The image presented to foreign players in lithium sector, regarding economic, political and social environment in the South American Lithium Triangle is usually very simplified. It paints a picture of stable and growing Chile, Argentina getting back on track with its technocratic leader and regional enfant terrible Bolivia with its populistic – and hence by definition labelled as business unfriendly, policies. More detailed analysis of socio-economic and political situation in these countries rarely reaches lithium industry decision makers and analysts. The Chinese quest for dominance in lithium and battery sector best reflected by a series of bold acquisitions and investments, concluded or attempted is also rarely discussed in a wider geopolitical context of changing US foreign policy, particularly in relation to Latin America and in context of frantic attempts to regain a level playing field by large Korean and Japanese corporations. We aim to fill-in this gap and re-examine some of those commonly hold perceptions and believes by taking a more macro view and providing a reader with better understanding of local realities.

 

Chile’s flawed image of stable democracy

Since it’s embrace of democracy in 1990 Chile became a model of development – politically and economically for its South American peers. Yet with rising inequalities, as illustrated by growing Gini index (Chile outranks Nigeria and is in top 25 of most unequal economies) and wide disenchantment with politics embodied by falling voting turnout rates (In 1989, 86 percent of voters cast a ballot. In last election only 46 percent did, with decline in turnout especially among poorer parts of society – who traditionally were more likely to vote left). Chile’s image has been tarnished. Future also remains uncertain. On one hand we have a right-wing president, detached from liberal society being in favor of extended abortion rights, stricter environmental protection measures and rights for sexual minorities. On the other, leftist government promising to curb corruption in which elites drawing its power from the time of Pinochet have been involved – failing to deliver while the left’s leader family member gets entangled in land dealing scandals.

Nobody negates Chile’s achievements in making its way to World Bank’s high-income bracket countries (despite only 25% percent of the population earning more than $700 per month) and therefore escaping infamous middle-income countries trap. In terms of Human Development Index, Chile also ranks well in comparison to its neighbours. Yet low social mobility and inequalities, magnified by noninclusive and expensive educational system (World Bank states that an average student debt to annual income ratio is 174 percent) spur mass protests among various members of the public, from students to employees of state owned companies. Propensity for social unrest is also related to lack of security on job market. 20% of workforce is self-employed. It does not necessarily imply large number of small business owners but employers’ preferences for hiring contractors working under same conditions as regular employees but without provision of any benefits.

On the other hand, that system keeps unemployment rate at 7%, around EU average. Nonetheless as for emerging market, Chile GDP growth is very low at 1.8% last year, below global average. Far away from its stellar performance years ago averaging at 5 percent for period of 30 years.

Chile’s privatization of social security system, from public pay as you go to privately managed contributions alike to US 401(k) program, turned out to not work so well for majority of population. The average monthly pension payment is $300, which is not enough to cover living expenses.

The growth in inequality is perhaps best illustrated by a fact that in 2000, according to a report by the United Nations Development Program, half of all Chileans agreed that it was fair that those who could pay more should have access to better health care and education for their children; today according to repeated survey only one-third do.

Hence the basis for populists coming one day to power is there. So far Chilean political scene has been effectively bi-partisan due to historically specific electoral system that supported this situation. These two parties being centre-left New Majority and the right-wing Vamos. Until 2015 due to prevailing electoral system the rise to power for small, new parties has been very hard. Now situation is different, and emergence of new populistic parties seems likely in near future, if the disillusionment with both New Majority and Vamos will not be addressed. So far, a take on reforms by left leaning government has been unsuccessful. Education reform has not met students demands and tax reform further alienated businesses from the left.

Social unrest and rapid political changes are more probable to take place in Chile when copper prices sink. Currently in the range of USD 6000-7000/MT they are double the lows of USD 3000/MT from 2008. Yet strong copper prices even if they keep economy going hamper the development of local export-oriented industries, by keeping local currency strong. When typical for commodities down-cycles come, economy goes into recession, currency weakens but an industrial base that could take advantage of weak currency to export competitively priced products is simply not there.

Even if we do not think that demand for copper will decline over the long run (this year we face a small deficit in supply, and development of EV industry will further contribute for need of more copper) the quality of ore in Chilean’s deposits is decreasing. To maintain an output at current level new investments are required.

Investment of commodity derived revenues in high added value industries, potentially based on strong commodities base could have been a panacea. Yet current efforts to move up the value chain as exemplified by imaginative initiatives as “Start-Up Chile,” which attracts entrepreneurs from abroad by providing visa, money, and office space to launch their businesses met with mixed success.

