TCMR: Let's move to the market's sour take on graphite plays. Is that specific to graphite or is it part of the larger trend?
CB: It is not specific at all. There has been a predictable pattern with share price appreciation of certain metals and minerals in recent years. Uranium went to $140/pound and collapsed. Lithium took off and then came back down to earth. Most recently, REE prices went parabolic, and have since come down. Graphite has followed the same pattern. Some people call this the "mystery history" curve when a company's share price rapidly appreciates due to investor excitement and then falls as the company matures from exploration to development to possible production. We wrote a Morning Note several months ago discussing this and basically stating the case that the mystery phase associated with graphite was over and now the companies in the space would need to begin the process to defining and developing a resource, proving economics and making the push towards production.
Regarding graphite, investor exuberance more than anything pushed shares higher and interest in graphene must also be mentioned. In addition, global growth rates and industrial demand have been falling for months. Graphite is an industrial mineral, so as we've seen growth slow, intuitively graphite prices must soften as well. On the positive side, graphite does offer multiple avenues of demand. In addition to current-day demand from refractories and steelmaking, you have future avenues of demand like fuel cells and batteries. I think this paints an overall positive longer-term picture for graphite demand.
When analyzing a given metal or mineral, I spend just as much time researching end users as I do researching juniors. Despite the uncertainty in various economies, long-term deals involving graphite are occurring. Earlier this year, SGL Carbon and ArcelorMittal S.A. (MT:NYSE) signed a five-year deal worth several hundred million dollars for SGL Carbon to supply graphite electrodes to ArcelorMittal. This was the biggest contract in SGL's history. This is only one example, but is indicative of a strong future for graphite.
TCMR: You talk a lot about graphite companies having a balanced footprint. What does that mean?
CB: Think of the footprint as the composition of a given deposit. There are different types of graphite—flake, amorphous and vein—and flake is comprised of different sizes. Generally speaking, the supply-and-demand dynamics are different for the various types and flake sizes and they all command different prices on world markets.
When I look at a graphite project, I want to get an idea for what the actual composition is, what the percentages of large, medium and small flake are and what the carbon content is. This gives me a rough idea of the potential economics.
To be fair, many of the junior mining companies involved in graphite have not done enough drilling on or analysis of their properties to know what the footprint actually looks like. However, with the "mystery" phase of graphite behind us, it is crucial to understand this information about a deposit.
TCMR: Does the graphite space need more companies reaching the bankable feasibility stage, like Northern Graphite Corporation (NGC:TSX.V; NGPHF:OTCQX), or is it more important that companies reach agreements with end users?
CB: The more information we know about a deposit, the better. I think a graphite company would have trouble securing an agreement with an end user without a bankable feasibility study or a great deal of due diligence. Graphite is a product requiring high degrees of specificity in terms of purity. End users would naturally want proof that a mining company can produce graphite to their very strict specifications before entering an agreement. Failure to do so would interrupt and perhaps halt an end user's supply chain.
TCMR: But end-user agreements have been signed throughout the REE space with far less than bankable feasibility studies.
CB: This is because China owns the entire REE value chain from "mine to market." This is not the case with graphite. Though China controls upwards of 80% of global graphite production, there exists a viable graphite supply chain outside of China, so you don't see the same urgency with graphite that you do with REEs.
TCMR: What are the top three crowd scores in the graphite space on DIS?
CB: There are no surprises here: Flinders Resources Ltd. (FDR:TSX.V), Northern Graphite and Focus Graphite Inc. (FMS:TSX.V) are the Top 3.
With respect to Flinders, the crowd seems most impressed with its management and financial soundness. The company has $18 million (M) in the bank and is working towards bringing its 100% owned Kringel graphite mine back into production. The fact that this is an existing mine is key as the company's capital expenditures and infrastructure costs will be relatively low.
The crowd has ranked Focus Graphite's asset potential and financial soundness as its best attributes. The Lac Knife deposit is one of the highest-grade graphite deposits in the world and its location in Quebec is also key, as it is no secret how favorably the provincial government looks upon mining exploration there. The refunding of exploration expenditures can help defray dilution and strengthen a company's share structure.
With Northern Graphite, the crowd has ranked management's capability and the asset potential highest. Bissett Creek is lower grade than most deposits out there, but it is big and highly scalable.
TCMR: What is the timeline to production for Focus?
CB: It is aiming for production in late 2013 or early 2014. I think the ultimate goal is to be able to produce 20 thousand tons (Kt)/year of 95% graphite, although I assume the company will ramp up to this amount rather than producing 20 Kt in year one. Focus' next big catalyst is the release of its preliminary economic assessment. Lac Knife is a high-grade deposit, so we think the costs-per-ton are pretty favorable, and so the market is waiting to see confirmation of the initial economics. Strong economics and good metallurgical results are the keys here.
TCMR: Focus says it will be producing for about $350/ton (t), which would be quite low.
CB: It would be at the lowest I have seen, and puts Focus in a position to compete with the Chinese. At the end of the day, this is what matters. It's really not accurate to say that Focus, Northern Graphite and Flinders are competing against each other because they aren't. They're competing against the lowest-cost producers—those who are in China currently.
TCMR: Flinders' biggest advantage seems to be that it is in Europe.
CB: Yes, Flinders has a readymade market right in its backyard. It has a historical resource estimate of about 8.8 million tons at about 6.5% graphitic carbon. Flinders plans to release an updated resource estimate in the next month or so. That will tell us more about the footprint of the deposit and some potential economics. There are graphite mines in Norway, Germany and Austria, but there is a place for Flinders.
TCMR: Does Northern Graphite's Bissett Creek deposit have a balanced footprint?
CB: Yes, its footprint is slanted toward higher-value graphite. When you look at graphite, you want a deposit that has predominately jumbo and large flake. That is because the highest-value graphite is actually spherical. You can reduce jumbo flake into a spherical shape, but you cannot take smaller flake and "upsize" it.
TCMR: Northern Graphite recently put out a release saying that it has created spherical graphite.
CB: Yes, the company has developed a proprietary process for creating spherical graphite and is working with Hazen Research and the National Research Council of Canada on continuing these tests and optimizing the entire process. For an additional $10M in capex, Northern Graphite can build a spherical graphite plant and I think this is sensible as it allows the company to capture the highest additional margin.
TCMR: When will Northern be in commercial production, and it will be rerated then?
CB: Its plan is to be in commercial production in 2014 and will ramp up production from there. I think it will be rerated between now and 2014 as the company has to raise $100M for capex and secure offtake agreements—two big challenges even in the best of times. However, successfully accomplishing these goals should give the share price new life, subject to the details.
Chris Berry, with a lifelong interest in geopolitics and the financial issues that emerge from these relationships, founded House Mountain Partners in 2010. The firm focuses on the evolving geopolitical relationship between emerging and developed economies, the commodity space and junior mining and resource stocks positioned to benefit from this phenomenon. Chris holds an MBA in finance with an international focus from Fordham University, and a BA in international studies from The Virginia Military Institute.