Allkem Limited (OTCPK:OROCF) Q2 2022 Results Conference Call February 27, 2022 7:30 PM ET
Martín Pérez de Solay – MD and CEO
Neil Kaplan – CFO
Christian Cortes – Chief Sales and Marketing Officer
Keith Muller – Business Leader, Australian Asset
Conference Call Participants
Rahul Anand – Morgan Stanley
Hayden Bairstow – Macquarie
Jack Gabb – Bank of America
Reg Spencer – Canaccord
Lachlan Shaw – UBS
Glyn Lawcock – Barrenjoey
Martín Pérez de Solay
Thank you, and welcome, everybody, for joining us to the Allkem Half Year Financial Results for the 2022 Financial Year.
Today, I will reflect back on the half year’s activities and operations and also provide commentary on our development assets and our growth pipeline. Also joining us today, we have CFO, Neil Kaplan, who will discuss our financial results; and Chief Sales and Marketing Officer, Christian Cortes.
Moving on to the summary slide on Slide 4. As you can see, we have delivered exceptional results across the multiple areas of the business since merging with Galaxy. It should be noted that the results presented today include those for the former Galaxy assets for the period 25 August to 31st December 2021. The merger was transformational for the company as it created an unparalleled development profile and positioned us to deliver high-quality products with the scale and flexibility required by our customers. It also comes at a time of tremendous growth for the lithium industry as the world transitions to a net zero carbon economy.
The merged entity entered the ASX/S&P 100 index during the period and achieved a record half year revenue of $192.3 million with strong prices for both spodumene and lithium carbonate. Cost management has been a major focus across the business. And despite material inflationary pressures, both Mt Cattlin and Olaroz have delivered significant operating margins with excellent operational performance. Most importantly, we achieved this because our teams across the group successfully and safely produced high-quality lithium products that continue to meet the requirements and specifications of our long-term customers. We also achieved significant advancements at all our development assets across the globe with both Olaroz Stage 2 and Naraha to commission this calendar year.
During the period, we achieved a gross profit margin of 62% across the business with a record result for both Mt Cattlin and Olaroz. The EBITDAIX margin across the business for the period was 51%. With 2 revenue-generating operations and $450 million cash on our balance sheet, we are in a strong financial position to further advance Sal de Vida and James Bay while exploring project finance opportunity for these tier 1 assets. Our strategic review of each asset and the business is advancing, and we have already made progress, which I will discuss throughout the presentation, including the development pathway for subsequent stages of Naraha, Olaroz, Sal de Vida and the James Bay project.
Moving on to Slide 5. We have steadily advanced our sustainability performance and transparency over the years. And during the half year, we were pleased to announce — we were pleased to publish our fifth sustainability report and retain our position in the Dow Jones Sustainability Indices Australia Index. Sustainability is a core driver of our business. And in the industry we work, our strategy focuses on 3 aspects: safe and sustainable operations, thriving communities and responsible products that promote the transition to a net zero carbon future.
We continue to operate within our COVID-19 Bio-Security Protocol to ensure we keep our people safe and our business operating. The half year period results in a rolling 12-month TRIFR of 3.6% for the group. We have rolled our group-wide health, safety and environmental standards for the merger, and we’ll continue to implement a number of initiatives across our sites. We have a designated Shared Value team that worked with our local communities to ensure regular communication and the creation of long-term benefits across areas such as education, health and local production. We also have a local hire and procurement philosophy.
We have now submitted our second Modern Slavery Statement to the Australian government and conducted training on human rights to employees across the company. We are also committed to the reduction of our global greenhouse emissions and the transition to our business to achieve a net zero across our scope 1 and scope 2 emissions by 2035.
Moving on to our operations and starting with Mt Cattlin in Western Australia. We concluded the calendar year with excellent results both operationally and financially. From the date of the merger, 25 August to 31 December 2022, Mt Cattlin generated approximately $115 million in revenue from the sale of 96,871 tonnes of spodumene concentrate averaging 5.7% lithium oxide, which was in line with customer requirements. In the same period, 71,500 tonnes of spodumene concentrate was produced, concluding the half year period with production of 120,156 dry metric tonnes.
Excellent operational performance was achieved due to favorable head grade and improved processing rates and recoveries. Front-end ore sorters also continued to make a positive contribution, treating material from low-grade ore stockpiles. As a result, the cash cost of production was only $335 per tonne over this period, beating previous guidance. Western Australia borders will reopen on March 3, and this will reduce the pressure on staff and material resourcing and improve cost management. We continue to experience very strong demand and pricing momentum for all our lithium products as supply side tightens, persists amid surging demand.
We will discuss further later in the presentation. In the second half of financial year ‘22, we expect to produce 80,000 to 90,000 dry metric tonnes as we return to life of mine average head grade, bringing the financial year ‘22 total production to 200,000 and 210,000 dry metric tonnes. We will also commence an exploration drilling program in March to take high-potential areas around current mineralization that may lead to an extension of the life of mine. Pricing for the March quarter is expected to be approximately $2,500 per tonne CIF for 6% lithium oxide and continues to improve as we move for the June quarter.