Hence are any major reform possible in short to medium term? With right wing Piñera at helm and leftists in government, it is difficult to introduce any large initiatives on which both blocks would agree. Any concessions taken in favour of the other party by pragmatic members of the first, will met with reaction of hardliners on the other side of the spectrum demanding something substantial in exchange.

In the meantime, streets became sensitive to any changes initiated by the top. Hence no matter if Chile decides to change the course or stay on the same path, it is prone to experience massive protests in near future.

In context of lithium industry, not everybody is happy with commercial success of SQM. The company has been privatized during Pinochet, and his former son-in-law Julio Ponce Lerou still keeps 30% of ownership through a series of holding companies, being a majority shareholder. There are voices in the society supporting re-nationalization of the company. Increasing extraction rates also face protests of environmentalists. It is a delicate act for government to balance a development of lithium economy and social discontent on some of those issues.

In beginning of the year regulator already had to pressure Ponce to resign from his voting control over SQM as a condition that allowed the company to increase the government regulated production quota.

In face of Chilean regulations, lithium is perceived as a strategic resource from military point, referring to its possible use as an element in nuclear fusion – hence its production and exports are strictly regulated.

At the same time government has been blamed by public and commentators alike to not exploit the boom in lithium to the adequate degree. Due to the fact that quota for extraction of lithium has not been increased to meet the global demand, despite Chile being world’s lowest cost producer.

SQM has been also accused in the past of secret financing of political parties. Controversies like this negatively impacted Chile’s image as a mature democracy. Hence it became a matter of prudency for many politicians and civic servants to treat it cautiously, at arm’s length, just to avoid a negative PR.

At some point relations became so tense, that government threatened to revoke SQM’s lease to the lithium deposits, claiming that company underpaid the royalties.

US disengagement after years of diplomatic efforts

An understanding of approach of super powers and key lithium consumers towards countries of lithium triangle is as important as analysis of their domestic situation.

US politics towards Chile, Argentina and Bolivia borders on disengagement. For the last decade and particularly under current administration US projects a lack of any broader strategy towards important economies of the region. This was not always a case – only a few now remember Clinton’s free trade initiatives stretching over South America to Chile.

Moreover, the carefully orchestrated initiatives to bring Latin American markets closer to US as Trans Pacific Partnership has been dismantled following Trump’s decisions. Effectively years of underlying diplomatic and administrative effort who could secure US a better access to “new oil” has been forgone.

This leadership vacuum is aggressively filled by Chinese economic initiatives and even by Russia that starts to either slowly re-engage with old allies as Cuba or enhance relationships with new friends as Bolivia. All that, when even the traditional US Latin American partners like Argentina are being ignored.

China aggressively builds up its influence in the Lithium Triangle by a skilful mix of investments, loans and trade opportunities. Its position towards lithium resources could be illustrated by a quote from Chinese Academy of Social Sciences’ (country’s top think tank) report from 2014 that ““Grabbing key resource mining assets overseas is key for lowering the prices of raw materials domestically” and hence of strategic importance. China already occupies position of first or second trading partner with Argentina, Chile and Bolivia. Chinese government officially declared an intention to invest $250 billion in the LatAm by 2019 and its lending in the region already exceeded the level of loans provided by World Bank.

Meanwhile Pew survey measuring favourable attitudes in South America towards the US observed a massive decline of support for US foreign policies, several months after the end of Obama’s presidency. Such sentiments are further propelled by some of US decisions.

While Latin American societies tend to hold multilateral regional initiatives in high regard, Trump administration first time in decades declined to send the representative to Organization of American States’ General Assembly where matters close to US geopolitical interests as potential sanctions towards Venezuela has been discussed.

Chinese courtship and lack of understanding

China seems to give LatAm the attention it deserves. When US steps out of Trans Pacific Partnership, Mr. Xi visits Latin America in person promoting Free Trade Area of the Asia-Pacific, Chinese backed trade agreement involving 21 APEC countries.

Nothing speaks more in favor of Latin American opportunities than numbers. US trade with the region has grown by over a half between 2007-20016, with significant US net surplus. Trade with US is also less likely to harm local manufacturing industries, as cheap Chinese imports do. Agreements, as FTA with Chile are still there, yet after over 10 years in place they are in dire need of an update.

