Consumer demand for iPads and smart phones is on the rise, and electric vehicle sales could jumpstart in the near future. Pinpointing production spikes is no simple task, but Economist Daniela Desormeaux of market intelligence company signumBox has plotted some important points in lithium’s demand timeline. In this exclusive interview with The Energy Report, Desormeaux highlights growth areas in the industry and explains why small-cap lithium producers will have room to compete with the big boys.
The Energy Report: The fourth annual Lithium Supply & Markets Conference in Argentina took place at the end of January. What was the mood at that time?
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Daniela Desormeaux: At that time, people were thinking about how the situation in Europe would impact the industry. I think we have more information about that now, but in January we did not. Regardless, the main drivers behind lithium demand are relatively independent of the economic cycle, and what we see is demand continuing to grow at a healthy rate despite the current situation in Europe. People in the industry know that the main driver of lithium demand is batteries. In the short-term, the economic cycle obviously affects the lithium industry, but from a long-term view I think expectations remain optimistic.
TER: We saw some lithium price increases in mid-June of 2011 when FMC Lithium Corp. (FMC:NYSE) and Chemetall (a unit of Rockwood Holdings Inc. [ROC:NYSE]) said that they were raising prices on both lithium hydroxide (LiOH) and lithium carbonate (Li2Co3). Will prices continue stronger, or will they stabilize?
DD: Well, lithium pricing is very interesting to follow because it’s not just about the balance between demand and supply; it’s determined by what the main lower-cost producers decide to do with prices, which then impacts the rest of the industry. That’s the pattern we have seen in the past. FMC and Chemetall did raise prices, and I think they had two reasons for doing that. One is that producers are facing higher raw material costs. The other thing is that FMC and Chemetall are both making some investments in the U.S., and FMC is making investments in Argentina. They need higher prices to justify financing these investments.
Also, it’s important to distinguish between nominal prices and real prices, inflation being another source of price pressure. But short-term prices may be stronger because of inflation and these new investments. prices should remain stable in the mid- to long-term because even as demand is growing, new production is coming into the market. This will help balance the market.
TER: When it comes to pricing individual lithium products, are grade and purity the most important factors?
DD: Yes, battery-grade lithium requires a small particle size, and to reduce particle size producers need more processing and energy. That increases costs. Therefore, battery-grade lithium carbonate is more expensive than commercial-grade lithium carbonate. Buyers have to pay for more purity.
TER: A recent article in Bloomberg Businessweek, “IPad Boom Straubs Lithium Supplies After Prices Triple,” was a very positive story, and it moved the market on small-cap lithium stocks. Is this a sign that the lithium market is beginning to wake up?
DD: I think the industry has already awakened. We have seen a lot of global interest in lithium over the last five years. But my fear is that in some cases there is an overestimation of lithium demand. Lithium is going to be important now and more important in the future because of its use in batteries for electric cars among other things, but it won’t replace oil.
TER: Could these overly robust demand expectation lead to a supply glut?
DD: In the past, the industry has overestimated demand, and that’s why we saw something like 90 projects in the works at one point. But it’s impossible for all of these projects to be part of the lithium supply because there is not enough demand in this space for everyone. Thus, most of these projects did not reach production.
TER: Nonetheless, demand is actually growing. The question is, at what pace?
DD: The lithium industry has a very promising future, and we think demand will grow at about 8% per year. But it’s also important to have a very realistic perspective about the industry.
TER: Daniela, aren’t component makers in transition now from nickel-metal hydride batteries to lithium-ion batteries? How significant is this shift?
DD: The replacement in the electronic-devices segment is largely already done. That happened in the nineties when Sony Corporation (SNE:NYSE) introduced the first lithium-ion cell. It took less than 10 years for lithium-ion batteries to take 90% of the market. But there is some new demand as well: because of environmental issues, China is prohibiting the use of acid batteries in motor scooters or bikes, so light electric vehicle makers are being forced to change from acid batteries to lithium-ion batteries.
TER: Are we back to pre-recession demand levels for lithium?
DD: I think this industry is really very interesting in that regard. Despite the recession, some expect the battery industry to grow 20% this year. By the end of the year I think that total demand will be higher than previous levels.
TER: Where are we now on the demand curve for lithium? At the foot? Near the peak?
DD: We are getting close to a breaking point. This will occur when electric cars become affordable for many consumers. We have seen this happen in some countries where there have been lots of subsidies, but it’s difficult to believe that European governments will continue with these subsidies, given economic conditions. But the numbers could be amazing. For example, the iPhone contains something like 5 grams (5g) of lithium carbonate while a battery for a car can have 30 kilos (30kg) of lithium carbonate in it. The difference in the numbers is huge. I do think we are approaching a change in the growth trend—a breaking point.
TER: When will we hit that inflection point?
DD: That’s a very good question. I think it will be after 2015. The situation in Europe will impact the uptake of electric cars. There are also some analysts who believe that China is slowing down as well. We’ll have three or four years before we see a massive taking off of the lithium-ion battery industry. It may be sooner or later depending on the economic situation, of course, but I think we are approaching it.
TER: Can small-cap lithium companies compete with the large companies on scale and margin?
DD: I think the answer is yes, because so far what we have seen is the big three lower-cost producers (Chemetall, FMC and Sociedad Química y Minera de Chile S.A. [SQM:NYSE; SQM-B:SSX; SQM-A:SSX]) are giving the space for newcomers to enter the market. Years ago, I did not think they would do that. I thought they would lower prices to where most of these new projects couldn’t be profitable. For example, if the big three lowered prices to, say, $2,000 per metric ton ($2,000/mt), most of these new projects wouldn’t be profitable. But they haven’t done that. That’s a signal that they are giving room to these newcomers to enter into the market because the demand is growing and the supply, so far, has not grown at the same rate. Smallcaps will have a chance, but of course they will have to compete against each other because room for new companies is limited. If too many come into the market, prices will start to go down, and that of course will impact those smaller companies. Ultimately, I think that the market will be balanced and the lowest-cost new producers will be part of the supply chain.
TER: Lithium equities’ performance has been very weak over the past 16 months, even with this recent uptick in lithium prices. With the exception of the Galaxy Resources Ltd. (GXY:ASX) and Lithium One Inc. (LI:TSX.V) merger that is happening now, why aren’t we seeing more consolidation?
DD: This global economic situation has had an effect on almost all publicly listed companies. The lithium industry is especially sensitive to that. On the other hand, the economic situation is very much related to what has happened with oil prices, and the oil price is very important to the uptake of electric cars. It is very important to know how the industry works and what the main forces are. We see the main trends in the lithium industry pointing to a very promising future. For example, we have seen many new large-scale energy storage projects that use huge batteries. This will represent an important source of demand, as will electric bikes in China.
TER: You have recently said that demand for lithium hydroxide would grow from 20% of lithium commodity consumption to 30–35% of lithium consumption by 2020. How can investors play this growth in lithium hydroxide demand?
DD: That’s a very interesting question because the market for lithium hydroxide is mainly for lubricating grease. New batteries are being developed, the lithium-ion phosphate battery, for example, that use lithium hydroxide instead of lithium carbonate. So, we expect a higher growth rate for lithium hydroxide than for lithium carbonate in the case of batteries. And this is very interesting for the companies that plan to produce lithium chemicals from spodumene (pegmatites), because the process of producing lithium hydroxide or lithium carbonate from lithium concentrate (obtained from spodumene) is very similar in terms of costs. Chinese lithium chemical producers can either produce carbonate or hydroxide directly from the concentrate. This gives them an advantage over brine producers because SQM, Chemetall and FMC have to produce the lithium hydroxide starting from the lithium carbonate.
TER: My understanding is that lithium hydroxide is the choice of some manufacturers, including Chinese battery and car manufacturer BYD Company Ltd. (BYDDF:OTCBB), of which Warren Buffett owns approximately 10%.
DD: That’s correct. BYD is working on the lithium-ion phosphate battery, which uses lithium hydroxide in the cathode, and I think this company will be a very important player in the future. Its K9 electric bus is being tested in many cities and if successful it will represent an important step towards the electrification of transportation.
TER: Daniela, what do you tell investors who want to invest in lithium?
DD: You have to look at the battery industry, because it is going to be crucial. Today it represents 30% of total lithium demand and we estimate that in 10 more years, it will represent about 50% of the demand. So far, there aren’t any substitutes for lithium in batteries. But who knows what will happen in the future. In any event, the lithium industry shows a very promising future, and among all of the commodities it represents one of the highest expected rates of growth.
TER: Thank you, Daniela.
DD: Thank you. I enjoyed it.
Daniela Desormeaux is an economist and an expert in industrial chemicals and natural resources. Prior to starting with signumBox, she was strategic marketing manager at SQM, where she was responsible for market intelligence on lithium, iodine and other industrial chemicals.
Lithium is lightest of all metallic elements, with low density and high electrochemical potential. These are essential characteristics that make the element especially suitable for use in various power-storage applications, including electric vehicles (EVs). In this exclusive interview with The Energy Report, Equity Research Analyst Mansur Khan of Dundee Capital Markets talks about his favorite junior lithium stocks that he expects to be major beneficiaries of dramatic growth in lithium-ion battery demand over the coming decade.
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The Energy Report: EVs don’t burn gas, but power must come from some source of fuel, such as nuclear, coal, hydro, gas, solar, geo or wind. So, what is the value of an electric vehicle (EV)? How does it help?
Mansur Khan: From a societal and governmental point of view, there are a number of benefits. EVs can really help reduce carbon emissions. Their energy efficiency is very high, sometimes over three times that of conventional combustion engines. I think it can be argued that, even assuming an EV uses a power-generating mix that includes carbon-emitting sources such as coal- or gas-fired power plants, its life-cycle net carbon-emission production is significantly less—anywhere from half to one-third of that from comparable combustion vehicles. Reducing our dependence on oil is another concern, although it’s more geopolitical. I think there is a top-down push to essentially steer the automotive industry into adopting electric vehicles.
Finally, from the end-consumer point of view, the operating cost of an EV is expected to be significantly less than an internal combustion vehicle. On average, they are about one-third the cost on a per-mile basis.
TER: In January, General Motors Inc. (GM:NYSE) announced that it would be producing 60,000 (60K) Chevrolet Volts per year, beginning this year. Does this signal a new wave of EV or hybrid development? How positive is this for lithium consumption?
MK: GM’s commitment to the EV model is reflective of what you’re seeing across the board with major auto manufacturers rolling out some form of an EV model in their lineup.
Aside from GM and Toyota Motor Corp. (TM:NYSE), Hyundai Motor Co. Ltd. (HYMLF:OTCPK), Nissan Motor Co. Ltd. (NSANY:OTCPK;7201:TYO), Volkswagen AG (VLKPY:OTCPK)—all the majors have announced their own models. And when you look on the battery side, you’re seeing considerable research and development (R&D) investment going into battery manufacturing and technology development. Majors like Chinese battery and car manufacturer BYD Co. Ltd. (BYDDF:OTCBB), of which Warren Buffett owns approximately 10%, and BASF Corp. (EUR53.17:XETRA) are making inroads into the technology’s development.
To answer your question, this is of course positive for lithium demand and consumption. Industry consultancy SignumBOX put out an estimate that electric and hybrid electric vehicles made up about 5% of total lithium carbonate equivalent (LCE) consumption in 2011, and that’s expected to grow to about 25% by 2020. So there’s quite a bit of room for growth there. The industry still has a long way to go, but in general, it’s absolutely positive.
TER: Mansur, what is the lithium-ion battery industry’s biggest challenge right now?
MK: The industry’s main challenge is really to scale up in size, from the small consumer electronics to the larger batteries required for EVs, and to be able to do this without compromising on cost, safety and longevity. Technological development may not be happening as quickly as people had expected a few years ago, but it is certainly happening, and I think you will see these growing pains addressed over the coming years as other derivative applications are opened up.
As manufacturing capacity continues to expand, the cost of these lithium-ion batteries will come down, and that is already happening. A few weeks ago a Bloomberg report said the cost of lithium-ion batteries fell 14% year over year, and has fallen about 30% since 2009.
TER: Your February 2012 report cited a third-party consultancy firm, Roskill, which found that lithium consumption has outperformed both industrial production and GDP trends since 2002. But I don’t see that reflected in equities. An index of small-cap lithium stocks shows a 40% decline over the last 10 years. A mix of larger- and small-cap companies is down 30% during the same period. Can you talk about the disconnect here?
MK: Without knowing the specifics of this particular index, I think I can make some general comments. Our view on this is that there are two aspects at play here, and both stem from the global recessionary environment that we are in.
Against this backdrop and coupled with slower technology development, we have seen a slower-than-expected uptake of lithium-ion batteries and EVs. The consensus view still holds that you’re likely to see a mass adoption of EVs by about 2015 and thereafter. We argue that the equities are taking a bit of a wait-and-see approach to this, and so that would probably be one aspect of why they have not done so well. EVs currently make up only a small part of the overall lithium market, as just mentioned, but they are expected to really drive the majority of the growth over the coming decade.
The second aspect is more directly linked to equity markets in general. As you know, stock markets dislike uncertainty and volatility, and unfortunately we have plenty of both right now. In this kind of risk-averse environment, small-cap stocks can face the additional challenge of financing their exploration and development projects without causing a lot of dilution. So there’s a bit of an added risk that is reflected in small-cap performance. We think these factors explain why the equity markets have not really kept pace with the underlying growth and demand for lithium that we are seeing.