Moving to the next slide. At Olaroz, we continue to produce high-quality lithium chemicals in line with our targets and customer requirements. 6,466 tonnes of lithium carbonates were produced in the half year, which was 6% higher than the prior corresponding period. Of that, 54% production was battery grade compared to 29% in the prior corresponding period. Cash cost of goods sold is a key focus and remains highly competitive despite the higher proportion of battery grade production, higher labor and other costs arising from inflationary — inflation materially exceeding the peso devaluation and increased gas prices.
Sales volume of 5,915 tonnes was down by 24%, reflecting a decision in 2020 to reduce excess inventory at the time of significant market softness and uncertainty arising from COVID-19. Revenue of approximately $66 million reflects a 143% increase from the prior corresponding period, largely due to average FOB pricing increasing by 218% to $11,095 per tonne. Encouragingly, our realized pricing will increase by a further 125% in the June half of the year to $25,000 per tonne, delivering material operational cash flow. The Olaroz 2 expansion will deliver up to 25,000 tonnes of additional capacity and is well advanced with first production anticipated by the second half of this calendar year, subject to any COVID-related delays, bringing the Olaroz lithium facility to a capacity over 40,000 tonnes per annum.
By 31 December 2021, Stage 2 has reached 68% completion with 91% of pond construction activity completed and the soda ash and carbonation plants being 37% and 43% complete, respectively. We have 2 lime plants operational and a third one under construction, which will deliver significantly increased capacity as we pump more brine to feed the expanded pond system. Construction, commissioning and operation of assets associated with brine handling and concentrations — and concentration are progressing in line with expectations. Capital expenditure for Stage 2 at 31 December 2021 was $266 million, excluding VAT and working capital, from a total CapEx estimate of $365 million to $380 million, as updated in the December quarter results.
I will now hand over to Neil to discuss the financial results for the group.
Thanks, Martin, and a good morning and evening to all. First up is the consolidated group profit and loss. Please note that the result from the Galaxy assets is only recorded and consolidated from 25th August 2021, the date the merger occurred. Given the merged entity and substantially increased pricing for both lithium carbonate and spodumene, record revenues of USD 192 million were achieved with a record gross profit of $118 million and EBITDAIX of USD 98 million.
Mt Cattlin had revenue of $115 million from sales of 96,871 tonnes at an average selling price of $1,186 a tonne CIF, whilst Olaroz revenue was approximately $66 million from sales of 5,950 tonnes with an average lithium carbonate FOB price of $11,095 a tonne in first half FY ‘22 compared to $3,492 a tonne in the prior corresponding period, a 218% increase.
Cash cost of goods sold increased by 20% at Olaroz due to higher production of battery grade than the prior corresponding period, 54% versus 29%; higher labor and other costs arising from the devaluation of the Argentine peso of approximately 7% versus inflation of approximately 20%; and increased gas prices. A bridge of Olaroz’ and Mt Cattlin’s EBITDAIX from FY ‘21 to FY ‘22 can be seen in an upcoming slide.
[Audio Gap] increased to $18.5 million in first half FY ‘22 versus $11.1 million in first half FY ‘21, mainly due to inclusion of the Mt Cattlin operation. Amortization of customer contracts of $13.4 million arising on the purchase price allocation related to the merger, in line with underlying shipments, is shown separately in this P&L, whilst in the financial statements, it’s included in the depreciation and amortization number. This is a once-off charge.
Acquisition costs of $12.8 million and an inventory adjustment due to the purchase price allocation on merger are both one-off charges. Net finance costs of $9.9 million are lower, mainly due to reduced interest rates and the reduced Mizuho Stage 1 loan principal outstanding balance. Income taxes large — has been largely impacted by foreign currency movements and high inflation in Argentina. This resulted in a profit after tax of $13 million versus a $29 million loss in the prior corresponding period.
Moving on to the next slide. This slide details the movement in Olaroz and Mt Cattlin EBITDAIX, excluding corporate costs, from first half FY ‘21 to first half FY ‘22. As you can see, the main factors in this result were substantial increases in the sales price, strong management of costs despite the increased percentage of battery products sold, lower tonnes produced and inflation outrunning devaluation. These combined to deliver a record EBITDAIX from operations of USD 106.3 million.
Moving to the next slide. This slide details the movement of Mt Cattlin’s EBITDAIX, excluding corporate costs, from first half FY ‘21 to first half FY ‘22. As can be noted, it is mainly sales price and sales volume increases that have been the main drivers of the record EBITDAIX of operations — from operations of $71 million.
Moving to the next slide. This slide details the underlying net profit after tax. In moving from the statutory net profit after tax of $13 million on a 100% basis to an underlying record net profit after tax of $57.1 million, we have made the necessary [indiscernible] as detailed on the slide, which reflects a very strong business performance. One-off charges related to the merger and related purchase price allocation totaled $38.6 million, whilst the Argentine tax charge related to devaluation and high inflation was $23.8 million with offsetting charges related to the tax effect of the purchase price allocation of USD 7.7 million and $13.2 million related to income generated in the financial instruments market.