Despite China’s courting and wooing, Chinese appetite for LatAm mineral resources and their proposal of financial assistance meets with some resistance from society and fuels the growth of left wing movements.
Paradoxically, however, those left-wing movement might be still more keen to cooperate with China, when in power than with Western counterparts, due to closer gap on ideological grounds, as it is a case in Bolivia.

Beijing is always ready to change an approach when trading partners give a cold shoulder. The efforts to protect domestic manufacturing industry, initiated by labour unions, met with periodical ban on imports of Argentine soy oil. Officially steps were taken on technical grounds but were regarded as retaliation for Argentine restrictions. In the future shipments of lithium might be also used as a leverage.

If China wants to change attitudes, it needs to invest more in processing capacity on the ground instead of just buying raw materials. This precisely reflects the hopes and plans of Lithium Triangle countries to build cluster of industries spanning battery and even EV manufacturing around its extractive operations.

Yet this is not a path of cooperation that China has chosen to take in the past.

To take again soya as an example, soy oil imports from Argentina have been banned, to encourage a growth of domestic soy oil producers while imports of raw soya continued. Currently China is only buying a 3% of total South American manufacturing production, while it heavily relies on its commodities.

Under these circumstances it does not come as surprise that in Chile, China’s attempt to strategically secure an access to lithium by buying up 32% of SQM for USD 5 billion has met with blockade from regulator.

Despite Chinese open declaration that such a measure will negatively impact any future economic and commercial relations between the countries. The justification for this step from the side of Chilean regulator was put forward on anti-trust grounds – in their opinion conclusion of the deal would give Tianqi Lithium too much influence over global supply chain. The alternative proposal was to sell part of the share on Chilean capital market to be acquired by cash-rich domestic pension funds and private investors.

At the same time CORFO (Chilean Development Agency, who previously tried to block the Chinese deal) – actively sought engagement with Tesla to invest in the country.

In the end, despite all the efforts, Tianqi Lithium acquired in May 2018 24% stake in SQM.

Chilean governmental agencies were not the only actors weary about Chinese acquisition. Repercussions of this move must have reverberated in Japan and South Korea. Chinese acquisition increased uncertainty for Samsung SDI (battery maker) & Posco who committed to build a battery components factory in Chile in exchange for securing lithium at a discount from SQM.

China also looks up to increasing its presence in Argentina’s lithium sector – Jiangxi Ganfeng Lithium is seeking a US$1 billion initial public offering in Hong Kong to raise funds toward the development of a mining project in the country. While Chemphys Chengdu Chemical Industry committed to an offtake agreement on all potential future production of lithium from the Salar of Hombre Muerto North project.

In the meantime, US fiscal policy may unintentionally push lithium triangle countries to adoption of Chinese and possibly yuan denominated debt and hence lead to further increases of Chinese clout in the region. US increases its public spending while simultaneously cutting tax rates what widens budget deficit which may soon reach 5% of GDP. At the same time, it finances this deficit by raising interest rates on its obligations to attract foreign capital. Foreign capital inflows strengthen the dollar, what makes repaying US dollar denominated debt more expensive.

As a remedy, African central banks already discussed a potential for holding yuan as part of their foreign reserves during Macroeconomic and Financial Management Institute of Eastern and Southern Africa forum.

Higher interest rates on US bonds also makes emerging debt markets relatively less attractive, so countries as Argentina and Chile will have to raise its own interest rates and hence increase they borrowing costs just to attract the new capital.

Emerging Markets, who has high level of domestic savings, as it is a case in some of the Asian economies have a choice, to turn to safer local currency denominated debt. Chile with its developed capital markets boosted by privately managed pension funds is in slightly better situation than Argentina who does not seem to have much choice but to borrow abroad.

Argentina’s fine balance and sensitivity to external factors

Foreign debt and its management has for long spelled trouble to Argentina.
Right after President Mauricio Macri achieved by no-means easy feat of settling Argentina’s holdout creditors, the country started to borrow again by coming on the market with new bond offering.

Inflows of foreign capital appreciated peso, without strengthening balance sheet in long run. Instead of building currency reserves, money was spent on imports.

As Chile is dependent on copper so Argentina is dependent on maize and soybeans. Weak harvest of 2017/2018 made GDP shrink by 1%. The foreign creditors facing higher uncertainty refused to keep on borrowing. Argentina had to turn once again to IMF for $50bn credit line, after the bold move to attract creditors by rising interest rates to 40%(!) failed. New loan has been granted under tight conditions that puts many limits on Argentina’s fiscal policy and under assumptions that weak peso will not weaken further.

