Matt Gowing: Hunting for Profits in Rare Graphite
TICKERS: MT, AXE, CHGI, CLF, FMS, NGC; NGPHF, SRK
Source: Brian Sylvester of The Critical Metals Report (9/20/11)
Lithium-ion batteries may be named for the alkali metal they contain, but graphite is actually used in greater amounts. Mackie Research Strategic Metals and Clean Tech Analyst Matt Gowing says investors would be wise to shift their attention to this still under-the-radar electrical conductor. While lithium supply concerns have made for splashy headlines, the graphite market is quietly ramping up to meet increasing demand. In this exclusive interview with The Critical Metals Report, Gowing discusses mining operations poised to ease supply gridlock as well as how to measure a mine by the size of its flakes.
The Critical Metals Report: Matt, companies with graphite deposits are somewhat unusual in the mining space. What's the investment thesis for graphite?
Matt Gowing: I look at graphite from the perspective of high-tech, high-demand applications, such as the lithium-ion battery, which will see its penetration in the market significantly increase due to the proliferation of electric vehicles. The demand side of the equation is very interesting, but the supply side of the equation is even more interesting. It's little understood that there's approximately 15 times the amount of graphite in a lithium-ion battery as there is lithium. Many graphite mines have actually ceased production in the past five years due to dropping prices. However, more recently, there's been a strong price improvement in graphite as the supply has come down.
New, high-tech applications require more and more graphite production. In China, which produces 70% of the world's graphite, they're essentially running out as mines are depleted. They are extracting graphite from deeper in the mines, which increases operating costs and prices. There is a very severe need for new graphite projects to come online in the world.
TCMR: The highest grade of graphite—crystalline, large flake, which runs between 94% and 97% carbon—traded at a high of $1,350/Mt. (million ton) in 2009. How much does 1 Mt. of crystalline, large-flake graphite sell for now?
MG: Generally, the range of between 94% and 97% carbon can be characterized as the highest purity graphite. Prices are positively correlated with the large flake size. Then mesh size is considered. Large flake generally starts at 80 or higher mesh size.
For example, the price for plus-80 mesh, large flake with 94%–97% carbon purity has probably doubled over the past year and tripled in the past three years to $2,500-$3,000/ton. The market remains tight and prices will continue to trend higher. Graphite producers have strong pricing power.
TCMR: Could the market face the risk of another price drop if more projects come into production?
MG: Absolutely. Prices are going to be driven by the dynamic of supply versus demand, but new mines take a number of years to be completed. And not every mine will prove to be commercial. There could still be a prolonged period with strong graphite prices and moderate increases. However, our long-term modeling for graphite companies is conservative. We are taking into account increasing supply. After continued modest increases in the graphite price over the next few years, we are looking for prices to moderate in the order of magnitude of about 25% from where they are now.
That being said, different pockets of the market lack new supply prospects—in particular large-flake graphite, which is a niche within the industry. A lot of the mines coming online will produce medium, small-flake and amorphous graphite. We think it's quite possible that prices for large flake could remain higher and even increase despite increasing supply in general graphite.
Another price factor is synthetic graphite, which essentially comes as a byproduct from steel production. A lack of excess capacity can be used to produce the synthetic graphite in the furnaces where steel is produced. As a result, we've seen synthetic graphite prices dramatically increase toward about $20,000/ton. Synthetic graphite and natural graphite are not direct substitutes of one another, but in those markets where they compete, synthetic graphite prices have trended up. Synthetic graphite is a competitor of natural graphite in the next generation of batteries for the electric vehicle market. That's another very important market dynamic that plays positively into the graphite price.
TCMR: It's a rare commodity, indeed, where China is not a major pricing influence these days. Since China controls a majority of the supply and there are now concerns over supply gaps in the West, is graphite becoming a strategic resource targeted by governments?
MG: A lot of these governments have identified that need. The European Union identified graphite as one of the most critical on a list of 41 critical minerals in the world. This is a theme that, we believe, we'll start to see more.
TCMR: The lithium battery is one technology driving up the graphite price. What other graphite-related technologies are seeing dramatic growth?
MG: There are several. A lot of nuclear plants under construction in Asia are large users of graphite. There is a new technology within the nuclear plant industry called pebble-bed nuclear reactors that takes advantage of graphite's unique properties.
The solar industry also uses graphite. More and more fuel-cell applications are in development every year. The auto industry has also identified graphite as a substitute for asbestos in car brake linings. Sparks plugs have been another very important addition.
What's really exciting is the graphene industry, which may in itself be a few years away from coming up with any product that can be commercially produced with economic technologies. The graphene market is very exciting because of the potential applications in construction and medical devices.
TCMR: What are the differences between graphite and graphene?
MG: Graphene is basically a flat-lining structure of the carbon. It creates challenges for its production because the carbon elements never want to be flat lined against each other. Graphite naturally wants to bunch up into a 3D crystalline structure. Flattening out the carbon elements is really the challenge for the developers of graphene.