Moving to the next slide. Segment reporting is included in the statutory financial statements in Note 1. The key points to note are record revenues at both Mt Cattlin and Olaroz of $114.9 million and $65.6 million, respectively; record EBITDAIX at both Mt Cattlin and Olaroz of $71 million and $35.3 million, respectively; one-off pretax charges related to the merger of $38.6 million; a tax charge mainly related to ForEx movements and high inflation impacts in Argentina of $23.8 million; statutory net profit after tax was $13 million. However, the underlying net profit after tax was $57 million.
Moving to the next slide. This slide details the consolidated group balance sheet at 31 December 2021. The key points to note are a healthy cash position of USD 450 million, with cash increasing mainly due to the merger and strong operational cash flow. Various balance sheet items have increased due to the merger, with PP&E increasing by approximately USD 1.5 billion due to the purchase price allocation as well as $49 million related to Olaroz Stage 2 expansion spend. Goodwill of $530 million was recognized on the Galaxy merger attributable to deferred tax liabilities on valuation uplifts for James Bay and Sal de Vida.
The net deferred tax liability increase is mainly due to the Galaxy valuation and the effect of inflation and devaluation in Argentina.
Noncurrent loans and borrowings increased due to project finance for Stage 2, partially offset by Stage 1 project loan repayment. The [indiscernible] project finance loan has reduced from $191.9 million to approximately $57 million at 31 December and in less than 2 weeks, will have reduced approximately $48 million. The drawdown of the USD 180 million from Mizuho for the Stage 2 expansion was completed during the half with repayments to commence in September 2022.
Moving to the next slide. Cash generated from operations resulted in a positive $57.6 million mainly driven by higher average sales prices. In detailing some of the main movements, cash acquired on the business combination relates to cash acquired due to the merger of nearly USD 210 million. The purchase of property, plant and equipment mainly relates to Stage 2 expansion CapEx and Sal de Vida. $13.2 million relates to income generated in the financial instruments market.
Proceeds from borrowings is represented mainly by the final drawdown of project financing for Olaroz Stage 2 and loans from the SDJ outside shareholder, Toyota Tsusho Corporation. Cash and cash equivalents at 31 December were approximately $450 million with $133.2 million of guarantee funds related to Olaroz, Naraha and a Sales de Jujuy supplier.
In summary, a robust lithium market has resulted in record revenue, gross profit and EBITDAIX with costs kept under control and improved operational efficiencies. We have reduced Stage 1 Mizuho debt by approximately $144 million, following the next repayment in March 2022 and continue to generate material operating cash flow, leaving the company well positioned for 2022 and the future.
Thank you, and I will now pass you back to Martin.
Martín Pérez de Solay
Thank you, Neil. On Slide 17, construction activities at Naraha lithium hydroxide plant are mostly complete. This facility is the first in its kind in Japan and fits into our long-term strategy to provide not only scale but product flexibility to meet customer preferences and also market demand. Site training and precommissioning works have commenced for the feedstock — with the feedstock from the Olaroz Stage 1 facility. Mechanical completion is expected by March quarter 2022 with first production to follow later this half following COVID-related border restrictions in Japan.
There is a growing need for lithium hydroxide domestically in Japan as it is required for the high-end battery technology, and we will strategically market this product with our joint venture partner, Toyota Tsusho Corporation.
On Slide 18. This Tier 1 project with competitive — I’m sorry, Sal de Vida is a Tier 1 project with competitive capital and operating cost estimates and a superior brine chemistry that readily upgrades to battery-grade lithium carbonate. Construction of the ponds and brine distribution network for Stage 1 commenced just a month after receiving final environmental permits from the provincial government in December. All production wells have been completed for Stage 1. Brine production and general infrastructure and early works are progressing.
The on-site piloting program has delivered excellent results to date, and activities will continue this year to train staff and support operational readiness for commercial production. Commissioning and first production are expected by second half calendar year ‘23, and studies are progressing to expand Stage 1 to 15,000 tonnes per annum from the current 11,000 tonnes per annum.
At the James Bay project, we achieved a significant milestone late last year with the release of the feasibility study and maiden ore reserves. The results demonstrate lowest quartile development capital and unit operating costs. The operation is also projected to generate a pretax NPV of $1.4 billion using a conservative long-term spodumene price of around $1,000 per tonne. The study details a 321,000 tonnes per annum operation utilizing clean renewable energy, conventional mining methods and a process flow sheet with a 2 million tonne per annum plant design similar to the Mt Cattlin operation. This project is strategically located near high electric vehicle growth regions and will play a very important role in the North American market.
