow, with relatively high spodumene prices. The trader believes that this is foretelling higher than expected demand for electric vehicles, and that lithium chemical prices do not yet fully reflect this demand. The trader goes long Lithium Hydroxide futures and short Spodumene futures.

Source: Fastmarkets. Analysis based on weekly spot market datapoints going back to January 2019.

Relative value trading offers a compelling lens through which to navigate the nascent yet rapidly evolving battery metal markets. The spreads between cobalt metal and hydroxide, lithium hydroxide and carbonate, and lithium chemicals versus spodumene encapsulate a complex interplay of refining costs, logistics, supply-demand imbalances and local vs. global price drivers.

As liquidity in these markets deepens, relative value strategies may become more attractive, creating opportunities not just for traditional market participants but also for financial investors seeking exposure to the energy transition. The foundation and narrative for relative value trading in battery metals is firmly in place, offering a unique avenue to capitalize on trading opportunities in this emerging asset class.