But if graphene can be economically produced, and if this is ultimately proven, it creates a very strong material that may even replace steel and concrete in many construction applications. There are a lot of other natural advantages to having graphite-based products within the construction industry. It's a very good conductor of electricity. It can withstand very high temperatures as well. It's been contemplated that graphene could play a very important role in heating buildings. It could play a very important role in conducting electricity and even capturing the energy from the sun in solar panels. It's a very exciting market.
TCMR: Graphite and graphene are, pound for pound, stronger than steel.
MG: Absolutely. There have been claims made in the industry that if the World Trade Center buildings had been made of graphene that the damage and destruction could have been reduced.
TCMR: How large is the global market for graphite right now?
MG: The market is about 1 Mt./year valued at about $2.5 billion. That breaks out into about 400,000 tons of natural graphite.
TCMR: What do you estimate the market worth could be in 2015?
MG: We believe graphite demand will grow. The battery industry should increase its consumption of graphite. We estimate that batteries currently represent about 10% of graphite consumption in the world. We think that segment of the market should have compound annual growth in the low double digits for the next 10 years. It could be driven higher than that if penetration of electric vehicles is higher than our estimate.
The rest of the graphite segments of the market should grow more in line with global gross domestic product. Considering all this, we expect consumption for graphite to grow at mid- to high-single-digit growth rates, somewhere around 7% compounded over the next 10 years.
TCMR: What are some essential characteristics of an ideal graphite deposit?
MG: The most important characteristic is if the mine can prove that it has a very high percentage of its graphite production coming from large flake. While China accounts for about 75% of the world's graphite production, very little of that is large flake. China has to actually import a lot of its large-flake graphite requirements, according to reports. A project with proven large-flake material will realize a higher value per ton produced and that positively impacts its gross profit margin per ton.
Second, we look for higher grades. Having higher grades allows less processing through the mill at a project and lowered operating costs. And the combination of a large percentage of large flake and very high grade—you can't get any better than that.
Outside of those elements, we look for features that are important to just about any mining investment: access to infrastructure, if the location is friendly for mineral development and if the project is scalable.
TCMR: You initiated coverage of Northern Graphite Corp. (NGC:TSX; NGPHF:OTCQX) in August with a speculative buy and a 12-month target price of $2.10. It's trading at around $1.10 now. What about this project makes you bullish on it?
MG: We're very excited about Northern Graphite. Its Bissett Creek project has the largest flake material ever produced in the industry that we've seen. We believe the value of its production is just under $3,000/ton. The grades are respectable at about 2.5%, implying operating costs of roughly $1,000/ton.
The project doesn't require a lot of capital, especially when you compare it to a lot of other mining projects outside of the graphite space. We believe the company can build the project for about $70 million (M) and be up-and-running in the second half of 2013, producing about 20,000 tons /year.
Another aspect that I like about the project is its ability to be scaled higher. It has recently reported the results from a 51-hole drilling campaign that are highly encouraging.
TCMR: What about its NI 43-101?
MG: That's the catalyst that should be out in the next several weeks to months. The NI 43-101 is going to summarize the drilling program, but the company has already released the assay results in a press release. The results show that it is a highly continuous deposit. It has grades that fairly tightly trend right around 2.5%.
More of the inferred resources may be upgraded to indicated. Some of the indicated resources may be even upgraded to measured. But what's really exciting to us is that the holes extend to the north from the current core zone. We think this deposit will ultimately show the market that it can be scaled higher and, within the next few years of the project coming to production, the company could significantly increase production and even double the production. The fact that these holes are extending northward and extending the zone is highly encouraging.
TCMR: The preliminary economic assessment had a resource of 14.7 Mt. indicated and approximately 18 Mt. inferred. Would that be considered a large resource by global standards?
MG: It would probably be considered a medium-size deposit within the graphite industry. That level of resource would really be enough to support a graphite mine producing 40,000 tons/year for roughly 20 years. An average-size graphite mine is probably from between 20,000 and 40,000 tons/year. The largest mines in the world are producing roughly 80,000 tons/year.
TCMR: Does the company have other potential drivers for appreciation?
MG: An aspect of Northern Graphite that's fairly exciting is the potential construction of an anode-material plant. An anode-material processing plant is going further down the value chain within the graphite industry and not simply selling a run-of-mill graphite product, but upgrading it to what's called battery-grade graphite. To do that, graphite from the mill at the mine is essentially upgraded through an anode-material processing plant. It significantly increases the value of that tonnage by over three times at a relatively low marginal cost. If Northern Graphite does, in fact, pursue that line of expansion, it could add $1 or more of net-present value to our $2.10 target price.
TCMR: This is an operation that is in far northern Ontario. Generally speaking, people don't like large, open-pit mines in their backyards. What's the political and public sentiment toward this operation?