TER: You’ve written that the lithium market is currently in a tight supply-demand balance, and that this has prompted capacity expansions by three of the four major lithium producers. You also wrote that prices have stabilized in the $5,500–6,500 per ton (/t) LCE. I realize there are different lithium compounds, but do you foresee a futures market for lithium?
MK: I think it’s too early for that. You would need a market sizeable enough to maintain a spot supply inventory. Right now, what we are seeing is that most of the supply and demand is on a contract-by-contract basis, and these are typically one-year contracts. There isn’t much of a spot market to speak of, and until you have a secondary market open up, you are unlikely to see a futures derivatives market develop.
TER: Looking at the lithium equities market today, do you see it as a deep-value market? Or do you see it as a growth market? Are we at the foot of a growth curve?
MK: Going to the question of growth, I think that’s definitely there in our view. The majors have been reflecting that, not just in what they’ve reported, but also in their outlooks. If you peruse through some of the recent commentary by the majors, they are all reporting strong growth in volume and prices, and in general they expect real growth in lithium demand to continue—anywhere from 6–11% by 2020. So that’s a fairly healthy growth in demand. If you look at Talison Lithium Ltd. (TLH:TSX; Not Rated), for example, it is saying that the lithium market will almost double by 2020, and that’s even excluding the EV component that you hear so much about. So that’s definitely positive, and there’s growth absolutely happening there.
TER: What lithium equities are you recommending to investors?
MK: When you’re looking at the juniors, we believe that only companies with quality assets that are in advanced stages or have strategic backing will have a reasonable chance of making it to production.
I would highlight Nemaska Lithium Inc. (NMX:TSX.V; NMKEF:OTCQX). We have it rated Buy, Speculative Risk with a $1 target price. Unlike the brine developers in Argentina and Chile, this is a hard-rock developer based in Québec. Its Whabouchi property project has a Measured and Indicated resource estimate of 25 million (M) tonnes (metric ton or mt) grading at 1.54% lithium oxide. It also has an Inferred resource of 4.4Mmt grading at 1.51% lithium oxide.
The company is envisioning a two-phase strategy. Phase one will see production of 200K tonnes per year (tpa) of lithium concentrate. This is concentrate, not carbonate, at about a 6% Li2O grade. The operating cost is about $138/t of concentrate. And the preliminary economic assessment (PEA) from last year had an initial capex of $86M for the project.
Phase two essentially envisions a chemical conversion plant that would produce higher-value downstream chemicals, and in particular they’re looking at lithium hydroxide. The PEA on this option was just commissioned. It has also done some pilot-level testing that shows some innovative departures from the conventional process used to produce lithium hydroxide, and the company is going to be filing for a patent on this pretty soon. This could be an interesting development.
Both the definitive feasibility study (DFS) of the concentrate production and the PEA are expected to be out in Q3/12. The company has a strategic partner behind it, Chengdu Tianqi Industry Group Co., the largest lithium battery material supplier in China, which owns 20% of Nemaska. Tianqi recently entered into an agreement with Targray Technology for international distribution of lithium compounds in North America and Europe. We see Nemaska fitting in quite well with this strategy.
Another thing we like about Nemaska is that it’s located in a mining-friendly jurisdiction of Québec, which is trying to build a world-class EV industry by supporting R&D and bringing mining companies and strategic partners together. And of course you could argue that the open-pit conventional mining process has less mining and processing risk. Also, there are a couple of upcoming milestones, the DFS and the PEA. So we like that name.
TER: Another company?
MK: Going over to the brine-developer world, I would highlight Rodinia Lithium Inc. (RM:TSX.V; RDNAF:OTCQX). We have it rated Buy, Speculative Risk, with a target price of $0.80. This is a lithium brine developer with its flagship 100%-owned Diablillos project in the province of Salta in Argentina, which hosts resources of about 5 Mmt of LCE and is adjacent to one of the largest lithium producers in the world, FMC Lithium Corp.’s (FMC:NYSE; Not Rated) Hombre Muerto project, which has been producing for decades.
Diablillos is also adjacent to Lithium One Inc.’s (LI:TSX.V) Sal de Vida project. As you know, Lithium One is currently in the process of being acquired by Galaxy Resources Ltd. (GXY:ASX; Not Rated), which has a wholly owned lithium carbonate plant in China. So that’s definitely an interesting development in the area. Diablillos has high lithium and potassium grades and low impurities that could enable economic extraction, and the PEA put out last year suggests robust economics. With cash costs coming in at a bit over $1,500/t of LCE, along with a strong potash byproduct credit potential, the company is envisioning production of 15K tpa of LCE. Aside from the flagship project, Rodinia also has a brine project in Nevada adjacent to Chemetall Foote’s [subsidiary of Rockwood Holdings Inc. (ROC:NYSE)] existing project there.
But despite all this, the company trades at a large discount to its brine-base developer peers. We estimate an enterprise value of about $3/t, compared to the average of about $10/t. We would say that part of this has to do with Rodinia’s relatively early-stage project and tight cash position. That’s a risk, given the nature of current markets. Management is being prudent with cash, but it is steadily moving the project forward. Also, it does have the Chinese company Ningbo Shanshan Co. at its side.
TER: You said your target on Rodinia was $0.80. You have just taken that down from $0.90, is that right?
MK: That’s correct. We put out a commodity update at the end of every quarter where we go back to the drawing board and look at foreign exchange (FX) rates and commodity assumptions. So part of the discount was about the FX, and the other part is that we are applying a slightly higher discount to the brine developers in Argentina due to the investment climate resulting from expropriation of Argentina’s largest energy company, YPF from Spain’s Reposol.
TER: You mentioned Rodinia’s neighbor producers. You must be implying potential M&A.
MK: Yes, and overall, what we like about this story is that the company has a salar that it is not sharing with anyone else, and it will potentially have two large lithium producers right in its backyard, FMC and potentially Galaxy, both of which have talked about expansion. The company has a strong management team, and both CEO Will Randall and head of exploration Ray Spanjers have extensive experience in managing projects. And Ray actually was previously with FMC’s lithium division.
TER: Another company?
MK: The second brine company that I would highlight is Lithium Americas Corp. (LAC:TSX; LHMAF:OTCQX). We are rating it a Buy, High Risk with a target price of $2.60. Now this is a more advanced brine developer, located in the province of Jujuy. Its Cauchari project hosts a high-grade resource of 8Mmt LCE. It’s had extensive pump tests, pond- and pilot-level tests, as well as hydrological work done, and the company is currently on the verge of putting out a DFS on the project. It’s also interesting to note that the DFS will trigger a decision by its strategic partners, Mitsubishi Corp (8058:TYO) and Magna International Inc. (MG:TSX, Not Rated), who have the option to secure 37.5% of lithium production in exchange for financing up to 37.5% of capital costs. So that’s definitely a good arrangement to have in this kind of market.
Lithium America’s PEA from last year had estimated low cash costs of about $1,434 per ton, based on 20K tpa of phase one production. And of course one common theme with these brine projects is that, given their low impurities, there’s strong byproduct credit potential. There’s good infrastructure in place. And as I said they’re currently working through the final project approval from the province of Jujuy, which should be another catalyst for the stock. By the way, the province of Jujuy had essentially designated lithium as a strategic metal last year, and both Lithium Americas and Orocobre Ltd. (ORL:TSX; ORE:ASX) are currently working out approvals here.
Orocobre will be the last one I’ll mention today. We have it rated Buy, High Risk with a target price of $2.80. This is the most advanced brine development project in our universe of coverage. Immediately north of Lithium Americas’ Cauchari project is Orocobre’s flagship Olaroz project, which also hosts a high-grade lithium resource of 6.4 Mmt of LCE. The company already has a DFS out on the project, and the cash costs are estimated at $1,512/t of LCE, and once again, given the low impurities, there is potential for byproduct credit.
A production rate of about 16K tpa is expected by the second half of 2013, and at the end of last year Orocobre finalized terms with its strategic partner, Toyota Tsusho Group (TYHOF:OTCPK). This will essentially enable Toyota to take an equity stake of up to 25% based on the project’s net present value (NPV) estimated from the DFS. This also includes debt financing by a Japanese consortium for 60% of the project capex, which is a bit over $200M. So the final sign-off on these financing agreements would occur once the Jujuy provincial approval comes through.
TER: I’ve enjoyed meeting you very much, Mansur.
MK: Thank you very much, George, I really enjoyed the interview as well.
Mining Analyst Mansur Khan joined Dundee Capital Markets in 2007 as an associate covering the industrial, aerospace and special situation sectors. In late 2010, he switched into Dundee’s mining group, where he covers a range of exploration and production companies in the uranium and lithium sectors. Since 2012, he has been providing lead coverage on the lithium sector. Prior to Dundee, Mansur worked for a number of years at a private design engineering company on various information systems and operations projects. He holds an MBA from the Rotman School of Management, University of Toronto and a Bachelor of Commerce in systems development from Ryerson University.
George Ireland, portfolio manager with Boston-based Geologic Resource Partners, believes in seeing what he invests in and his passport bears witness: 80 countries visited in five years. From Africa to Argentina, from gold to lithium and graphite, he and his team seek out companies with experienced management, promising geology, good infrastructure and strong cash flow. Ireland shares his views on issues facing the mining industry in all corners of the world in this exclusive Gold Report interview.
The Gold Report: Your grandfather was a mining engineer. Your father founded a coal company. You are a geologist, worked with Cliffs and ASARCO and are on the boards of several mining companies. How much of your success at Geologic Resource Partners do you attribute to your business acumen and how much to your relationships in the industry?
George Ireland: Having grown up in a mining-oriented family, the dinner table conversations from an early age steeped me in the lore and intrigue of business. Based on that early interest, I have built up quite a book of relationships and a broad knowledge over the years, but I attribute a lot of the opportunities that have come my way to hard work and perseverance in an industry that was, for quite a long time, out of favor.
TGR: What wisdom did you pick up at the dinner table that you use today?
GI: One of the first things I learned was to see for yourself what you are investing in and who you are investing with. The second—and I give this advice to companies that we invest in and to other fund managers—is to talk to your investors, to the people who are giving you their faith and money.
TGR: Does that mean you make regular site visits to projects?
GI: My team and I have visited about 80 countries over the last five years.
TGR: What are your “must-sees” on a site visit?
GI: Typically, we are looking at the lay of the land: how the project sits in the political jurisdiction, the social environment, the environmental issues. We look at management, from the senior level down into the junior ranks. We want to know if they are capable of performing the work they are being asked to do. We look at the assets themselves, reviewing public information found in various documents such as NI 43-101s. We look extensively at the drill cores, site and plan maps and other data to assess the quality of work being performed with regards to our own assessment of value of the company.
TGR: Do you expect your clients to meet a certain annual performance threshold?
GI: We do not have a specific threshold. Our orientation is toward compensation and performance over the long term.
TGR: Would it be fair to say that you look for at least double-digit growth?
GI: Very definitely. Given the expected risks in the mining industry, our investors look to us for rates of return comparable to other venture capital or private equity businesses. We believe it is important to note that the mineral exploration business, much like the pharmaceutical or tech business, can create substantial growth of value through exploration and discovery. Our general focus is to capture those areas of growth, rather than the commodity trends.
TGR: What is your time horizon?
GI: Our investment horizons typically stretch from two to five years. We focus on a firm’s capabilities and ability to grow, not its latest drill or production results.
TGR: Are you concerned that equities have trailed the underlying commodity, especially in the precious metal side, for close to 18 months?
GI: The market trends are changing. We are now seeing the precious metal mining companies being valued using similar metrics to other mining companies, whereas historically they traded at a substantial premium. We believe this is both a natural evolution of the market and a direct result of the widespread acceptance of the metal exchange-traded funds (ETFs) like SPDR Gold Shares (GLD:NYSE.A). On a smaller scale, we see a lot of opportunity in exploration and development companies. Fortunately for us and unfortunately for them, these companies are having trouble getting financed, which means we can pick and choose among the assets that interest us.
TGR: Are you paying more attention now to things like infrastructure?
GI: Infrastructure has always been a critical component of mining investment. Our approach always includes taking into account all the necessary factors for a mining situation to be developed. The infrastructure demands of a mining project and how they will be financed are always crucial factors in deciding to invest in any remote mining situation.
TGR: Are most of your positions private placements or do you buy positions in the market?
GI: We do both.
TGR: In terms of your private placements, how important is a warrant?
GI: Not critical, although we like warrants. We particularly like financings that are elegantly structured, meaning the warrants are tied to the company’s financing needs rather than an unrelated timeframe.
For example, if a company is raising money for a drill program it expects to complete in 15 months, we like to see that the warrants are tied to the completion of that program so they can be used to fund the next stage of exploration and development.
A big problem for many junior companies is the potential dilution caused by a large number of warrants outstanding with no implicit or explicit linkage to the cash requirements of the company.
TGR: Can you give us an example of a recent private placement you did versus the market price for the company involved, without naming a specific company?
GI: Typically, private placement terms are on the higher end of the historic band for discounts, namely 10–15% off a recent weighted-average price, as opposed to 5–10%.
TGR: Are you looking for companies offering a dividend?
GI: Absolutely. As a long-term investment fund, our focus is on total return to our investors. That comes through both capital appreciation and dividends.
TGR: Does that mean you are looking beyond companies in the exploration and development stage and into mid-tier and top-tier producers?