This project is unique in that it utilizes a sustainable source of hydropower to provide approximately 45% of site power needs, which will predominantly be used in the processing plant, fixed infrastructure and selected mobile equipment. Basic engineering has commenced alongside the procurement process, and preparation of construction permits for early works is underway.
In early January, the first drilling rig mobilized to site, and drilling has commenced as part of the sterilization and resource extension drilling program. Positive stakeholder engagement continued with all community and government stakeholders, and completion and release of the feasibility study will allow environmental and social impact assessment and impact and benefit agreement and other regulatory approvals to progress towards completion. Allkem expects construction activity at the James Bay project commence in the third quarter calendar year ‘22 with commissioning to follow in the first half of calendar year ‘24.
Moving on to the market. As we know, global electric vehicle adoption is robust and is becoming revolutionary across the globe as major economies make significant commitments to a net zero carbon future through their energy supply and transport. New supply, particularly for lithium, is critical to meet this market demand. There has been significant build-out capacity throughout the lithium-ion supply chain. Forecast global lithium-ion battery cell production capacity for 2031 rose to 5.1 gigawatt hour — 5,137 gigawatt hour in January ‘22, an approximately 60% increase over 12 months.
As demonstrated in the figure on the right from Benchmark Minerals, forecast global demand outstrips all known possible new supply. Market participants are already experiencing the pressure of supply shortages, which has triggered a significant surge in lithium prices. Last year alone, we experienced tremendous pricing momentum in raw materials and chemicals, which increased the profitability of our business.
Taking a closer look at the business. Our customers are showing a strong preference to enter long-term supply agreements to reduce their exposure to a forecast supply deficit. Throughout calendar year ‘21, our sales volume of lithium carbonate and spodumene concentrate have mostly been to customers with supply contracts of 1- to 3-year tenure. In the December half year, contracted prices were gradually adjusted upwards to reflect the tightening market conditions across the supply chain.
At Mt Cattlin, volumes are contracted, and price is negotiated quarterly on a cargo basis with reference to spot pricing. The average realized price increased by 126% during the reported period. And in the current March quarter, indicative prices — pricing of 43,500 — indicative pricing for 43,500 tonnes of shipments is $2,500 CIF for 6% lithium oxide. As mentioned, price momentum upwards continue, and we are reflecting — and we are receiving offers for future shipments in line with the current spot pricing that is being reported by brokers and agencies.
At Olaroz, pricing for lithium carbonate contracts during calendar ‘21 were approximately 1/3 linked to average monthly spot indices, 1/3 with annual fixed price agreements in late 2020 and 1/3 linked to contract indices with quarterly adjustments. In 2022, annual contracts that previously had a fixed price will be linked to contract indices with an average bimonthly adjustments. Therefore, we have moved away from the fixed pricing, maintained our exposure to spot pricing and increased our exposure to contract indices, which are moving upwards in line with the spot pricing.
During the reporting period, average realized price increased by 58%. Lithium carbonate prices for the second half financial year ‘22 are expected to be $25,000 per tonne FOB basis, up 125% for the — on the first half of financial year ‘22, up 25% from our previous guidance.
At Allkem, we measure our success by our performance in sustainability, product quality, customer focus and cost leadership and growth. We are focused on sustainable operations and development and continual improving product quality and cost leadership as part of our customer focus. We have been working closely with our customers since the start of our operations, and we’ll continue to do this as we expand our customer profile alongside with our unique growth pipeline with world-class assets.
We remain a very strong — we remain in a very strong financial position with 2 revenue-generating operations and a number of project finance opportunities. Our key focus areas for this year are to continue delivering sustainable operations at Mt Cattlin and Olaroz, commissioning Naraha and Olaroz Stage 2 and advance Sal de Vida construction and James Bay basic engineering. As mentioned, we will be providing a strategic review of our development projects in March. In this, we will provide detail around plans to deliver our material growth assets as our customers and the industry supply-demand profile to 2030 is very supportive on developing projects as soon as possible.
Thank you. And I will move on now to the Q&A section.
[Operator Instructions] Your first question comes from Rahul Anand from Morgan Stanley.
Martin, first one is on prices. So from the quarterly report to today, we basically have the spot prices rise 47%. You had the contract prices for Japan, Korea, China rise about 66%. You flagged about a 25% increase today to your guidance for this half. How should we think about prices in general?
Firstly, why are you getting a lower uplift? I thought most of the contracts were moving to flexible pricing now with a 2-month lag. And if it is all flexible, should we expect prices to be materially higher in the 2 months to come or the months to come? That’s the first one.
Martín Pérez de Solay
Thank you, Rahul. I will ask Christian to answer your questions since he’s more up to speed on the marketing.
Sure. Rahul, thank you for your question. So the guidance that we recently upgraded is particularly focused on what we can see on the indices that we’re pricing our product towards to. It’s a bit early for us to comment beyond the current quarter. As such, the 25,000 tonne price is something that we can comfortably estimate based on the indices prices. That means as we move into the following quarter and those indices are effectively opted, we’ll be able to provide further commentary with regards to incremental pricing for the next quarter, i.e., the fourth quarter of the financial year.
