Lithium: the ‘new oil’

China is the world’s leading producer of consumer electronic appliances, including laptop computers, mobile phones and cameras. China also boasts the world’s largest market for automobiles, including electric cars. So, how will these new appliances, large and small, be powered? In recent years, lithium has emerged as the “new oil,” and today lithium is playing a central role in the switch to battery-powered alternatives to fossil fuels.

Lithium is the lightest metal and the least dense solid. It is typically extracted from beneath salt flats. Although China has a domestic reserve of lithium in its western Qinghai province and Tibet region, the soaring demand for consumer electronics, hybrid vehicles and electric cars has forced China to look beyond its borders for additional supplies. As a result, Chinese investors have cast their eyes towards Latin American countries where over 70% of the world’s salt lake lithium deposits are found.

Investing in lithium

Perhaps the quickest and cheapest way to secure a foreign lithium supply is to acquire the salt lakes directly from their owners in Latin America.

Unfortunately, many salt lake owners are not easily accessible. Chinese investors may therefore prefer to work through international companies that already own rights to Latin American salt lakes. Those companies may be private or public. Investors working through private, third-party companies should conduct thorough due diligence. The review should include a complete analysis of the target company, including its ownership interests in the lithium deposits in Latin America. Investments through a publicly traded company carry a different set of concerns. While the need for comprehensive due diligence may be relaxed slightly where public companies are involved, investors interested in a publicly traded company should be prepared for a more expensive purchase price as well as for the numerous reporting and disclosure obligations that come with public status.

Critical factors

Regardless of whether an investor chooses to directly invest in a lithium project in Latin America or through an intermediary, several critical factors need to be taken into consideration before making the investment.

Considerations for investors

At the very earliest stages, investors must consider the political complexity of the Latin American region. (See coverage on pages 35 and 49.) The United States Geological Survey reports that Bolivia contains almost half of the world’s lithium reserves. However, few foreigners can cope with Bolivia’s political environment and its often-demonstrated hostility towards outside investors. As a case in point, Bolivia requires that lithium batteries produced using Bolivian lithium must be manufactured locally. As a result of these and other onerous requirements, lithium batteries have yet to be produced in Bolivia. Investors have looked to other countries, namely Argentina and Chile, with more relaxed requirements relating to the export of lithium and other relevant matters. Although these countries may not have lithium quantities as abundant as Bolivia, they are more hospitable to foreign investment.

Once a potential investor is comfortable with a chosen jurisdiction, attention should be paid to the ownership of the salt lake deposits in question. In the best case scenario, a salt lake deposit will be owned by a single owner. However, in most cases, a salt lake containing significant deposits is likely to have multiple owners. Investors looking to acquire the entire lake will need to negotiate with each owner.

In these circumstances, it is critical that the investor try its utmost to keep each negotiation strictly confidential. If not, the various individual owners may attempt to use their knowledge of prior or parallel negotiations to their advantage, thereby raising the transaction costs significantly.

Buying a salt lake

It is also important to determine whether investors will be acquiring the entire ownership interest in the salt lake deposit, or entering into a joint venture with the local owners. Although exclusive ownership carries its own benefits in the form of control and profit, it may be more practical to enter into a joint venture with local owners, in order to capitalize on their experience and support. A joint venture, if entered into with caution, can be a way of ensuring smooth and continued operations after the initial investment is made. Additionally, by engaging in a joint venture with a local owner, the Chinese investor may be able to shift some of the risks to the local owner. For example, the investor may develop a production-based payment method with the local partners. This type of structure is especially beneficial when the salt lake is yet to be explored and its reserve remains unproven.

Joint ventures can be wildly successful, or potentially disastrous. What makes the difference? Culture and style alone can make or break a joint venture. A successful joint venture will also be built around an unambiguous management structure. There should be no doubt as to who has the right to hire, fire, promote, assign resources, and make investment decisions. Remember, if either partner feels as if they are losing control, the joint venture’s objectives will be difficult, if not impossible, to meet. Successful joint ventures will also have realistic objectives. The partners’ expectations will be properly managed. Promises made will be kept, and performance benchmarks will be consistent with the capacity, skill, and resources of the joint venture. Of course, while there are other factors contributing to success (or failure), communication and transparency remain key. Joint venture partners must be open, fair, and frank with each other.

Evaluate each opportunity

China’s manufacturing goals and energy needs continue to drive the country to search for and locate raw materials around the world. Latin America’s abundant natural resources make the region an attractive option for Chinese investors. While the potential for profits is high, investors must take care to evaluate each opportunity to ensure that a potential deal makes sense from a business, political, and practical standpoint.

Xin “Joe” Zhang and Marta Colomar are associate attorneys at law with Diaz Reus & Targ.