GI: Yes, we invest in companies in all phases of the mining sector. We utilize our judgment to decide which companies are the most appealing based on projected risk-weighted rate of return. In practice, that means you would not expect the same returns in lower risk senior producers compared to higher risk explorers once you remove the issue of the movement of the underlying commodity price. As for capital reinvestment and dividends, it is logical to expect that smaller, more rapidly growing companies would be less likely to pay a dividend than their more senior competitors.
TGR: Has your asset base moved from companies with market caps less than $200 million to larger companies, given that more of them are offering dividends than they used to?
GI: For us, dividends by themselves are not a driver; they are part of the total return on a particular investment. What causes us to change the portfolio in one direction or another is where we see the best prospect for total return relative to the level of risk inherent to an investment. It all depends on our view of the potential return on an individual company, not a particular segment of the business.
TGR: Would you be willing to name some of the dividend-issuing companies you hold?
GI: We hold names such as Barrick Gold Corp. (ABX:TSX; ABX:NYSE) and Goldcorp Inc. (G:TSX; GG:NYSE), to name two of the larger ones in the gold sector. Outside of the gold business, we hold Cliffs Natural Resources Inc. (CLF:NYSE) and Cameco Corp. (CCO:TSX; CCJ:NYSE), for example.
TGR: What are your strategies for playing ETFs?
GI: Our strategy for metal and metal stock ETFs is to look at relative return in the metal versus the equities.
For example, we hold platinum and palladium ETFs because we like the outlook for the metal, but we do not like the outlook for most of the companies, particularly those operating in Southern Africa and Russia.
TGR: Without naming companies, what have you seen on site visits that made you decide not to invest?
GI: Our site review process has uncovered everything from operational issues related to the geology or the quality of the drilling to engineering challenges associated with site layout or metallurgy. There may be infrastructure issues related to access to the project or, more importantly, shipping routes away from the project. Political and economic issues in the region or country can also come up. And finally, site visits allow us a better chance to see the quality of management in their “home” as opposed to being in a nice office or boardroom.
TGR: Brent Cook has suggested that there are too few people properly trained in preliminary economic assessments (PEA) and prefeasibility studies (PFS), leaving untrained people to plug numbers into models that cannot be relied on to predict whether a project can be mined. If you agree, what are some common errors retail investors should look for that might raise a red flag?
GI: We are deeply committed to doing onsite due diligence as we want to be able to make our own assessments of the numbers being used in the PEAs or PFSs being prepared. That said, it is important for retail (and institutional) investors to read and understand these documents for what they are: namely, preliminary estimates. If I had to characterize the most common area for error at this stage, it would be the assessment of the geology of the deposit and how it relates to the calculation of resourses and reserves.
Concurrently, the investor needs to understand how the economic numbers were calculated, particularly such things as metallurgical recoveries and costs such as the cost of electricity, fuel, labor and metals prices.
Investors need to understand the upside case, and more importantly, the downside case.
TGR: What are some of the common problems you see on site visits?
GI: One general theme is the lack of trained staff and labor, ranging from engineers and geologists to skilled operators and trades people. This continues to be a big problem worldwide.
The second would be the uncertainty associated with legal title and the project investment climate. This includes the tax rates or ownership structures being imposed by host countries.
The third is the temptation to use advanced technology where it is not completely understood or is being misapplied. Too often, this leads to failure or poor performance.
TGR: Once financed and in production a lot of mines fail to meet production targets. A management change soon follows. Is this a result of some of those factors?
GI: Very much so. It is the combination of, first, the expectations of the original group not being met and, second, not having the depth of experience to understand and correct for all the variables. It is no surprise to see issues come forward that were not anticipated in the feasibility studies. An axiom that one of my analyst partners loves to use is “there has never been a failed mine without a positive feasibility study.”
TGR: I like that. Can you tell us about some of your recent site visits?
GI: My team and I have recently been to the Democratic Republic of the Congo (DRC) to visit Banro Corporation (BAA:TSX; BAA:NYSE) and Loncor Resources Inc. (LON:NYSE.A; LN:TSX.V). I recently visited Continental Gold Ltd. (CNL:TSX) and other companies in Colombia. I also visited a number of non-precious metal names, including Lithium Americas Corp. (LAC:TSX; LHMAF:OTCQX) in Argentina. In the rare earth space, I visited Great Western Minerals Group Ltd. (GWG:TSX.V; GWMGF:OTCQX) in South Africa, where I just joined the board.
TGR: In South Africa, calls to nationalize more of the mining industry are growing. Why?
GI: South Africa is not alone. It seems that 80–90% of the countries around the world want more of the patrimony to be shared with the government and the citizens.
The history and economic ramifications of apartheid influenced the move for local ownership in South Africa. There also are labor/management conflicts over wages and profit sharing. We believe the South African political outlook has declined substantially over the last five years.
However, South Africa is not alone. In 2010, the Australian government sought a very large tax increase on the mining sector. The U.S. Environmental Protection Agency has taken actions relative to the coal industry.
TGR: Let’s go into more detail on your African visits. Banro recently chose a debt financing over equity financing. What are your thoughts on that?
GI: It was entirely appropriate, given the cash generation capability of its Twangiza project and the relatively accelerated development at Namoya, its number-two project. Banro looked at the cost of capital of equity, convertible debt and straight debt and decided the debt issue was the best alternative.
TGR: You have seen Namoya firsthand. What do you think?
GI: When I visited approximately 18 months ago, I was very impressed. Namoya has a relatively easy physical layout to build, a good operating environment in terms of climate and, relative to Africa, ease of access.
TGR: Banro has a position in Loncor, is that right?
GI: Yes. Many of Banro’s early exploration team members were shifted to Loncor to develop exploration projects in North Kivu. As North and South Kivu became safer to explore, we noted their success with the Banro projects and wanted to invest with them.
TGR: Loncor has an agreement with Newmont Mining Corp. (NEM:NYSE) on its Makapela project, a high-grade gold deposit in North Kivu. Geologically speaking, can it be a mine?
GI: We believe so. The drilling is very early stage. There are two development options. One would be a larger, lower-grade, open-pit development. We are interested in the second option, a higher grade underground mine. It would have lower capital costs and be easier and faster to bring into production.
TGR: What are your thoughts on Peter Cowley and the management team?
GI: My teammates and I have known Peter for a number of years and have a lot of respect for the job he and his team have done. On our site visits, we have been pleased with the work being carried out under their direction. As a non-technical factor, we have been very pleased with the training programs that Loncor is offering its Congolese employees and the care being taken to build social relationships locally through their charitable foundation.
TGR: Many people consider the DRC to be the riskiest district in Africa. But the geology is irresistible. How do you balance those two considerations?
GI: High risk/high potential return is the mantra. While we believe that a number of assets in DRC that offer potentially returns to investors, the risk associated with each one must be closely scrutinized. For us, one of the key risks comes back to the question of whom we are investing with. In the case of Banro and Loncor, we believe the team, from the board down to the men with feet on the ground, has experience and relationships in the DRC to develop profitable mines with social and environmental sensitivity.
TGR: You visited Continental Gold’s Buriticá Project in Colombia. What can you tell us about that?
GI: We began investing in Colombia a number of years ago, principally in the private company that evolved into Continental Gold. We initially saw Colombia as a regional play, just opening up for exploration and systematically underexplored by modern standards.
Developing Buriticá as the company’s chief asset with the Berlin asset in second place struck us as a very good strategy. We like the high-grade ore reserves at Buriticá and the very high probability that it will be an underground mine using bulk tonnage mining methods. This approach should cause the project to have a relatively small footprint on the surface environment, which eases permitting and causes less social disruption.
TGR: Ari Sussman is Continental Gold’s CEO, as well as CEO of Colossus Minerals Inc. (CSI:TSX; COLUF:OTCQX). Is this a management team you follow?
GI: We also invest in Colossus, and, yes, Ari has attracted strong people. We are particularly impressed with Sussman’s ability to build up management teams with people as they are needed at each stage: exploration, development, construction, production.
In our evaluations, we ask how well management is prepared to transition itself in terms of its skill set as the company grows in value and as it develops its assets. That is one of the major risks in any kind of venture capital or private equity business.
TGR: What are your investment themes for non-precious metals equities?
GI: One of our major themes is in what we call “green metals,” metals that will benefit from the environmental issues associated with global warming and climate change. An example is the lithium/graphite complex.
Lithium Americas is one of the most advanced brines project in South America, producing lithium using brine technology and solar evaporation—a very low-cost production method. We expect it to be among the first to market, in relatively due course.
And because lithium batteries utilize graphite in their anodes, we started to look at graphite producers. One of the most intriguing projects is Northern Graphite Corp.’s (NGC:TSX; NGPHF:OTCQX) Bissett Creek in Northern Ontario. The management team has the right combination of geologic, mining and marketing smarts. We became a cornerstone investor.
TGR: You have done well; since August Northern Graphite’s share price probably rose about 300%.
GI: There is an old adage, “never mistake intelligence for a bull market.”
TGR: So, is it a bit too frothy right now?
GI: It depends on your view for graphite. We fundamentally believe in the green metal theme and have decided that the lithium/graphite complex will be a winning technology.
If you believe market penetration for electric vehicles will be in the 3–4% range over the next 5–10 years, graphite prices will have a lot of upside. If you believe in market penetration rates of 10–15%, graphite prices will have to be that much higher in order to bring out the amount of material needed.
TGR: As an institutional investor, can you offer any wisdom to retail investors wondering if they should stay in the mining equity space?
GI: The generic advice to any investor in any business is to know what you are investing in. Know whom you are investing with. Do your homework.
Structure your investments appropriately relative to your risk profile. That is essential for institutional or individual investors in this high-risk, potentially high-return sector.
TGR: George, thank you for your time and your insights.
George Ireland founded Geologic Resource Partners LLC in 2004 and serves as its chief investment officer and managing member. He serves as portfolio manager of the associated Geologic Resource Funds and has been president of GRI Holdings LLC since June 2000. Ireland has 30 years of experience in all aspects of the resource sector, ranging from field geology to banking and venture capital.
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The lithium market is currently dominated by a handful of major producers, but investors naturally look to smaller junior exploration and production (E&P) companies for the real growth. Economist Daniela Desormeaux of Santiago, Chile-based signumBOX takes a global macroeconomic view of the lithium industry and concludes that supply will meet demand, but if the adoption of vehicular lithium ion batteries occurs sooner than the market expects, demand could overtake supply. In this exclusive interview with The Energy Report, Desormeaux discusses some of the juniors that could ultimately add some energy to portfolios.
The Energy Report: Daniela, over the past three months the small-cap lithium developers have on the whole been in positive territory. Are we at the beginning of a
long-overdue bull market in lithium equities?
Daniela Desormeaux: Most of the smaller-scale suppliers trading in the open market are young, junior mining companies. The stock price fluctuations observed during recent months reflect the market’s sensitivity to the companies’ announcements and news.
TER: What is currently driving lithium demand? What will drive it in the future?
DD: Lithium demand has a promising future. Rechargeable batteries are the largest application, accounting for about 30% of the lithium demand. This is also the segment with the highest growth rate for the next 10–15 years, by which point we believe batteries will represent more than 50% of demand. The main driver is the automotive industry. Electrification of transportation is now driving the use of lithium in energy storage devices for hybrid and electric cars. The amounts of lithium required in these batteries are significant, from between 5–60kg lithium carbonate equivalent (LCE) depending on the battery type and specification. When compared with the lithium required for mobile phone batteries, for example, the difference is huge. A mobile phone battery device requires less than 5g LCE. Other battery applications will also show very interesting growth rates in the coming years. These include smartphones, tablets, power tools and batteries for grid storage, among others. Other current lithium applications include glass and ceramics as well as lubricating greases. Considering all of its applications, we estimate lithium’s average demand will grow around 10%/year, which is greater than the growth of the economy.
TER: How are lithium prices holding up currently?
DD: In the last few months we have seen lithium prices going up in response to announcements made by FMC Lithium Corporation (FMC:NYSE) and Chemetall (a unit of Rockwood Holdings Inc. (ROC:NYSE)). Both companies announced price increases of around 20% on all of their lithium products last year. According to the companies, the main reason behind the rise in prices was higher raw material costs. So, we might be seeing an inflation phenomenon in this industry. In real terms, prices have remained stable, and probably will go down since new capacity is being added. Talison Lithium Ltd. (TLH:TSX) is expanding capacity in Western Australia, and Chemetall is also expanding in the U.S. Other new projects are in the pipeline coming from Galaxy Resources Ltd. (GXY:ASX) in Australia and from other projects in Argentina and Canada.
TER: So, for the moment there is currently some pricing power in the market?
DD: In general terms, prices are driven by the balance between production capacity and demand. If the market is tight, prices go up. Nevertheless, this industry has been, and still is, very concentrated and the largest, lowest-cost lithium chemicals producers drive prices. However, we have seen more competition in the market. Chinese lithium hydroxide producers have entered with an aggressive price strategy in order to gain market share from the other producers.
TER: But not all the large producers are raising prices, right?
DD: So far, Sociedad Química y Minera de Chile S.A. (SQM:NYSE; SQM-B:SSX; SQM-A) has kept prices stable. It hasn’t announced any price increase the way FMC or Chemetall have. The company probably wants to give a signal to the new competitors that they can “afford” higher costs. Most of the Chinese lithium hydroxide is produced from lithium concentrate, which is obtained mainly from spodumene. Producing lithium hydroxide from hard rock pegmatites has competitive advantages compared with producing from the lithium carbonate like Sociedad Química y Minera de Chile does, and so the Chinese can compete better in this field.