MG: I think you raise an important point. There's always the not-in-my-backyard sentiment for any type of industrial facility. If you take a look at Northern Graphite itself, the Bissett Creek mine actually was an operational mine at one point in its history. It didn't produce that much graphite, but it was in production. There were some issues around the recovery process and the method that was developed to process and mill the graphite. There was a dry recovery process that was tested and attempted by previous operators. Now Northern Graphite is using a wet recovery process, which is more traditional, lower risk and proven out. It's very important to note that this was a project that had received all of the required permits in the past, and we believe that's a strong case that it should again get those required permits to get the project operating.
TCMR: You recently had a site visit to the Focus Metals Inc. (FMS:TSX.V) graphite project. The company claims to have the largest "technology graphite resource in the world" at 17% grade technology graphite.
MG: It doesn't have an NI 43-101 resource report, but it has completed a lot of its drill work. There are analyses by assay labs that are currently being conducted and an NI 43-101 is planned for the not too distant future. It's believed that that grade is going to be proven out. There have been a couple of feasibility reports done on the project about 15 years ago. That was the grade that was defined on the project then.
The production is not as large flake as Northern Graphite—it's quite a bit smaller generally speaking—but there is a large percentage of the project that can be sold into the electric vehicle industry and other technology markets. However, 100% of Northern Graphite's production will qualify for that technology industry.
I think the important thing to remember on Focus Metals is that it is very high grade, and this is going to translate into a lower operating cost. But the fact that it is smaller flake will detract from its average selling price. It's going to have an average selling price lower than Northern Graphite. I think both of the projects are very interesting and they both offer very attractive ways to play the graphite market.
TCMR: What were some of your thoughts during your visit there?
MG: The site is located in Northern Quebec, about an hour-and-20-minute drive south of Labrador City. It's a stone's throw distance from considerable mining infrastructure in the area.
ArcelorMittal S.A. (MT:NYSE), one of the largest mining companies in the world, is nearby. It has what I believe to be the largest open-pit, iron ore mine just outside of Wabush, Quebec. Cliffs Natural Resources Inc. (CLF:NYSE) also has a very large, open-pit, iron ore mine in the area. These are operations that employ thousands of mining professionals and mining laborers. The ArcelorMittal mine has been in operation for 50 or 60 years. A lot of the infrastructure is there. This is only going to benefit Focus Metals when it ultimately builds its project.
I think another thing that really struck me at the mine site was a visual look at the rocks. You're able to split them open with your hands and visually see the high-grade graphite. That bodes well for the project.
TCMR: Something unique to graphite and rare earths is that the companies really need people who understand the end uses and the markets for these particular elements and metals. Does the management team of Focus bring that to the table?
MG: Yes, I think so. The management team is one of the most important factors when you're evaluating a mining company. I believe both Northern Graphite and Focus Metals have a very strong knowledge of the graphite industry. They also have put together teams that are very rich in resource development experience and have a track record.
TCMR: What are some other companies in this space that are exciting?
MG: Ontario Graphite Ltd. is a privately held miner, which has the graphite project adjacent to the west part of Algonquin Park. It's probably the most-advanced Canadian graphite project that's being put back into operation. I find this company interesting because it can be back up and producing graphite with a relatively small capital investment.
There are also some considerably early-stage companies in the graphite industry, some of which are private. MEGA Graphite Inc. and Archer Exploration Ltd. (AXE:ASX) both have Australian-based graphite projects.
Last week, we saw a transaction within the graphite space. A company called Strike Gold Corp. (SRK:TSX.V) agreed to acquire mining rights to a couple of graphite projects in Saskatchewan.
There is also a Chinese company trading in the U.S. called China Carbon Graphite Group Inc (CHGI:OTCQB) that has graphite processing facilities producing advanced, value-added graphite products and marketing them worldwide.
TCMR: Do you have some practical advice on investing in graphite plays that you can leave our readers with?
MG: In this particular market, I think investors want to focus on projects that are more advanced and have visibility to get to production and line up the customers. Having those relationships with the markets and consumers of graphite is going to be a key variable in sourcing capital.
TCMR: Are we going to see that in the form of offtake agreements or other contracts?
MG: I'm looking for some agreements similar to what we saw in the lithium industry. A lot of the lithium developers partner up with the large lithium users. The world's largest automotive companies are realizing they need to position their companies to take advantage of the vehicle electrification trend. They have to secure access to long-term sources of lithium now.
The financing structures that we've seen in these lithium partnerships should be very similar to what unfolds in the graphite space. That's going to be very exciting for all the graphite companies.
TCMR: Thanks Matt; this has been very informative.
Matt Gowing is a research analyst covering strategic metal and clean tech. Gowing joined Mackie Research in 2008 as a research associate, assisting in the industrial products group. Matt has over seven years of investment experience, including investment management, research and banking in several industries, including diversified industries, consumer products, oil and gas and income trusts. Previously, Gowing worked at London Capital Management as an investment analyst, helping to manage both U.S. and Canadian equity funds as well as co-op terms at Blackmont Capital (then First Associates) and Scotia Capital. Gowing completed his B.A. (Honors) in Business and Administration at Wilfrid Laurier University and is also a CFA Charterholder with the CFA Institute.