Those covenants draw a line on what Macri can do with the country’s stagnant growth (GDP forecast for this year at 1,8% level). With no options to stimulate the economy through public spending, his tactic is to further liberalize it – most of export taxes have been scrapped. Most of Macri’s moves have been not popular, as cutting energy subsidies. Despite large wave of optimism that he induced during election, his approval ratings fall sharply, just after a few months in the office and remain low. This year inflation is at 26% and peso is world’s worst performing currency.

IMF imposed austerity measures in practice translate to postponement of infrastructure projects, further cuts of subsidies and transfers to economically weaker regions of the country, as well as salaries cuts for civil servants. Yet implementation of this measures requires votes from house of congress, where Macri lacks support.

In terms of propensity to social unrest, situation in Argentina is similar to Chile. The last general strike by General Confederation of Labour effectively brought the country to halt.

Some recent polls may indicate return of Peronists predecessor, Cristina Fernández de Kirchner as a serious contender. Despite her facing accusations in the past for allegedly defrauding the treasury of over $5 billion during last months in office.

Analysts say that if Macri were to lose in the next election in fall of 2019, the agreement with the IMF might be in jeopardy. It would not reflect well on prospects for lithium industry in the country, effectively hindering availability of funds for its further development. With left-centre coming to power both in parliament and in presidential office, the voices for re-nationalization of SQM, protectionist measures and increase of tax burden on exploration and export might become more audible and perhaps at least partly reflected in legislation.

Morales – another economically skilled authoritarian?

Temporary success of Hugo Chavez paved a way for left yielding undivided power in most of key South American markets including Chile and Argentina. Yet along with collapse of Venezuelan economy, the left started its retreat, being replaced by representatives from opposite side of political spectrum.

With an exception of Evo Morales. He was inaugurated as Bolivia’s president in 2006 and re-elected in 2009 and 2014. Only recently parliament passed a reform that would allow him to run for another five-year term, what would potentially let him to stay in power until 2025. His party Movement Toward Socialism (MAS) has done very well in every election between 2006 and 2014 and dominates local political scene. Perhaps a key to understanding of Morales success is his and his party’s origins.

MAS was built from the ground up by consolidating rural and urban popular movements. Morales himself is a first indigenous Bolivian president. It gives him a massive support in this predominantly rural country.

Despite populistic government, Bolivia is doing well economically. It has experienced GDP growth averaging five percent since his coming to power. Treasury is running surpluses, the amount in reserve currencies and gold held by Bolivia’s Central Bank advanced from 1.085 billion US dollars in 2000, to 15.282 billion US dollars in 2014, all during MAS’ rule. Bolivia has the second largest natural gas reserves in South America, that it successively exports to Argentina and Brazil. Natural gas has been largest source of hard currency until this year, when due to redirection of exports from US and Europe to Asia and particularly China, minerals (zinc, gold, silver, lead, tin, copper, antimony) became largest Bolivian export amounting to 47.4 percent of total export share and 7.846 billion dollars in revenue. Morales levied royalties on extractive industries in the country and increased government spending on education, healthcare and social security effectively decreasing social inequalities (between 2006 and 2015, the Gini coefficient, declined from 56.7 to 45.5). MAS also provided a security net for elderly by establishing universal non-contributory pension scheme.

Despite worries over ever looming threat of nationalisation, some of Western commodities companies as Shell, for long successively operate in the country. Currently Shell is investing more money in exploration in Bolivia than in any part of South America. Yet the case of nationalization of two smelters, together with small tin and zinc mine in 2007 and 2010, all owned by Glencore, without any compensation paid whatsoever, prevails as a cautionary tale for any investor with appetite for Bolivian lithium.

Even with budgetary surpluses Bolivia does not say “no “to Chinese loans and seeks close relationship with China for technology transfer. This is well exemplified by launch of Túpac Katari 1 – a telecommunications satellite by Chinese government on behalf of Bolivia to increase mobile, internet and television use in less accessible areas of this mountainous country. At a cost of around $300 million, of which $251 million came in form of a loan from the China Development Bank.