TER: Here in the U.S. we are seeing proliferation of TV ads for hybrid and electric cars (EVs). Manufactures are beginning to advertise these cars with some zing. Will this jump start hybrid and EV sales?
DD: It is difficult to know because these are still considered “luxury” cars because of their high price. We have tested a statistical model on how hybrid car sales in the U.S. responded to changes in the economic cycle and changes in gasoline prices. Conclusions are very interesting. We found some price elasticity with gasoline prices, as higher gasoline prices incentivize decisions to buy more efficient cars. But income elasticity is huge, which means these cars are very sensitive to the economic cycle. Of course these conclusions will change in the future when these cars become more affordable.
TER: Investors need to see double-digit sales and real increases in cash flow, and small companies have the tremendous advantage of not having the law of large numbers work against them. Can any of the companies you follow begin to double production and revenue and create exciting bottom lines?
DD: In the short term I don’t think so, but it’s likely in a future. Main sources of uncertainty are how fast/slow hybrid and electric cars will enter into the market in a massive way (at lower prices), and how fast/slow producers will respond to the demand. In the last years we have seen that in more than 90 projects under evaluation. We believe that 4–5 projects have chances to become part of the lithium supply very soon. That means that more competition will be added in the market.
TER: I’m recalling the way the mobile phone industry took off in less-developed countries in Asia and elsewhere because there was no pre-existing buildout of copper wire infrastructure. Mobile phones were an instant success in those areas. Why then are we not seeing large lithium ion storage batteries powering neighborhoods in the developing world where power grids have not been developed?
DD: Well, the thing is that batteries are expensive. The technology has only been in development since the early 90s. It took 30 years to make progress in developing batteries for mobile phones and electronic devices, and these are small batteries and less costly than larger batteries. This is where the industry has been focused, and now we are seeing a shift from batteries for cell phones and electronic devices to electric cars.
The requirement in terms of energy storage capacity is huge, and so the cost so far is also huge. That’s why we haven’t seen implementation of these batteries in neighborhoods and in small towns. There are also some projects that try to store energy for the grid, but in order to make these projects profitable, you have to store an important amount of energy. For a power grid, the main issue is cost.
TER: With a lot of new lithium supply coming onto the market over the next few years, will supply overpower demand, or will it be the other way around?
DD: Again, while demand is growing, so is supply. Talison Lithium Ltd. in Australia, for example, is performing a very aggressive expansion plan. We see expansions in Argentina and in the U.S., and the Chinese are also expanding capacity. The main question mark is how fast or slow electric cars will come into the market. But without subsidies and without incentives from the government, it’s very difficult to enter the market because the electric and hybrid vehicles are expensive right now. If demand for lithium grows sooner than expected, we might see a delay if supply is unable to meet demand, but I don’t think this is going to happen. In short, I think supply will meet demand.
TER: Which types of projects do you favor?
DD: There are projects based on pegmatites and projects based on brines. These are two completely different worlds. I think projects based on lower-cost brine have better chances to compete with current low-cost producers.
TER: What companies are interesting to you?
DD: Australian company Galaxy Resources Ltd. extracts lithium from pegmatite and has already started producing. Apparently, the company is competitive, and it has started to ship concentrated spodumene to its lithium carbonate plant in China.
Other pegmatite projects include Canada Lithium Corp. (CLQ:TSX; CLQMF:OTCQX) and Nemaska Lithium Inc. (NMX:TSX.V; NMKEF:OTCQX). All of these projects have a chance to become part of the lithium supply. In Argentina there’s Lithium Americas Corp. (LAC:TSX; LHMAF:OTCQX), Lithium One Inc. (LI:TSX.V) and Orocobre Ltd. (ORL:TSX; ORE:ASX). These and the previous ones I mentioned have the highest project ranking by our methodology and have more chances to become part of the lithium supply.
TER: What about Li3 Energy Inc. (LIEG:OTCBB)? Back in December, it executed a letter of intent to acquire a 100% mining interest in one of the biggest assets to be had near the Maricunga Salar in Northern Chile. That makes Li3 Energy a potential major player in Chile and one of the few developers inside of Maricunga. What does this mean to the company, particularly with regard to the ban?
DD: Li3 is developing a project in the Salar de Maricunga, the second-best salar after Atacama in Chile. The company has a project and has a strategic partner (POSCAN), but current Chilean regulation does not allow newcomers to exploit lithium. We have a ban that only allows lithium extraction from those mining concessions that were assessed before 1984, which is the case of most of the mining concessions at Atacama. I think that the ban will be removed this year, but we really can’t yet know the formula that the government will use.
TER: Lithium One is close to production, and it has established a good relationship and a joint venture with Korea Resources Corp. I believe the stock has been supported by this relationship. What are the prospects here?
DD: Lithium One is in a very advanced stage of development, and it is very well ranked in our signumBOX ranking. One of its upsides is that it is located in Salar del Hombre Muerto. It’s the only startup that actually is operating in Argentina. So it has really good prospects for the future.
TER: Back in November, Rodinia Lithium Inc. (RM:TSX.V; RDNAF:OTCQX) delivered results of a preliminary economic assessment (PEA) for the Salar de Diablillos lithium brine deposit. There are estimates of 15 kilotons (kt)/year production of lithium carbonate and 51 kt/year of potash. This implies a 34% internal rate of return (IRR), which is excellent. Is this a viable project?
DD: I think it can work, but Rodinia faces huge competition. The company estimates costs will be in the range of $1,500/t lithium carbonate. But I think that it is very different to have an estimated cost before starting production than when you’ve already started producing. I think that Rodinia can be a player in the lithium industry, but like other players in Argentina it will face huge competition. It will have to be competitive because new production is coming from China and Australia. And if Chile removes the ban, they will have to deal also with that.
TER: Talison Lithium is the leading global producer of lithium, and it’s a pure play. It’s a mature company. How much can it grow?
DD: Yes, Talison is the largest lithium concentrate producer, but it’s not the lowest-cost producer. It produces lithium concentrate in Australia and most of its product is shipped to China, where it’s converted into chemicals. I think Talison will face more competition, and that’s why it has expanded production capacity. It has performed a very aggressive expansion plan at its Greenbushes project in Australia. Nevertheless, its deposit has a short mining life; that’s why it is looking for other sources of lithium and performing an evaluation project in Chile.
TER: Daniela, thank you very much for your time.
DD: Thanks to you.
Daniela Desormeaux is an economist and an expert in industrial chemicals and natural resources. She runs signumBOX, a Chilean-based company with extensive experience in the lithium industry. signumBOX has issued several reports regarding the use of lithium in batteries and vehicles and its prospects and trends.
Lithium continues to be in high demand as battery application growth outpaces the economy. In this exclusive interview with The Energy Report, Jonathan Lee of Byron Capital calls on his engineering and manufacturing background to explain the factors shaping the evolution of this growing market. He also brings us up to date on several promising companies blazing trails in the lithium industry.
The Energy Report: Thank you for joining us this afternoon, Jonathan. You have a technical background in engineering and manufacturing in addition to your experience as an analyst. This gives you a unique perspective in evaluating investment opportunities. What do you look for specifically in a lithium company?
Jonathan Lee: Numerous factors. Our strategy is to find low-cost producers within a sector. Then from a capital cost side, it’s always more beneficial to have a lower capital cost to get a better return on equity and make the project more feasible. We like to have low capital expenditures and operating expenditures. Beyond that, it really comes down to valuing the company and trying to make sure that the equity is purchased at the right price. The two major factors that contribute to a better return on equity are good assets and low costs.
TER: Are you looking across the broad spectrum of levels of development, from prospectors to companies that are already producers? Or do you narrow it down to more advanced companies?
JL: We look at everything from exploration to producing companies. When we look at producing companies, a lot of times there is less technological risk or execution risk involved. At the earlier stage, there’s a lot more risk entailed in proving out the deposit, proving up a resource and gathering more metallurgical information, etc. Earlier-stage companies usually are valued less and have the potential of higher returns but also entail more risk.
TER: Lithium has been a hot topic in the past several years. For those readers who are not all that familiar with it, can you give us a little background on the metal, its uses and what people should be looking at when considering lithium investments?
JL: Lithium is a metal that’s used in a slew of different products. Batteries are a big percentage of it, roughly 25%-30% of production. Glass and ceramics are also a big usage because it lowers the heating temperature, which saves energy. It’s also used in lubricants and castings. A variety of products utilize the element, but these end users make up the majority.
TER: Is battery usage growing faster than other applications?
JL: Yes. Although penetration into automobiles is not great as of yet, there is significant growth in consumer applications for lithium-ion batteries, and you’re seeing that growth year over year. We think that’s going to continue to grow as things get switched over from, say, nickel-metal hydride rechargeable batteries to lithium-ion batteries in consumer electronics.
TER: With all the market turmoil that we’ve had here since you last spoke with us back in April, can you bring us up to date on what’s been happening in the battery materials industry in the past six months? Have there been any major changes?
JL: There are only four major lithium producers. Chemetall and FMC Lithium Corporation (FMC:NYSE) publicly stated in July that they were raising their prices, partly because of increased demand. That definitely helped out along with rising raw materials prices. Soda ash (sodium carbonate) has increased dramatically, thereby increasing the cost to produce lithium carbonate. Because demand is still strong, they’ve been able to raise prices and pass on those extra costs to customers. If you look at companies like Talison Lithium Ltd. (TLH:TSX), which we currently cover and have a Buy recommendation on—it is also selling at capacity. You’re likely to see FMC increase its capacity by 30% next year. So the overall strength of the market is definitely there in the short term. We believe producing companies, such as Talison, will be able to take advantage of that market demand.
TER: Has anything happened recently on the technical front to affect the lithium market in either a positive or negative way?
JL: As kind of a leading indicator of where the market is going, you can look at the amount of money that a company is going to spend on new lithium-ion plants. GS Yuasa Corp. (TYO:6674) is increasing the capacity of its plant. It’s spending roughly $300M on that plant. When it’s up and running in 2014, that will be a significant buyer of lithium for batteries. Panasonic, although it’s scrapping its plant in Japan, is also expanding in China. More and more battery producers are increasing capacity, and that’s a clear signal of where we think the market is going.
TER: A number of companies are mining lithium deposits, mainly in South America, but also in Canada. Do you foresee a supply glut in the market?
JL: Most of the mining companies could come into production within the next year. Demand should increase in step with supply. Talison is increasing its production as is FMC. The markets have a pretty good way of clearing out producers that aren’t able to compete. That is why locating potential low-cost producers is part of our investment strategy. Just like any other market or mining sector, not all exploration juniors make it to production. We try to find those companies that will be in the lower quartile of relative production costs.
TER: You mentioned that a couple of the major producers raised prices. Is lithium mainly a negotiated or supplier price-based market rather than one driven by investment demand?
JL: Yes, it’s mainly supplier-price based. It’s sold over the counter, and we doubt there is going to be any type of LME (London Metal Exchange). It’s not going to be an exchange-traded material because customers have specific criteria for batteries on the chemical side as well as the physical side. A lot of the juniors that we cover are working with trading or industrial companies or even an end user like the Argonne National Laboratory, which has an agreement with Western Lithium USA Corp. (WLC:TSX; WLCDF:OTCQX). Determining the physical and chemical characteristics of lithium products will be based on customers’ needs. Because each customer has different needs, we think that it will remain a negotiated market, and people will pay different prices for different chemical and physical characteristics.
TER: Back in April, you told us about the four major companies that dominate the market, which are Sociedad Química y Minera de Chile S.A. (SQM:NYSE; SQM-B:SSX; SQM-A) a Chilean company; FMC Lithium Corp.; Chemetall, a unit of Rockwood Holdings, Inc. (ROC:NYSE); and Talison. What are the prospects for smaller companies now entering the market?
JL: Recently, demand has been strong and the majors are expanding. But we believe there will be space for companies to enter the market because the four majors will, at some point, max out on capacity. We think there is space for some of the juniors. In the short or medium term, you may see companies that have strategic investors who may pay up for the security of having that supply in an offtake agreement. If one of those strategic investors makes a more substantial equity investment in the near future, we think that shows that the customers are more worried about the security of supply rather than price. And that could bode well for some of these juniors.
TER: You’ve done some research reports recently on Talison Lithium, Lithium One Inc. (LI:TSX.V) and also Western Lithium. Of course, Talison is one of the majors. What can you tell us about Lithium One and Western Lithium, which are not in that category?
JL: Lithium One is a junior brine exploration company in Argentina. It just released its preliminary economic assessment (PEA), which showed positive economics. It showed it could be a low-cost producer of lithium as well as potash. Its estimated production includes a substantial amount of potash, which, on the byproduct credit basis, significantly reduces the cost of lithium production. It’s similar to the model that SQM uses in Chile, where it has potassium and lithium co-products that make for positive economics. We think it’s definitely tangible given that its salar looks very much like FMC’s salar.
On Western Lithium’s front, it signed up with the Argonne National Laboratory to collaborate and work on creating better lithium products. Because lithium is a non-commodity with respect to its chemical and physical characteristics, having that knowledge of what its customers want is a significant turn of events.
TER: How close are these companies to production?