Okay. So — but it’s fair to say that…
Martín Pérez de Solay
And if I can, Rahul…
Sorry, go ahead. Sorry, go ahead.
Martín Pérez de Solay
Yes. Rahul, if you look at the pricing guidance for the second half of the year of $25,000 per tonne, that’s about a 127% increase for the first half of the year. That’s a significant increase.
Yes. Yes. No, I completely understand that. Okay. Perfect. Look, I might follow up with another one on pricing later on. But second question was for Neil. Neil, the cash tax paid, 0 for the period. Can you perhaps provide a bit of guidance as to how we should be thinking about it for the half to come and perhaps stepping into next year in terms of tax losses, et cetera?
Sure. Thanks, Rahul. Look, firstly, you’ve got to consider the Argentine tax law and regulations requires taxes be calculated in the local currency, pesos, as opposed to the SDJ functional currency of U.S. dollars. This means as the peso devalues against the USD, the deferred tax liability position of SDJ is going to increase, resulting in a noncash tax expense.
In addition, Argentine tax law and regulation have other tax measures as a consequence of high inflation, which provides some limited relief against the full impact of inflation. So basically — and this inflationary adjustment also results in no noncash tax expense are being recognized. So out of that tax charge that you see of approximately $29 million, you’ve got $24 million of it as a direct result of the devaluation of the Argentine peso and high inflation.
As far as the — and then sorry, let me just stay on Argentina for a moment. As the prices remain this sort of — these sorts of levels, we were forecasting FY ‘25 where we would probably be paying taxes. If they remain at these sort of levels, there’s a very strong chance we may have to pay taxes in Argentina. So that’s as far as Argentina goes.
As far as Australia, there was in that $29 million about — a little over $5 million derived from Australian taxable profits, the Australia — the Galaxy side of the business that bring along a whole bunch of tax losses. However, the Australian tax laws restrict the rate at which we can use these losses in our Australian tax consolidated group, given it’s based in terms of an available fraction. I won’t get too technical, but it’s a fraction that we can use.
So we get to use all of them but more on a delayed basis, which resulted in us having to pay taxes at these very high lithium prices. So hopefully, that’s answered, Rahul, what you require. If you want to get into more detail on it, certainly happy to have a separate call.
Sure, Neil. Just one follow-up because I did miss part of that. So FY ‘25, you said, was the initial expectation of paying taxes. But you think it might be FY ‘24, given where lithium prices is. Is that what I…
Yes. For Argentina, Rahul. For Argentina. So the second part I was just talking about was Australia. I mean, this certainly is what we’ve put into our financial statements right now. It reflects management’s estimates of the amount at the half year. And this will be looked at the full year given the tax expense right now is really affected by — was also affected by nondeductible transaction costs associated with the merger.
So Argentina, FY ‘25 was initial, brought back to FY ‘24. And Argentine — and Australian taxes, we expect to pay probably towards the end of the year due to the available fraction following the merger and how the tax losses of Galaxy can be used. I don’t know if you heard all of that when I went through it.
Yes. Yes, I heard it.
Yes. Good. Okay.
Your next question comes from Hayden Bairstow from Macquarie.
Just a couple of questions on CapEx and — well, one on CapEx and one on Sal de Vida, just on the increase for Olaroz. I mean, how do we think about just broader cost pressures and the potential impact on Sal de Vida? And will that have to be revised, either the CapEx budgets or timing on development, just given the pressures you’re seeing there?
And then just on James Bay, just interested in your development options there. I mean, there’s a couple of other players up in that region. Is there any sort of potential tie-up with downstream processing that’s being investigated? Are you looking at this purely as a stand-alone development with maybe, longer term, your own stand-alone downstream plant as well?
Martín Pérez de Solay
Thank you, Hayden, for your question. With regards to the CapEx increase in Olaroz, which was released jointly with the December quarter figures about a month ago, that increase in CapEx, as we explained, responded to COVID-related delays, inflationary pressures on steel and other important parts of equipment. It also related to increased labor costs in Argentina and lower devaluation rate, which increased the capital cost. So more or less, there’s a detailed explanation in the December quarter, but they answer to those 3 factors.
We are looking into the overall CapEx for Sal de Vida as we’re looking into an expansion of the project from the current 10,700 tonnes to 15,000 tonnes, and those numbers will be released along with the results from the study. But I don’t foresee any surprises. And costs and capital intensity for Sal de Vida will be along the very competitive rates and comparable to what we are seeing in Olaroz and other projects. As I said before, we are finalizing that study.
With regards to the James Bay question, yes, there’s a significant movement in the industry in Quebec. I’m having meetings with the — with provincial authorities over there, and there are lots of discussions going around about potential teams up. But I will tell you, very preliminary at this stage. It’s — we have our project with our own stand-alone facility, but I’m of the view that larger scale brings lower cost to all parties. So if there’s an opportunity to do something there, we’ll look into it in more detail. But our project — our stand-alone project is quite strong from a financial and operational point of view. And if any team-up improves the returns there, we shall look into it.