Bolivia is estimated to hold over 40% of world’s lithium reserves. Yet it is not clear who and when is going to develop them. Chinese satellite programme has been seen by some commentators as door opener for cooperation on lithium. China openly expressed interest in working with Bolivia on extraction and offtake. The development of a plant by The China CAMC Engineering Company on Salar de Uyuni for the production of potassium chloride fertiliser has been universally perceived as a long step in this direction.

Yet in April 2018 Bolivia’s energy minister announced that government will select a partner coming either from Germany or Russia to work together across the value chain from lithium extraction to battery production and invest from $750 million to $1 billion. Considering Russia’s involvement in development of nuclear energy in the country ($300 million nuclear reactor by Rosatom) and commissioning of German firm K-UTEC by Bolivian government for construction of industrial-scale lithium carbonate plant, this announcement is not coming entirely as a surprise.

Bolivia is also actively seeking cooperation with India by proposing Preferential Trade Agreement, in an effort to secure an enormous future market for its lithium with India’s extremely ambitious goal to have all-electric car fleet by 2030.

Glimpse of the future

Meanwhile Japanese and Korean battery and EV makers woke up to new realities of Chinese global acquisitions, and seem particularly worried about situation in lithium triangle, for long having long-term agreements with local producers and sourcing much of lithium from the region. The biggest Japanese investment preceding Chinese acquisition moves and currently in operation is Salar de Olaroz, JV between Toyota Tsusho and Orocobre’s Argentine subsidiary.

One of the response strategies for Japan and South Korea, when stakes in major players have been predominantly either bought or not for sale is to invest in junior projects increasingly popping out across the triangle.

To sum up, the situation in Lithium Triangle is complex and increasingly uncertain, due to shifts on local and global political scene and members’ economies highly sensitive to external influences. US continues to lose hard won economic and social gravitas in the region, precisely at the time when it gains in geopolitical importance. This vacuum is being filled by extremely active China, whose initiatives even if possibly well-meant do not reflect ambitions of the region seeking to move up the value chain. The presence in the triangle of minor players, from non-obvious ones as Russia to such as Japan and Korea who should have perhaps worked harder to secure its interests in the past, also weights in on situation.

Whoever wants to establish good relations in the region and secure the access to lithium, needs to tune in better to local expectation’s. Misguided actions on the side of major powers as US and China, open up possibilities for smaller players to build bridges and position themselves for the future where lithium will be more key for economic success than it is now. It is also in interest of everybody to stabilize the region in macro-economic and political terms, so the extreme elements will not come to power.

Economic success of many authoritarian regimes, proves that Morales and his équipe, which so far has shown more economic prudency and sober management skills than his liberal democratic counterparts in the region, have a chance to keep a country on the road to prosperity and successfully develop world’s biggest lithium resources. Yet he needs to be cautious that the extreme moves as with nationalization of Glencore assets will never happen again. To appease foreign investors which he needs much more for technology-transfers than purely for capital, maybe he should also make up for a damage already done.

As OPEC story shows, common economic interests, can unite in action regimes representing highly different ideologies and even make old foes come together to the table. For Chile, Argentina and Bolivia, neighbouring countries, already united by growing energy dependencies (natural gas exports from Bolivia to Argentina, and Argentina to Chile), uniting together to control lithium market would be much easier. The triangle is estimated to contain around 54% of world’s lithium resources. For comparison 15 OPEC members control almost 82% of world’s oil reserves. Yet for only 3 countries agreement on the level of outputs and its further monitoring would be much more manageable. Controversial question to put is, whether it is in the interest of Argentina and Chile for the significant Bolivian production to develop, as even if at the very beginning of the road now, Bolivia could potentially eclipse its neighbours and become a “swing producer” among the trio in the future. For Bolivia being landlocked, access to the ports to export lithium is of vital importance. Transport trough Chile as things stand, seem as the only viable option. It could be entirely possible for Chile to cut off Bolivian exports by simply introducing high tariffs on the border. Other neighbours with access to oceans either do not have well developed infrastructure (as Peru) or as it is in the case of Brazil the distances are much more considerable. However, it is also true that Brazilian state bordering with Bolivia – Matto Grasso is extremely well connected to ports due to voluminous exports of soya from there.

Such scenarios seem far away now, bordering on geopolitical fiction but considering the pace of development of EV and battery storage industries, societal change not only in developed but also emerging markets, where the pro-environmental changes can immediately bring tangible impact on general quality of life and legislative initiatives spurred both from the top and ground-up promoting EV use, we might be closer to them than we think.


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