JL: Most of them are at least a few years away from production. I guess the closest one out of the brine projects would potentially be Orocobre Ltd. (ORL:TSX; ORE:ASX). It’s in negotiations with Toyota Tsusho Group (TYHOF:OTCPK) to finalize its offtake and strategic investment. Even after that is done, you still have to construct the mine, pump brine into the ponds and evaporate it for at least a year. So you are looking at a timeframe of at least two to three years to production. I think it would be one of the earliest companies to come to production. Most of them are fairly far off.
TER: What kind of capital costs are associated with putting these operations into production?
JL: It really depends on the size, but a lot of their economic assessments have come in roughly between $200-$360M, ranging in size from 15,000-25,000 tons. And those estimates seem fairly reasonable. Financing is going to be one of the risks for companies getting projects up and running. Mining is a capital-intensive business.
TER: Are there any other lithium development names that you think are worth considering at this point?
JL: The other two names that we cover are Lithium Americas Corp. (LAC:TSX; LHMAF:OTCQX) and Rodinia Lithium Inc. (RM:TSX.V; RDNAF:OTCQX). Lithium Americas has a strong management team with a property adjacent to Orocobre with very similar brine chemistry, and it already has strategic partners in Magna International Inc. and the Mitsubishi Corporation. Rodinia has a brine project in Argentina, which is highly prospective. It should have its PEA released within this quarter. That should bode well for it and prove up its economics as well.
TER: How would you summarize your reading on the lithium business at this point?
JL: I think the lithium business is strong. I’m seeing strong growth in the near term. With the consumption of lithium in consumer batteries, you’ll see substantial growth, especially with the implementation of transportation vehicles. Companies are committing hundreds of millions of dollars in capital to build these plants. We think that’s a leading indicator of where demand is heading.
TER: As far as you are aware, is anyone developing any competing technology?
JL: No. When you look at where lithium is on the periodic table, it’s on the top left, so it’s the cathode of choice because of its energy density.
TER: It looks like lithium is here to stay for the foreseeable future.
JL: We believe so as well.
TER: Very good. We appreciate the update and your current thoughts. Thanks for talking with us today.
JL: Thank you.
Jonathan Lee is a battery materials and technologies analyst with Byron Capital Markets in Toronto. As a member of Byron’s research department, Lee’s primary focus is on the battery materials sectors, which includes lithium, vanadium and cobalt.
Although lithium equities have not elevated moods much recently, House Mountain Partners founder Chris Berry makes his case that over the longer term the element will be in such strong demand for the electric vehicle (EV) revolution that investors will no longer be able to ignore explorers and emerging producers. The crucial growth driver is the nascent lithium-ion battery industry that will be vital to management and allocation of energy sources ranging from nuclear and coal to wind and solar. In this exclusive Energy Report interview, Chris has identified several publicly traded lithium juniors priced low enough to reward patient investors with big multiples on investment.
The Energy Report: I’m looking at an unweighted basket of lithium stocks and it’s down about 17% since July 22. During the past six months, these stocks have underperformed the S&P 500 by about 30%. Chris, what does this tell you? Is it heralding a slowdown in manufacturing and the economy in general? Or, are lithium equities a screaming buy here?
Chris Berry: I think it tells us both. If you look at recent gross domestic product (GDP) data in the United States or, most recently in Germany, many Western economies are in stall speed with second quarter GDP numbers barely coming in above zero. So, the world economy is at a little bit of a crossroads—the West is slowing down and relying on the East as the sole engine of economic growth. There is a risk of a double-dip recession here in the United States, but I think it remains to be seen if that will happen. Regarding whether lithium equities are a “screaming buy,” I think there are some lithium stocks that are undervalued at their current levels, but it’s not safe to assume that all lithium stocks are a buy right now.
There are two reasons you’ve seen lithium equities get pushed down in the last couple of months. The first has to do directly with uncertainty in Western economies. Second is the fact that there are likely too many junior exploration companies in the lithium space based on current and near-term supply and demand. So based on these two factors, everyone is just getting pounded. It’s a flight to quality, and it’s a reaction of fear in terms of where to put your money, which is why you’ve seen gold hit historic highs. Lithium, itself, is an industrial metal, whether or not it’s used for polishing glass, as a grease, or its most popular current-day use—in batteries. The long-term potential of lithium rests with growth and innovation in the automotive industry. Electric vehicles are a key growth driver for lithium demand in the future. So electrification in the automotive industry, energy storage and consumer electronics demand are all themes to focus on when developing an opinion on long-term lithium demand. There is a great deal of debate in scientific circles regarding what the optimal battery chemistry is or will be. Lithium will play a central role here, but there are other choices, as well, clouding the end game.
TER: Will some look back at this as a missed opportunity in lithium equities?
CB: I think so as long as you are selective. One of the main themes that we look at in our research at House Mountain is how GDP growth is directly related to access to cheap and reliable energy. How that energy is generated is a question with a number of different answers. If you think about the potential that lithium has in terms of energy storage and generation, it will no doubt play a role in the world’s future energy mix. Hydrocarbons will always be with us thanks to their availability and energy density, but lithium will, in my opinion, play a central role in transportation. This isn’t something that is going to all shake itself out next week or next year. We are looking at a process that is slowly evolving.
TER: At the end of June, Rockwood Holdings, Inc. (NYSE:ROC), a $4 billion market-cap company announced a 20% lithium price increase and the stock really responded quite well until things began to turn down. What is driving that kind of pricing power?
CB: You are absolutely right about Rockwood. I believe a week or two after the Rockwood announcement FMC Lithium, a division of FMC Lithium Corporation (NYSE:FMC) raised prices as well. The prices of select lithium end products were increased by 20–25%. What I read into this was the fact that there is a substantial amount of raw materials inflation globally and these companies are passing higher costs on to their customers. It remains to be seen whether these higher prices stick.
TER: Right now, given the current economic environment, what is the bull case for lithium?
CB: I’m not sure the bull case is particularly compelling, again, because you’re looking at a predominantly industrial mineral facing a slowing global economy; granted some economies are expanding faster than others. I think the lithium industry draws an interesting parallel with the rare earth industry. You are at the beginning stages of a huge shake out in the rare earth space where many of the junior explorers there won’t achieve production as the small size of the market cannot support the 200-plus companies involved in rare earth exploration. With lithium, you’ve got four primary global producers and a couple near-term producers in a market that today has too many participants given the current global lithium demand picture.
But I do think over the coming years as this emerging growth phenomenon in countries like China, Brazil and India continues and other economies recover, the case for lithium is strong. Lithium can play a huge role, whether or not it’s in electricity generation, electricity storage, or the transportation sector. I don’t want to underestimate how critical a viable transportation sector is to any economy. If you think about supply chains and what they mean to a given economy in terms of the movement of raw materials, the transportation sector is absolutely critical to maintaining or sustaining any increased quality of life.
TER: I know you travel to Latin America at times. Exports from Chile and Argentina are up over last year, and the lithium industry looks very positive down there. What’s going on in South America? Is this a resource issue, a policy issue or both?
CB: I think it’s a mixture of both. When you talk about Chile and Argentina, they are two of the top lithium producers and exporters in the world. Most, if not all, of the producers are brines and they are solidly economic. You have healthy demand for lithium and lithium carbonate coming from Asia so that’s, in my opinion at least, why you are seeing these export numbers increase from Chile and Argentina. Both of these countries have mining as a central driver of their economic growth. Various provinces in both countries have been mining metals—lithium, gold, copper, you name it—for hundreds of years. They also understand how important mining is to local economies. I know, for example, in some provinces in Argentina, the mining industry accounts for up to 70% of the local economy. So it’s an overwhelming engine of growth. That’s not lost on local and national politicians in these countries. These countries are stable geopolitical jurisdictions with a set rule of law and very clear royalty schemes. That is what attracts foreign direct investment and creates jobs.
TER: I don’t know if you go to Australia, but it’s friendly to mining as well, isn’t it?
CB: I was actually in Australia visiting Talison Lithium Ltd.’s (TSX:TLH) Greenbushes project in April. Australia is an extremely mining friendly country. What is interesting there, however, is that the last few heads of state have tried to push ahead with a carbon tax. It’s no surprise that the proposed higher taxes have been viewed unfavorably by large producers with operations there—Rio Tinto (NYSE:RIO; ASX:RIO) and BHP Billiton Ltd. (NYSE:BHP; OTCPK:BHPLF) for example. It remains to be seen what will come of this legislation, but it is really one of the only potential stumbling blocks I see in an otherwise solid mining jurisdiction.
TER: Speaking of Talison, its chart is an inverse or mirror image pattern to Sociedad Química y Minera de Chile S.A. (NYSE:SQM; SSX:SQM-B, SQM-A). I was comparing them because they are the two largest producers of lithium. Over the past six months, Sociedad Química is up 10%, and Talison is down 41%. Talison is the world’s largest producer, and it’s set to double production by 2013 with expansion of its Greenbushes project you just spoke about. Why has it underperformed so badly?
CB: I have followed Talison for a long time and visiting the site provided a lot of new perspective. This is a company that has been producing high-grade lithium for 25 years. It has a very strong technical team that knows exactly what it is doing. It is mining an asset that is actually the highest grade hard rock lithium in the world. I don’t know if that is necessarily lost on the market, but in the mining industry one of the themes in terms of evaluating a project is that grade is king. If that’s the case, then Talison is a runaway winner. You have an asset with a substantial mine life with an incredibly high grade in a safe geopolitical jurisdiction that supplies China with upwards of 75% of that country’s lithium needs. Think about the growth taking place in China in cleantech research and the battery manufacturing business. The overwhelming majority of the lithium used here comes from Talison.
Talison is the only pure-play lithium producer in the world. So comparing it to a company like FMC or Sociedad Química or Rockwood is not exactly fair because those are chemical companies that produce fertilizers and other chemicals aside from lithium.
TER: At the risk of comparing apples and oranges once again, Sociedad Química is a brine producer of lithium. Talison is a hard rock producer. Which method do you prefer?
CB: On a cost per-ton basis and on a head-to-head evaluation, the brines are cheaper. But it can take 18 months to extract and evaporate the brine and produce lithium carbonate, whereas with hard rock you can do it much faster. How Talison competes with brine producers is interesting. In many cases, it can out-compete brine producers because it is producing such high-grade product. Even though mining may be more expensive for Talison compared to a brine producer, its higher grade allows it to capture a higher margin for the end product that it sells.
TER: Chris, what other companies are you talking to investors about?
CB: One, in particular, that we are focusing on right now is Lithium One Inc. (TSX.V:LI). This is a company that has two assets—a brine asset in Argentina, which is its centerpiece project, and a hard rock pegmatite property in the James Bay region of Quebec. The company is planning on producing lithium carbonate and potash from the Argentinean property named Sal de Vida. In the lithium space, I like to see this because if you can produce a byproduct profitably, that is going to lower your overall cost of production. Additionally, you have very strong management in Paul Matysek and Patrick Highsmith.
TER: Do you give Lithium One an advantage because it produces from both hard rock and brine?
CB: The company isn’t yet producing from either, but plans on production from the brines first. I suppose there is an advantage in having a diversity of supply, but the real advantage will be that it will be predominantly producing lithium from the brine along with potash and lowering overall cost of production. So that is the advantage. This asset borders a property from which FMC is now producing and has substantial grades of both lithium and potash.
Near-term catalysts for this company are a preliminary economic assessment in Q311 and a prefeasibility study in the middle of 2012. We are looking for positive catalysts over the next 6–12 months here.
One of the other things we really like about Lithium One is the fact that it has done strategic joint ventures for each of its assets. For the Sal de Vida property, it has partnered with a Korean consortium of three different companies—LG International Corp., Korea Resource Corporation (KORES) and GS Caltex Corp. The consortium will fund the project to feasibility in exchange for up to a 30% ownership of the property. The key benefit for the consortium is to lock up a secure supply of raw material. For Lithium One, the company is carried to feasibility. It is important to consider how a company is going to ultimately start generating cash. Is it going to continue to dilute through share issuance to get there? In my opinion, Lithium One has really executed a masterstroke in negotiating a partnership with this Korean consortium.
On its James Bay asset in Quebec, Lithium One has done the same thing with Galaxy Resources Ltd. (ASX:GXY), which is a company that just started producing lithium in Australia on its own. Galaxy can earn up to 70% of the James Bay property by completing a definitive feasibility study by the end of 2012. So Galaxy can ensure security of supply and Lithium One is carried to definitive feasibility on the project.
Another interesting company is Western Lithium USA Corp. (TSX:WLC; OTCQX:WLCDF). It’s a little bit of a hybrid as it’s not a traditional brine or hard rock play. This is a very large clay asset in Nevada called Kings Valley. Western Lithium recently updated its NI 43-101 resource estimate, which I think was received positively as the tonnage and grade of the deposit increased, which helps the already good economics of the project. When you talk about lithium, one of the keys is security of supply. When the electric vehicle revolution really takes hold, the idea of having a ready domestic supply of the key asset lithium carbonate is of paramount importance. I’m currently reading a book titled “Bottled Lightning: Superbatteries, Electric Cars, and the New Lithium Economy” by Seth Fletcher. In the book, the “story” of Western Lithium is told and WLC CEO Jay Chemelauskas is featured prominently. The book is an interesting read on the history of lithium’s role in electrification and more importantly, it’s future.
TER: What about earlier stage plays?