Your next question comes from Jack Gabb from Bank of America.
One question on the markets and then one just question on Mt Cattlin. Just in terms of the market, Christian, I think I remember asking back when you gave the $20,000 a tonne guidance for your spread in pricing, and I think you said at that time that your spread in pricing was sort of $15,000 to $35,000 a tonne. Just curious with the updated guidance that you’ve given today, what does your spread in pricing look like? And I guess what I’m asking is, does the increase reflect just an increase at the top end and you’re still selling some material at $15,000? Or is it sort of a broader brush?
And then the second question on Mt Cattlin, interesting in your presentation, you talked about exploration, focus on extending the mine life. Just curious, is there an opportunity to mine lower grade given where spodumene prices are at the moment? Or is this more about sort of greenfield exploration in and around the existing resource? Just curious what you’re looking at.
Martín Pérez de Solay
Thank you, Jack, for your question. First one will be answered by Christian, the second one by Keith Muller, who manages the Mt Cattlin assets.
Jack, thank you for your question. With regards to the price spread within our existing contracts, the spread has increased predominantly on the top side. We had already started delivering volumes at the bottom range. So that really doesn’t change. However, as the price index from different agencies was updated towards the end of January, we were able to push that top range higher.
So I would probably say the spread is looking more like $15,000 to $45,000 for the existing quarter.
And I’ll take the second question, Jack. Just in terms of the exploration at Mt Cattlin, we intend a 32,000-meter drill program over the next 6 to 8 months starting in March. Out of that 32,000, 30,000 will be localized to the immediate pit expansion. And yes, we are targeting a lower grade at the moment. Our reserve cutoff is at 0.4%.
So with these prices, we are evaluating if there’s any benefit in dropping that bottom cutoff grade. 2,000 meters that we’ll be drilling is in exploration leases around the vicinity of Mt Cattlin, so not directly associated with an immediate expansion but more so with a greenfield valuation of what else is in the facility.
Perfect. And just on that potential grade cutoff reduction, have you got any sensitivity as to how many tonnes that could bring into the pit?
Not at the moment, no, Jack. Look, we first have to do the drilling to firm up and convert those resources to reserves before we can further evaluate the effect of cutoff grade.
Your next question comes from Reg Spencer from Canaccord.
Martin, Neil, Christian, first question relates to the statement in the presentation where you’re looking at changing the structural nature of your contracts moving to more index-linked pricing. Will that be effective immediately? Or is that more a case where as supply contracts roll off, you would move to that different structure? And I guess as part of that question, will we likely see greater impact on your prices received in the June quarter as opposed to the March quarter?
Martín Pérez de Solay
Thank you, Reg, for your question. Christian can answer the details of the questions. However, you have seen a significant increase in the second half of the year in the price guidance that we are giving. Christian, if you could please go through the details.
Yes, Martin. Reg, so you have 2 questions. I’ll address the first one about the contracts. We have successfully moved towards flexible pricing arrangements across our portfolio. However, I did point out last time during the quarterly call that a couple of our customers were still getting product associated with their fiscal year 2021 volume/prices. So that’s coming to an end this quarter. And as we move to the last quarter of our financial year or the second quarter of the calendar year, we’re effectively moving everything to flexible pricing.
So that would then help to answer the second question with regards to guidance or prices for the following quarter. Considering the nature of floating pricing mechanisms we have, it will certainly be, I guess, a reflection as to what the prices on these indices will look like in the next month or 2. If they continue to be revised up, then I would expect that we’ll capture some of that growth in the following — to the following quarter.
Excellent. Thanks, Christian. That’s useful. My next question relates to Naraha. So that looks like it’s on schedule to be commissioned this quarter. Will you guys provide some kind of guidance as to the pricing structure at which product will be sold to the joint venture in Japan? And just so we can get an understanding of how that relationship between Naraha and SDJ might work. There’s no way of transfer pricing, right? This is going to be arm length pricing. But is — I guess where I’m going with the question, are the profits more likely to be at the Olaroz level? Or will there be some kind of lower pricing to Naraha and those profits be at the Naraha joint venture?
Martín Pérez de Solay
Well, thank you, Reg. As you said, pricing is going to be arm’s length. And the pricing in which Olaroz will sell the product to Naraha will be based on market. So it’s going to be market pricing for the product going from Olaroz to Naraha. And profitability would be on lithium carbonate in Olaroz. And the upgrade from technical grade carbonate to battery grade hydroxide profitability will stay in Naraha. That’s the way the pricing and the profit between both operations will be.
Okay. So, understood. So just on that then, Martin, is there a benefit in sending lower spec — well, it would obviously be lower-spec product, and it will be priced accordingly based on whatever the industry’s moving at that particular time. And so the profit uplift will come down to your conversion costs and whatever you can get hydroxide for in Japan and Korea or in Japan.