CB: We have talked about Rock Tech Lithium Inc. (TSX.V:RCK; OTCPK:RCKTF; Fkft:RJIA) before. This is a very early-stage play. It’s not quite as far along as Lithium One or certainly not as far as Talison. Rock Tech is a hard rock explorer and it has several assets in Ontario and Quebec. The primary property is the Georgia Lake lithium deposit about 200 km. north of Thunder Bay, Ontario. It has a historic resource, and it will be updating and releasing information on that before the end of the year. So we will get an idea of the tonnage and grade of its Georgia Lake asset. It also has an asset in Quebec that borders Lithium One’s hard rock deposit. You can take a look at the tonnage and grade specifics for Lithium One at James Bay and infer what Rock Tech might have if the geology underlying the deposits is consistent and continuous.
TER: Will that upcoming resource estimate be an NI 43-101? What has been the historic estimate?
CB: It will be a qualified NI 43-101 resource estimate. The historic estimate at its Georgia Lake prospect is 9.8 million tons of lithium oxide at a grade of 1.18%. Rock Tech is conducting bulk sampling, and has produced very high-quality lithium carbonate from one of the bulk samples. So the metallurgy there is very close to being understood, and that is a huge key with a lot of these lithium plays.
TER: Do you expect Rock Tech’s NI 43-101 to be a market-moving event?
CB: I think it will be significant because what you are looking at now is historic or backwards information. So you have an idea of what this company has and what the size and grade are, but you don’t really know. So an NI 43-101 is certainly a significant step in Rock Tech’s future. I don’t know if I would necessarily say it is market-moving. One of the keys with juniors, whether you are dealing with lithium or gold, is patience. A lot of times patience can wear thin, but I think with a company like Rock Tech, patience may ultimately be rewarded despite the fact that the lithium space has too many participants
TER: Thank you very much, Chris. It has been a pleasure.
CB: I think a lot of what you guys do at Streetwise. Thank you.
With a lifelong interest in geopolitics and the financial issues that emerge from these relationships, Chris Berry founded House Mountain Partners in 2010. House Mountain firmly believes that the emerging quality-of-life cycle emanating from Asia is a “game-changer” that will affect everyone throughout the world for decades. With that in mind, the firm focuses on the intersection of three topics: 1) The evolving geopolitical relationship between emerging and developed economies; 2) The commodity space; and 3) Junior mining and resource stocks are positioned to benefit from this phenomenon. Chris spent 14 years working across various roles in sales and brokerage on Wall Street before founding House Mountain Partners. He holds an MBA in finance with an international focus from Fordham University and a BA in international studies from the Virginia Military Institute. Chris is also a member of the Canadian American Business Council. He invites readers to receive a complimentary subscription to Morning Notes, which provides analyses of emerging geopolitical, technological and economic trends. Go to www.discoveryinvesting.com.
Siddharth “Sid” Rajeev isn’t a miner. But in his search for value, Sid, head of research for Fundamental Research Corp. in Vancouver, digs deep into the world of small- and micro-cap stocks to find undiscovered gems. In this exclusive interview with The Energy Report, Sid drills down on some relatively unknown resource stocks he has uncovered.
The Energy Report: Sid, you’re an electrical engineer by training. How did you end up the head of research at your boutique investment bank?
Sid Rajeev: I initially worked for an engineering firm for a few years. I developed a strong interest in finance and investment analysis in those years, so I decided to pursue an MBA degree. Soon after I got my degree, I joined Fundamental Research and it’s my sixth year here. At Fundamental, we have a team of analysts, including financial analysts and geologists. We cover about 150 companies, three-quarters of which are in the natural resource sector. The rest are from agriculture, technology, aerospace and other industries.
TER: Instead of putting target prices on stocks, your firm uses a fair-value metric. Does that imply perfect pricing, a theoretical point at which there’s no upside or downside?
SR: Fair value, basically, is the intrinsic value of a stock on a particular day, which is calculated based on the stock’s fundamentals. And you’re right, essentially, it’s the point at which there’s no upside or downside.
TER: When shares reach fair value, do you recommend them as momentum plays?
SR: No, our valuation methodology is always based on fundamentals—we will not give a buy recommendation on a stock if its share price is higher than its intrinsic value. We tend to evaluate or review our valuations on a particular company every three to four months—sooner if some significant news develops.
TER: With a fundamental theory, you recommend taking money off the table when a company achieves fair value and seeking fair value in another company’s shares.
TER: What are you trying to achieve for your clientele through your general investment theory?
SR: Our main goal at Fundamental is to bring out those underexposed small- to mid-cap companies that no one really follows—those are the companies most likely to be undervalued. Our geologists look at the technical aspects. They work in conjunction with our financial analysts to come up with the intrinsic value and a recommendation.
TER: Are you generally bullish on commodities right now and, if so, which ones?
SR: Our favorite now is uranium. We’ve been bullish on uranium for the past couple of years. Yes, the incident in Japan caused uranium to take a huge hit, along with the companies that follow or track uranium, but we believe the fundamentals of uranium are still intact. It’s still one of the cheapest and cleanest sources of power out there. Particularly when fossil fuels are at extremely high prices, we need sources like uranium going forward. Having said that, I don’t think we are going to see any spike but rather a slow and gradual recovery in uranium prices and, therefore, we believe uranium is very attractive for investors with a longer time horizon (at least 12 months).
TER: Where should investors be deploying capital?
SR: Our three top picks are Western Potash Corp. (TSX.V:WPX), Compliance Energy Corp. (TSX.V:CEC), a coal company, and Strathmore Minerals Corp. (TSX:STM; OTCQX:STHJF), a uranium company.
Western Potash is an advanced-stage exploration company with potash in Saskatchewan. We think it’s a good acquisition target.
We picked up Strathmore Minerals when it was at $0.57. It traded as high as $1.60 but, after the disaster in Japan, the stock dropped significantly and now is sitting at about $0.62. We believe uranium companies with quality assets, like Strathmore, should do well going forward.
Compliance Energy recently announced a positive feasibility study, and it should go into production in the next 24–36 months. It has a quality management team, strong cash and investments—especially its significant position in Copper Mountain Mining Corp. (TSX:CUM).
TER: Great. Any others?
SR: Rock Tech Lithium Inc. (TSX.V:RCK; OTCPK:RCKTF; Fkft:RJIA) is a very interesting company under our coverage. Its main focus is on the Georgia Lake lithium project in the Thunder Bay Mining District in Ontario. That project has a historic resource of 9.8 million tons (Mt.) at 1.18% lithium oxide. We like this company particularly because it is expected to complete several milestones in the next 6–12 months. Number one, Rock Tech is expecting to convert its historic resource to an NI 43-101-compliant resource in the next month or so. Second, the company is awaiting metallurgical test results on a 1-ton bulk sample, which will determine the recovery rates for different separation methods and also evaluate the potential to produce battery-quality lithium carbonate. Third, in addition to Georgia Lake, the company also plans to advance its recently acquired projects in Quebec, which are located close to some well-known lithium projects.
The Kapiwak project (James Bay area in Northern Quebec) is located close to a new discovery and the Lacorne project (Val d’Or) is close to a near-term producer (18–24 months). We expect this stock to move closer to our fair value estimate of $0.55 per share if these developments turn out to be positive. The current share price is $0.25.
TER: The main driver here is the growing popularity of electric cars?
SR: Exactly. We think lithium is attractive for use in electronic devices and vehicle batteries because lithium is the lightest metal in the periodic table. Lithium has the highest specific heat of any solid element. Lithium batteries also hold a charge for a long time and could be utilized to store energy from alternate sources, such as wind and solar, as the electricity production from these sources is variable.
TER: What else can we look forward to from Fundamental Research?
SR: Another company that is worth tracking is Mesa Exploration (TSX.V:MSA). It’s exploring for lithium, potash and uranium in Utah and Arizona. All the projects are in proven mining districts with accessibility and infrastructure. The company recently released an NI 43-101 technical report for its flagship Green Energy Lithium Project in Utah, where drilling is expected to begin this spring once the permits are received. Mesa also has a joint venture (JV) partnership with Passport Potash Inc. (TSX.V:PPI, OTCQX:PPRTF) on its Holbrook Basin Potash Project.
We recently picked Plains Creek Phosphate Corp. (TSX.V:PCP) and will be initiating coverage on the company shortly. It has an advanced-stage phosphate project in Guinea-Bissau in West Africa. A bankable feasibility study is expected in Q411. The company has already received a production license, and production is expected to commence in 2013. Our recommendation and rating on the company should follow in the next few weeks.
TER: Do you believe a phosphate company can grow due to the success in potash, and that it might be time for phosphate to catch up?
SR: Exactly, phosphate has the same drivers as potash. The main idea behind phosphate and potash is increasing demand for food, increasing population and diet improvement in developing economies. Also, meat consumption in developing countries is expected to significantly increase in the future, which would drive up demand for grains to be used as livestock feed. All this requires fertilizers, and that’s where potash and phosphate come in.
TER: Got it. I’ve enjoyed meeting you very much Sid. Thank you for your time today.
At Fundamental Research Corp., Sid Rajeev heads the research department, which covers over 150 small- and micro-cap companies and 15 exempt market/private issues from a broad array of industries including energy, mining, real estate and technology. He also manages the FRC list of Top Picks, which are the stocks under coverage that he has the highest conviction level about. These picks have historically helped the firm finish strong in various third party analyst performance rankings.
Sid holds a bachelor of technology degree in electronics engineering from Cochin University of Science & Technology and an MBA in finance from the University of British Columbia. He is a CFA Charterholder and has completed studies in exploration and prospecting at the British Columbia Institute of Technology.
Demand for lithium, a super-light, yet super-charged metal used in batteries, has been slowly rebounding from a dip in 2009. Main players in the space are planning to expand and new market entrants are on the horizon. But which are poised to benefit if there is a glut in supply? In this exclusive interview with The Energy Report, Byron Capital Markets Battery Materials and Technology Analyst Jonathan Lee reveals his forecast for prices, supply and demand.
The Energy Report: Jonathan, please tell us about lithium and its core uses.
Jonathan Lee: Lithium metal is used mainly in the glass and ceramics industry and in lithium-ion batteries, which, collectively, comprise about one-half of all lithium used. The other remaining uses are anything from greases, casting and aluminum production to pharmaceuticals. It’s a very versatile metal.
TER: What is the investment thesis for lithium?
JL: Lithium is an important component of the batteries that power electric vehicles (EVs). We believe in the electrification of vehicles over time. It’s a transition; Nissan’s LEAF has come to commercial production, the Tesla Roadster has come out and the Chevy Volt also has come into commercial production. We focus on the metals that play a role in the electrification of our transportation mechanisms and associated infrastructure. Obviously, lithium came up as one of the key metals that will be used in this revolution.
TER: The green revolution?
JL: The green revolution is a nice way of saying it. Demand for lithium will continue to grow at a much higher rate than gross domestic product (GDP) over the next 10 years.
TER: What has lithium’s supply/demand curve looked like during the past few years?
JL: Lithium experienced a dip in 2009, but production has been around 120,000 metric tons (120 Kt.) lithium-carbonate equivalent since 2008. That’s equal to about 23 Kt. lithium metal. In 2009, lithium demand, along with many other materials, dropped pretty severely to under 100 Kt. Estimates for last year, 2010, range from less than 100 Kt. to about 120 Kt. It’s hard to get very exact numbers because it’s a fairly opaque market.
Four major players dominate the market: Sociedad Química y Minera de Chile S.A. (NYSE:SQM; SSX:SQM-B, SQM-A), FMC Lithium Corp. (NYSE:FMC), Chemetall, which is a unit of Rockwood Holdings Inc. (NYSE:ROC), and Talison Lithium Ltd. (TSX:TLH). We estimate there was about 108 Kt. tons in 2010. FMC, a large lithium miner in Argentina, estimates it at 100 Kt.
TER: Do you think the lithium market will become more transparent and perhaps trade on the LME, for example?
JL: Lithium is not that big of an industry, but you saw cobalt and molybdenum start to trade on the LME in early 2010. If there is some success in trading those materials, maybe there are some benefits in trading lithium. The problem is that lithium is traded in different forms. That would make it more difficult to trade on any exchange because it is sold as spodumene, which is lithium oxide concentrate, lithium chloride, lithium hydroxide or lithium carbonate. It is really customer specific; so, it probably won’t be trading on an exchange any time soon.
TER: What has the price of lithium been like in the recent past?
JL: Each form of lithium brings a different price. In the second half of 2008, a big run-up in the price of lithium carbonate equivalent (LCE) resulted in highs of $6,000/ton. In 2009, SQM’s figures show lithium was selling at around $5,300/ton and its latest financials indicate that it was selling at around $4,700/ton last year.
TER: Where do you expect the price to be by year-end?
JL: We think it’s going to finish at around $5,000/ton lithium carbonate. With so few players in the market and not many low-cost juniors expecting to come into production this year, I don’t foresee a price move upward or downward in the next year.
TER: Do you believe there’s long-term upside in the price of lithium?
JL: I’m not sure if there’s a real upward price trend for lithium in the long term; thus, any high-cost supplier that comes to the market is really going to have a hard time competing. I don’t believe there will be a dramatic increase in the lithium price in the near, medium or long term.
TER: So, it’s all about the margins on these projects? A company must bring lithium to market at a low cost to have a good margin?
JL: I believe that the low-cost suppliers will be able to thrive in this marketplace. Obviously, the product has to meet customers’ end specifications. The problem is that often juniors don’t know whether or not they meet customers’ specs. Only some have offtake options for steady customers but, in forming options, companies have access to customer specifications with which they can develop around. It’s hard to gain a market share without being a low-cost producer or having an offtake agreement.
Also, three of the four main lithium companies are planning expansions. Chemetall wants to—whether or not it will get permission is another question because it’s in Chile and lithium is a strategic metal. FMC is looking to expand its operations 30% this year.
Talison is planning to double its production capacity. The company recently raised money, has all the capital costs to invest and is willing and ready to compete. However, it does produce slightly different material—spodumene—mainly to customers in China for the ceramics and glass market. Talison is considering going from a mine to spodumene, and then from spodumene to lithium carbonate.
TER: Isn’t that a hard rock deposit that’s in Australia?
JL: Yes. The company is looking at whether or not it will be economically feasible to go from spodumene to lithium carbonate at this time. It hasn’t made that decision but, like FMC, it is definitely expanding its operations to increase capacity. For us, hedging risk implies being a potential low-cost producer trying to compete with these expanding companies for the growing lithium demand.
TER: The market is dominated by four companies but there are some up-and-comers in this space, most of which have brine deposits. What are some of Byron’s favorite names among the up-and-comers?
JL: A few low-cost producers have the potential to thrive and return money to investors in this marketplace. Lithium Americas Corp. (TSX:LAC) has the Cauchari-Olaroz project that is scheduled to go into production in 2014. We like the company because it has very good chemistry. It has a very high lithium concentration and a very low magnesium level. Its preliminary economic assessment (PEA) should be released fairly soon. We’re looking forward to seeing that and the results of all the hard work the company has done over the last few months. We currently have a Speculative Buy rating on LAC and a $2.80 target price.
The Sal de Vida project is another one that we really like. It is being developed by Lithium One Inc. (TSX.V:LI). We have a Speculative Buy rating on LI with a $2.45 target price. The company has some of the best brine chemistry; and with good lithium and potassium concentrations combined with the right magnesium and sulfate concentrations, it may be one of the lowest-cost producers. The Sal de Vida project has very similar brine chemistry to that of FMC, which is one of the four main producers.
TER: The companies’ projects are basically right next to each other?
JL: FMC is on the west side and Sal de Vida is on the east side of Farallon Catal, a volcanic intrusion that comes up and separates the two. Lithium One released its inferred resource report in early March and the brine chemistry results were better than expected—very high potash levels, very high lithium concentrations and very low magnesium levels, which are good indicators of a low-cost production. Lithium One also has a pilot plant producing lithium carbonate. It is not only progressing with drilling and determining the size of the resource, but also making sure it can produce lithium carbonate.
TER: Has the company recovered potash, too?
JL: It really comes down to working with chemistry. There will be a potash byproduct credit, but it really depends on the economics of it and how much potash the company wants to create relative to lithium. There’s always give and take because production utilizes an evaporation method. Lithium One has to determine whether it wants to produce more lithium or potash.
We also cover Orocobre Ltd. (TSX:ORL; ASX:ORE) with a Speculative Buy rating and a $3.05 price target. The company is probably the most advanced to date and should come out with a definitive feasibility study. It has a joint venture (JV) agreement with metals trading house Toyota Tsusho Group (OTCPK:TYHOF), an affiliate of Toyota Motor Corp. Subsequent to the definitive feasibility study, the plan is to have Toyota Tsusho make a 25% equity infusion to start construction on the mine.
TER: And as Lithium One is to FMC, Orocobre is to Lithium Americas. They’re pretty close to each other, too, right?
JL: Yes, Lithium Americas and Orocobre are in the Olaroz-Cauchari Basin. A river delta separates the two salars.
TER: Given their proximity, what’s your opinion about the possibility of those companies joining forces?
JL: There would be a lot of synergies if the two merged. Obviously, infrastructure and capital costs could be shared; but it comes down to valuation. I think there would be enough synergies to warrant investigating a merger.
TER: Which company is more likely to become the consolidator?
JL: It’s hard to say. They both have pretty good cash positions right now, but Orocobre has a larger market capitalization.
TER: Talison Lithium also has been trying to get into brine deposits due to the high margin on high-grade brine deposits. Have you heard anything about that?
JL: Talison Lithium went public on September 23 through a reverse takeover (RTO) in which a private company acquires a public company. Talison merged with Salares Lithium and, in doing so, acquired early stage brine projects in Chile. It was a nice complement. I think it’s a long-term story for the company, given that it has such a good customer base in China from its high-grade lithium-bearing spodumene project, the Greenbushes Lithium operation.
Rodinia Lithium Inc. (TSX.V:RM; OTCQX:RDNAF) also has a brine deposit at its Salar de Diablillos project in Argentina. We have a Speculative Buy rating on it with a $2.25 target price. It’s another example of fairly good chemistry and good, effective porosity levels. And the project is another that, potentially, could be a low-cost producer. It has a decent level of lithium grade, reasonable magnesium:lithium ratio and very attractive sulfate levels—that’s another key. It has a lot of positive qualities.
Rodinia has a strategic investor in Shanshan Resources Co., Ltd., a wholly owned subsidiary of the largest battery manufacturer in China—Ningbo Shanshan. Some of Shanshan’s partners have extensive experience doing brine chemistry in the Tibetan salars. Shanshan is a value-add for that company.
TER: Where is lithium demand going relative to new technologies like EVs and batteries for smart phones, laptops and tablets?
JL: We’re definitely very bullish on the demand for lithium. Being that lithium is in the top left of the periodic table, it’s an energy-dense, but light, material for battery applications. Demand began to pick up in the latter half of 2010 and I believe it will increase significantly from 2014–2016 on, due to the implementation of EVs. To give you some perspective on lithium use, there’s roughly 20 kg. (44 lb.) of lithium in every Nissan LEAF battery; and the Tesla Roadster contains twice as much lithium.
TER: One of the issues with some specialty metals like lithium is that cheaper substitutes are often found when prices for specialty metals get too high. Is this a threat in the lithium space, or are its unique properties of lightness and high-energy density virtually irreplaceable?
JL: I don’t think there is any danger of lithium being replaced by another metal. If it was to be replaced, it would be swapped out for a different technology. Lithium is the choice material for rechargeable batteries. President Obama has come out and said that, by 2015, all federal vehicles purchased will be alternative-fuel vehicles. That’s a steppingstone to where lithium demand can go. I know China’s following suit also, in terms of electrification of it vehicles. We firmly believe that because of road electrification, lithium will be used more and more.
TER: Thanks, Jonathan, this has been very informative.
Jonathan Lee is a battery materials and technologies analyst with Byron Capital Markets in Toronto. As a member of Byron’s research department, Lee applies his beliefs, skills and investment acumen to evaluate and select equity securities, and then recommend investment ideas to the firm’s proprietary traders and institutional clients. His primary focus is on the battery materials sector, which includes lithium, vanadium and cobalt. Prior to joining Byron in 2010, Lee had more than seven years of professional industry experience in the manufacturing and engineering sectors. He previously worked in an engineering capacity preparing feasibility studies for economic assessments and engineering designs for construction projects. Lee has an MBA from the Leonard N. Stern School of Business at New York University, BSc in chemical engineering from Tufts University and is a CFA Level III candidate.
House Mountain Partners Founder Chris Berry points to the rising quality of life in Asia as competition for strategic resources that could push the cost of energy to the breaking point. There won’t be a single solution, but more efficient electricity storage to power vehicles will be critical. High-capacity batteries are dependent on several metals, including lithium, which is still underappreciated by the commodity and equity markets. In this exclusive interview with The Energy Report, Chris shares some of his favorite lithium companies and why he sees dramatic upside potential in each one.
The Energy Report: You propose that development of lithium-ion batteries for electric vehicles (EVs) will drive increasing demand for lithium. But even assuming these new batteries, ultimately, have storage capacity of three, four or five times that of conventional nickel-metal hydride batteries (NiMH), they still have to be charged with power that comes from a source like coal, hydro, solar, wind, nuclear or whatever. My question is how do EVs alleviate the drain on resources? What’s the benefit?
Chris Berry: You know that’s a great question because it’s one that a lot of people struggle with, me included. People say that with electric vehicles you’re just trading dependence on oil for a dependence on coal or other dirty fuels to power your car. I don’t see one form of energy winning over all others.
I think coal and nuclear will probably lead the way in powering electric vehicles and providing electricity in the coming decades. But there’s definitely going to be a role for renewables, such as solar, to play in places like Phoenix, Arizona and hydropower in the northwestern United States, for example. One thing to remember is that, as the rise of the middle class in Asia continues, there certainly will be increased auto demand coming out of these countries, which means increased fossil fuel demand. This gets us back to your question, the net benefit of using EVs is resource sustainability and finding the right balance of baseload power sources. You can charge a battery from many different power sources; and, as battery technology continues to advance, so too will the power sources. But there likely won’t be a singular winner.
TER: Does your investment theory assume that higher oil prices will spur development of lithium-ion (Li-Ion) battery technology?
CB: I think that’s one of the keys but I’m not sure what the tipping point is; for instance, I don’t know if it’s $150 or $200/barrel. Higher oil prices are already filtering down to higher gasoline prices at the pump. As gas prices continue to rise, people start getting a little antsy and that filters up to politicians who can spur research and development (R&D) through increased funding on the Federal level. I just hope it’s not a matter of too little too late, as development of Li-Ion battery technology is a global competition involving multiple countries throughout the world.
TER: What’s being done now to advance lithium-ion battery technology?
CB: There’s a global competition unfolding right now to own the next-generation battery technology. Four countries are the real players here. South Korea and Japan are producing Li-Ion batteries currently, while the United States and China are playing catch-up. The competition is focused on finding a battery chemistry around which you can build an entire industry. If you own the intellectual property, you can own the supply chain, which creates manufacturing jobs—something we’ve lost in this country over the past decades.
Currently, China is investing more in battery technology than any country—to the tune of hundreds of millions of dollars—even more if you consider its entire cleantech spending budget. In 2010, China invested $34 billion in cleantech research of which battery technology is a part. In the mid-1980s, the country created what it called the “863 Program,” which still exists today under the Five-Year Plans it uses as a guide for economic policy. The 12th Five-Year Plan, by the way, which was just released is thought to be the “greenest” in China’s history. That could say something about Chinese leadership’s priorities. The 863 Program has a mandate to develop high-tech and cleantech industries; so, if you want to know what China is spending R&D dollars on and where it is focusing, looking at this data is a good start.
In the U.S., President Obama helped spur development of lithium-ion battery technology with the American Reinvestment and Recovery Act of 2009. To establish a battery-manufacturing base, $2.4 billion in grants was earmarked. The Argonne National Laboratory is also at the forefront of the research to find that next-generation breakthrough. Billions of dollars in grants have also gone to the private sector in the U.S. I’ve called this a ‘Manhattan Project’ or ‘Cold War’ because, really, we are trying to outspend and out-innovate foreign competitors to own this intellectual property. That’s the name of the game going forward.
TER: As an investor, do you have a preferred type of lithium ore? Hard rock, brine or clay? Which is best?
CB: I’m not sure if one is better than the others; I think each deposit has its own pluses and minuses. Typically, brines are the cheapest from a cost-per-ton standpoint but it can take up to 18 months to produce the lithium. On the other hand, hard rock producers can adjust to a spike in lithium demand more quickly because they can increase the rate at which they mine the ore. But they have a higher—arguably the highest—production cost among any of these ore sources. Clay is right in the middle.
TER: Which lithium producers do you prefer?
CB: The four major lithium producers are working with the highest grade of known resources currently. On the hard rock side, Talison Lithium Ltd. (TSX:TLH) has its Greenbushes operation near Perth, Australia. It has 3.5%–4.5% lithium oxide, which is extremely high for hard rock deposits and is, in fact, the highest-grade lithium produced in the world today. That gives the company a distinct production economics advantage. Talison is an interesting story because it’s the only pure-play lithium producer listed on an exchange globally. It came public through a reverse takeover of a small junior called Salares Lithium in Chile. As I mentioned, Talison is producing the highest-grade lithium in the world and because of that, it is supplying 75% of China’s lithium needs—nobody else comes close.
On the brine side, the same can be said with Sociedad Quimica y Minera de Chile SA (NYSE:SQM; SN:SQM) in Chile. It produces lithium from the Salar de Atacama, an extremely high-grade brine lake. I know it can be controversial, but I prefer hard rock production due to the ability to scale to both size and demand more quickly.
TER: Talison’s market cap is just under $500 million. That really sounds low considering it’s the only public pure-play lithium company. From what I understand, it supplies one-third of the world’s current lithium market. So what am I missing here, Chris?
CB: It’s still a new story, relatively unknown. It has been public only for five or six months now, and I think the market may not understand the pure-play aspect of this company, which is extremely powerful. The other three major lithium producers globally are SQM, FMC Lithium Corporation (NYSE:FMC) and a specialty company Chemetall (Pty) Ltd., which is a division of Rockwood Holdings, Inc. (NYSE:ROC). All three of these companies trade on the New York Stock Exchange between roughly $50 and $80 per share but are known for the specialty chemical aspects of their businesses. SQM is a great example. It is a huge potash producer with lithium produced as a byproduct. Lithium accounts for just 8% of SQM’s total yearly revenue and yet the company’s one of the largest lithium producers in the world, even though the company views it as a byproduct.