Martín Pérez de Solay
Exactly. This is part of the strategy to increase the value added to our products. So we were firm believers that hydroxide — the spread between hydroxide and carbonate will grow and has been impacted by some particular events during this year. But in the long run, we trust profitability from hydroxide will be significant. And that’s what we are doing by growing our production and the value chain, by getting into more complex molecules delivering the solutions that the customers need.
Your next question comes from Lachlan Shaw from UBS.
So just a question on Olaroz Stage 1. Can you just remind us of your thinking around the battery grade-technical grade split going forward? I do note you had higher OpEx with the higher battery grade split in the half. What should we be thinking about that split going forward for Stage 1? And specifically, how should we sort of take forward the OpEx related to that? I’ve got a second question, and I’ll come back to it.
Martín Pérez de Solay
Well, thank you very much for your question. The answer on that is that the — going forward, you should see a split similar to what we’ve seen in this quarter, slightly 50-50, slightly higher than 50% in battery grade, but around this level until Stage 2 comes in for production. And as we increase production from Stage 2, we may change the split of product within Stage 1. Currently, this product split maximizes the production capacity from Olaroz as well as the price and also enables us to meet our customer contracts.
With regards to the costs, they came down in the December quarter from what they were in the June quarter. We expect them to be around this range for the second half of the year, still depending on the devaluation of inflation rates in Argentina. In the last 2 quarters, we’ve been impacted by higher inflation than devaluation rate, which impacted on the costs. It’s not a significant number in the cost, but it moves the number around a bit. Roughly 55% of our costs are peso-based and 45% are dollar-based.
But — and that impacts in the way in which we see the cost evolving. But from a product split, you should see something similar to what you are seeing because that enables us to maximize productivity and meet the customer contracts we have.
Great. And then a second question from me. So just on Mt Cattlin, and again, looking at the OpEx line there, the borders are opening in WA shortly. Do you expect to see some benefit to the cost line in terms of that border opening? How much of that cost that we saw in the December half do we take forward?
Martín Pérez de Solay
Well, thank you. We’ll let Keith answer your question in more detail. But clearly, the opening of the border in the second — from March 3 will enable us to better manage our cost basis. Keith, please, if you can provide more details.
Certainly. Thanks. The majority of that escalated cost is associated with the higher stripping ratio that we are seeing over the next 12 months. Very little of that cost is associated with the impact of COVID. If anything, that has actually suppressed the expenditure as we struggle to get a workforce in out of the tight WA market. So we’ve slightly mined less than what we anticipated. So I wouldn’t expect that our expenditure will go down. If anything, it will go slightly up as we are now capable of increasing our mining volumes and sustaining the production levels.
Your next question comes from Glyn Lawcock from Barrenjoey.
Martin, in your presentation, you said market participants are experiencing shortages. It’s an interesting comment. Just wondering if you could maybe provide some color. I know I only asked 4 weeks ago on the January call. But can you maybe talk about through the supply chain? I assume you talk to OEM, car manufacturers, battery manufacturers, converters now that you’re a spodumene producer as well. Just any insights you can offer on the inventory positions, whether it’s the raw material, the batteries or even cars?
And then just on Mt Cattlin, just shipping logistics. I mean, everyone seems to be whinging about shipping logistics. Just wondering if you can provide any color on how that’s maybe tracking now another month on. Are we getting much more success at getting product out of Western Australia and out of Argentina?
Martín Pérez de Solay
Thank you very much, Glyn. I will ask Christian to answer your questions. On inventories, we are seeing pressure from customers to secure products. But Christian can be more detailed around the inventories. And Christian, Keith, if there’s any detail we can give Glyn around the shipping logistics of — from Western Australia?
Glyn, yes, in fact, we do have conversations with customers and, I guess, potential customers throughout the value chain. I guess if we just quickly start with converters, I think that it’s probably the most obvious one that the delays on incremental production are just effectively not being able to capture some of the lack of utilization in Chinese conversion capacity. So that is quite evident. We certainly get a lot of queries from none of the customers for this — well, for any product really. And the conversations have really changed towards their requirements around cutoff grade and specifications, which obviously gives you an understanding that they’re effectively trying to get whatever they can get.
As we move up the value chain, particularly with cathode customers, I think traditionally speaking, cathode customers either in Japan, South Korea or China have different sourcing strategies. Those that usually pick up volumes and fixed volumes for the year have come back with additional volumes, and that’s in response to just higher demand of their own production into the battery supply chain. So that’s where we’re seeing some of those requirements or requests having to be, I guess, turned down because we simply don’t have the ability to provide them with further volumes to the ones that we have already agreed to. And in China, I think China is a lot more geared towards securing a percentage of their annual offtake with contracts. And the other component, they’ll pick up from the spot market. We have seen a lot of queries from Chinese participants requiring us to provide them with any level of support, particularly in 2022 as they are significantly concerned of not having enough inventory for the year.
So I think — look, I think as you look across the value chain, inventories are certainly down. We understand that some of the converters in China are at — running at less than a month of inventory. And as you look at cathode producers, whilst there was some restocking activities prior to the lunar year celebrations and have continued since then, our understanding is that inventory levels are effectively just there to get them through the monthly production. And they’re not carrying a lot of excess for the following months.
And you had a question around shipping and logistics. The situation in the current quarter has become a lot better. I think whilst you still have those restrictions that need to be addressed on the quarantine protocols, the supply has improved. There are more vessels. The rates are also more competitive than what they were in the previous half. But it is a little bit of — we have to monitor this every time we look at securing vessels because the situation can change quite rapidly as we have seen in the past.
So Christian, just maybe going back to the inventory question, if I could just ask a follow-up. Do you have any insight — I mean, you’re obviously further down the chain. Like we asked this — we talked about this back 4 weeks ago. But the OEMs, the actual car manufacturers talking to them, do you have a sense of what their biggest fear is? I mean, it sounds like, obviously, the converters and the battery manufacturers can’t get enough lithium. But is that transpiring all the way through the chain?
Yes. Glyn, we’ve seen a lot more active behaviors from certain OEMs that have traditionally left those negotiations and securing a lot of supply with battery or cathode manufacturers. A few of them are playing a more active role at assisting wherever they can, stepping in and trying to basically secure supply in the current year, whereas previous conversations were more about long-term security of supply. So I think that just, again, reinforces that the concern is there sort of the whole value chain now as it — as contrary to what was probably 6 months ago.
Okay. And I know it’s early, but is there anything changing as a result of what’s happening in Europe from what you can see talking to customers?
Well, most of our customers are in Asia, Glyn. The reality is we have limited volume into Europe. At the moment, that has been predominantly for industrial applications. I suspect there will be obviously an impact on industrial activity in Europe, and that may — that might mean that some of those volumes won’t be there in the next 6 months. However, our ability to place products with our existing customer book in Asia is quite strong. So I don’t think we would have any issues to reallocate product if we have to.
There are no further phone questions at this time. We will now move on to webcast questions.
The first question is, “In the disaggregation of the group’s revenue from customers, there is $4.6 million in revenue for Olaroz from Europe. Is that for battery grade lithium carbonate?”
Martín Pérez de Solay
Neil, can you please answer that one?
I can pick up that, if that’s okay, Neil.
Martín Pérez de Solay
Yes. Thank you, Christian.
Look, the — as I was just explaining to Glyn a minute ago, most of the volumes that we sell into Europe are for industrial customers. It will probably be somewhere between 70% to 75% industrial customers. The remaining goes into customers that produce electrolyte cells.
Your next webcast question reads, “For Olaroz, there is a net loss despite the huge price increase for lithium. As in FY ‘20, this is largely due to income tax expense. Is this likely to continue into the future?”
Martín Pérez de Solay
Thank you very much. Neil, you can answer this one, please.
Yes. So it all depends — it all comes back to exactly what I explained a little bit earlier as far as devaluation and high inflation. We expect those numbers, to some extent, start equaling each other, but there will be an effect as that continues with a high inflation rate and high devaluation. The tax charge has to be booked. Hence, it’s a noncash charge, but it does have to be booked in the opposite side of the accounting entries on the balance sheet where it affects the deferred tax liability.
Thank you. Your next question, “What do you think is the ceiling on carbonate and spodumene pricing that the market can realistically absorb?”
Martín Pérez de Solay
Thank you for the question. It’s quite an interesting one. Christian, you may give some color, but we have seen the price increasing every quarter over the last year. So difficult to set a ceiling. Christian, you may have some more detailed views here.
Thank you, Martin. I can’t really comment on what the ceiling may look like. But what I can, I guess, share is that the elasticity for lithium prices has obviously been a lot wider than what we thought before in previous years.
Now to provide some color, the impact on pricing on lithium with regards to the total cost of a vehicle, and therefore, the potential incremental cost of the electric vehicle to the end customer, is probably not as significant as most people would think. The reality is an average electric vehicle will take approximately 40 kilos of lithium into their batteries. So if we were to effectively look at the price run that lithium chemicals have experienced over the past year, the incremental cost to a battery pack has probably been in the range of $1,000 to $2,000 per vehicle. And so when you’re looking at an average price of a vehicle, somewhere around USD 50,000, the incremental cost of having such a significant increase in pricing is not that significant. And we haven’t seen a slowdown in demand even after some of the OEMs have lifted their prices for the 2022 year.
So I think just to sum that up, I don’t think I have a view on what the limit or the ceiling pricing would be. I can only conclude that the overall demand is not really being reduced as a result of having an incremental cost of $1,000 to $2,000 on the vehicle.
That does conclude our time for questions. I’ll now hand back to Mr. Pérez de Solay for closing remarks.
Martín Pérez de Solay
Thank you, everyone, for joining us today. For further inquiries, please contact our Investor Relations team, who will also respond to any additional questions submitted on the webcast today. Thank you very much.