So, the point with Talison is that it’s the only one that owns this pure-play production space, has the highest-grade lithium in the world and is still in its public company infancy. As Talison continues to increase capacity and supply high-grade lithium to China (predominately), more and more people are going to find out about this. There’s also additional exploration upside at the Salares 7 brines in Chile that it acquired in the reverse takeover of Salares Lithium. I think the stock is really undervalued given the stranglehold Talison has on the lithium space.
TER: Does Talison own its entire supply chain?
CB: Not currently. The company supplies two types of concentrates—one is a technical grade and the other a chemical grade. The technical grade is used in glass and ceramics, which account for 30% of global lithium demand. The chemical grade is what TLH sends to China for conversion into lithium carbonate for batteries. Talison has begun a scoping study to evaluate the possibility of building its own lithium carbonate plant.
TER: How much can Talison increase margins by owning a lithium carbonate processing plant?
CB: It’s hard to say without knowing the capital costs. If the company can build and operate the plant with expenses of less than $2,800/ton to produce lithium carbonate (which sells on the open market for around $5,000/ton now), it could see some really healthy margins.
TER: So, at this point, Talison is more of a growth story than a value story?
CB: I think it’s a growth story, but there is unrealized value here. The fact that Talison’s customers are dependent on it for the quality of lithium the company produces, and also that Talison is not only selling 100% of what it produces but working to double production capacity, should only cement its place as a globally dominant lithium producer.
TER: I note that TLH has pulled back by almost one-third over the past three months. Was there any particular tipping point, or was this a technical issue? (Others also pulled back during that time.)
CB: With respect to Talison, I think it’s likely a technical issue. The lithium space, in general, has had a few hiccups lately. Some interesting companies are still out there, however. One example is Western Lithium USA Corp. (TSX:WLC; OTCQX:WLCDF), a lithium clay explorer based in Nevada. It has a very large resource called Kings Valley in Nevada where it has produced battery-grade lithium in pilot tests as recently as late last year. That provides a high degree of confidence regarding any metallurgy issues.
The company is working on a prefeasibility study (PFS) this year and continuing to drill and increase the size of the resource. The good thing about lithium is that, unlike rare earths, the United States is not 100% dependent on lithium imports. There’s plenty of lithium out there in stable geopolitical locales and Western Lithium’s Nevada deposit is an example.
The questions are: What’s the cost of production? What’s the grade? Western Lithium has said it will be able to produce at just under $2,000/ton, which is slightly more expensive than the brines but a heck of a lot cheaper than the hard rock guys. This company is planning to be in production by 2014. It’s doing all the right things to position itself to achieve this; so, Western Lithium has a great chance.
Another interesting early stage play is Rock Tech Lithium, Inc. (TSX.V:RCK; OTCPK:RCKTF; Fkft:RJIA), which is focused on hard rock lithium and rare metal deposits in Canada. The company has a historical resource that it’s working to bring into NI 43-101 compliance by this summer. The location of the deposits and a wealth of historic drill data are two reasons this stock interests me. The whole lithium space has been under pressure recently as have many lithium juniors, but I think it’s been a market overreaction more than anything specific.
One possible cause of the recent depressed stock prices could be that Galaxy Resources Ltd. (ASX:GXY) was planning on doing a $250M IPO in Hong Kong to increase its footprint in the lithium space but delayed it due to market conditions. I think that may have hurt the price of many of the lithium juniors more than any other reason.
TER: Do you expect Galaxy to proceed with its IPO this year?
CB: My understanding is that the company shelved it because market conditions weren’t optimal. If things change, it may, but that’s really a question that company management would be better suited to answer. I know Galaxy recently achieved production out of its Ravensthorpe deposit in Western Australia, which is a positive sign; so, perhaps the IPO can wait, as the company is now generating cash from the sale of its product. Galaxy also has done a joint venture (JV) with Lithium One Inc. (TSX.V:LI), which is another interesting company in that it has attracted the attention of not only a lithium producer (Galaxy), but also Korea Resource Corporation (KORES), GS Caltex Corp. and LG Chem Ltd. (KSE:051910; KSE:051915; OTC:LGCEY)—one of the largest battery manufacturers in the world.
TER: Considering the mindset of North American investors, is there something they’re not seeing here? Because we’re going to drive big vehicles, so perhaps we don’t see the potential in these EVs?
CB: That raises a good point. I think there are certain psychological drawbacks to electric vehicles in this country today, and one of those is “range anxiety.” It’s the underlying question, ‘If I get a Nissan Leaf and the battery dies after 75 miles, what do I do?’ ‘What do I do if I have to drive 300 miles?’ That’s why I think plug-in hybrids—those that have a small gas tank and an electric battery—are going to be more popular in the U.S., at least initially. I’m not sure if the size of the vehicle is as important an issue as finding the right battery chemistry that discharges more slowly and recharges more quickly than do current EV batteries.
TER: What about the concept of battery exchanges along the way where you might drive 75–100 miles and exchange that battery for a charged one?
CB: Absolutely. An Israeli company called Better Place is attempting to address this issue. What you mentioned in your question is essentially Founder Shai Agassi’s business model. You drive and when the battery gets close to running out, you go to a depot and exchange it for a new one. Additionally, the company is working to set up a charging infrastructure and make its battery-switching technology and charging stations standard across different vehicle models.
You also raised an interesting point about infrastructure and battery-charging infrastructure in this country. I think this whole EV phenomenon is going to take place much faster in Asia, where the company’s building its infrastructure from the ground up. In the U.S., there’s a chicken and the egg problem. I’m generalizing here, but nobody wants to buy an electric car until they know there are ample charging stations and better battery chemistry in place. But governments and private industries aren’t likely to spend, time, money and other resources building charging stations until they’re confident there’s enough EV demand out there. Ultimately, this is a multidecade phenomenon. Infrastructure buildouts are happening in places like Israel and Asia but, going forward, the real winners in this industry will own the entire electric vehicle supply chain—from raw material sourcing to battery manufacture to charging infrastructure. The race is on.
TER: Chris, I’ve enjoyed meeting you very much. This has been a tremendous pleasure for me.
CB: Me, too. Thank you.
With a lifelong interest in geopolitics and the financial issues that emerge from these relationships, Chris Berry founded House Mountain Partners in 2010. House Mountain firmly believes that the emerging quality-of-life cycle emanating from Asia is a “game-changer” that will affect everyone throughout the world for decades. With that in mind, the firm focuses on the intersection of three topics: 1) The evolving geopolitical relationship between emerging and developed economies; 2) The commodity space; and 3) Junior mining and resource stocks are positioned to benefit from this phenomenon. Chris spent 13 years working across various roles in sales and brokerage on Wall Street before founding House Mountain Partners. He holds an MBA in finance with an international focus from Fordham University and a BA in international studies from the Virginia Military Institute. Chris is also a member of the Canadian American Business Council. He invites readers to receive a complimentary subscription to Morning Notes, which provides analyses of emerging geopolitical, technological and economic trends. Go to www.discoveryinvesting.com.
Philip Williams, Pinetree Capital’s VP of business development, says the spot price for uranium will likely explode above $100/lb. in 2011, much as it did in 2007 when it topped at $137. The good news, Philip says, is that even when uranium comes off its high, it will likely only fall to around $80. It’s around $73 now. If Philip’s right, we’re on the cusp of another round of uranium market madness. And you will want to read this Energy Report exclusive for some of Pinetree’s favorite uranium and lithium plays.
The Energy Report: In January, Macquarie Research said it expects the uranium spot price to reach $75/lb. in the first half of 2011 with the main driver being China’s growing energy demands. Where does Pinetree Capital Ltd. (TSX:PNP) see uranium trading at in 2011 relative to Macquarie’s forecast?
Philip Williams: We continue to be very bullish on the price of uranium. It’s had a very good run of late and we see that continuing for many of the same reasons that Macquarie does. I think for the early part of the year $75 is a good number, but it could surpass that substantially by year-end. By then, we think that the price will be at the $100 level and maybe even higher. We’ve got China doing quite a lot of stockpiling, especially on the spot market. We see the producers as being overcommitted right now. We also think that financial-speculator activity will come back to the market. All those events will culminate in a much higher price.
TER: The last time we saw a similar price spike in uranium was in 2007, when prices for yellowcake rose above $130 per pound. After that, prices dropped off dramatically. If these financial speculators are just looking for short-term money and getting out again, could we see a similar price drop?
PW: I think there are two things to think about. In 2006–2007, the uranium price was driven up mostly by financial speculators and I think they’re coming back into the market. When the run-up in the price was on, in some cases, a very small amount of uranium actually changed hands. With China’s recent uranium stockpiling, we’ve seen quite a lot of material go through the market at these prices. I think we’ll probably get a spike similar to the last one and it could be even higher, and then it will pull back. But I think we’re going to have a much higher base price this time than we did last time. After 2007, the price came back to about $40. I think it’s going to be substantially higher; it could be a price that falls back into the $80–$100 range.
TER: You mentioned China is stockpiling uranium, and China National Nuclear Corp. just received governmental approval to work on four new reactors. The European Commission just published a 10-year strategy plan that encourages development of nuclear energy as a means of clean energy. Japan’s Kyushu Electric Power Co., Inc. (TKY:9508.T) has submitted plans to build a third reactor at the country’s Sendai Plant, and India just brought a new reactor online. Where is North America in this global nuclear buildout?
PW: In a word North America is lagging. When it comes to nuclear, the U.S. is the largest generator of nuclear power with 30% of worldwide nuclear generation; but a reactor hasn’t been built in the U.S. in decades. While there are quite a few on the drawing board, only a handful is expected to come online by 2018. The real growth here is in the developing countries that you mentioned, China, India, etc.
TER: What’s largely responsible for the U.S.’ lagging nuclear growth?
PW: I think government policy is improving toward new nuclear energy but cost is still a big issue. Some of the numbers Macquarie recently published listed the cost of a new reactor built in China at about $2 billion versus $7 billion in the U.S.—that’s a huge factor. And natural gas-powered plants compete against new nuclear reactors. I think there’s still a lot of public opinion against new reactors being built. There are 104 reactors in the U.S. right now, so adding four is a very small growth rate compared to what’s happening in China and India. The U.S. was very successful on its first nuclear energy buildout but has since lost a lot of that technical knowhow, especially when it comes to building new reactors. Now, the U.S. is climbing back up that curve.
TER: Late last summer and into the fall, we watched big uranium producers like Cameco Corp. (TSX:CCO; NYSE:CCJ) and BHP Billiton Ltd. (NYSE:BHP; OTCPK:BHPLF) dip into the uranium market to meet their supply contracts because it was cheaper to buy uranium on the open market than bring on more production. What minimum price level is necessary for new uranium producers to be profitable?
PW: I expect the spot price will get to around $85 soon, and I think everything that’s in—or very close to—production will be profitable at that level. Lots of groups out there have done cost-curve analysis for future production that suggests we need a much higher number. It’s hard to give just one specific number but I think it’s at least $80/lb. It could even be higher depending on cost inflation. The next generation of uranium projects are lower-grade, more technically challenging and farther from infrastructure and major markets than most of the current mines. So, these new projects require a significantly higher uranium price to make them profitable. You need a higher incentive just to get them into production.
TER: But just a few months ago, we had $40 uranium. What’s going to sustain the uranium price at $80?
PW: You need to distinguish between the spot price and the term price. The spot price tends to be a lot more volatile. That price was $40 but the term price was above that at the time. Now, the term price is below the spot price. But it’s that long-term price that applies to new projects because a lot of these projects will forward sell their production into that price.
Fundamental supply and demand issues are ultimately going to sustain the price. Going back to that Macquarie report you quoted, we’re seeing a lot of strategic buyers like utilities from Asia and other places buying projects outright. At some point, it’s going to be very difficult to get production at any price because it will be all tied up. The end users will be integrated in such a way that they’re already contracted for any material produced. When you get into that type of environment, the price can be as high as it needs to be.
TER: But JP Morgan was far less bullish on the short-term price for uranium. It predicted uranium prices in the neighborhood of $60–$65 in 2011. Why is one big bank so much more bullish than the other?
PW: I think the difference, which Macquarie discusses in its report, is that they missed the China stockpiling. Again, you’re talking about what’s happening today between buyers and sellers that need material today—not what people are looking for in the future. When China comes in and buys close to 3,000 tons of uranium oxide in December alone, that really impacts the spot market. Because the spot market represents just a fraction of the total uranium required in any given year, it is subject to much more swings in price than the term price.
TER: How large is that fraction?
PW: I think it’s 20%–30%. Last year and the year before were particularly active years on the spot market. That’s what gives us the confidence that this move on the spot market is real and can be sustained because of the volumes that are trading on the spot market. The spot price is much more transparent; the term price is far less so. It’s a referenced price that’s provided by the pricing groups, but it’s not as transparent as the spot price in terms of where it might actually be on any given day. It could be higher; but until an actual contract transacts that meets those specific criteria, it doesn’t actually change.
TER: What’s the term price right now?
PW: About $73.
TER: As of Sept. 30, 2010, Pinetree Capital had 55 different investments in uranium. That accounted for 18% of your holdings. I dare say that that’s even greater now based on stock-price appreciation since then. Either way, that’s a sizeable bet on uranium. Could you tell us about your investment thesis and why you own so many positions in so many different plays?
PW: That September number also includes coal. We have one very significant coal position that represented a large portion of that amount and that’s Cline Mining Corp. (TSX:CMK). Cline has done great since the end of September and we think there’s a lot of potential there. As you pointed out, there have been some tremendous performances by the uranium stocks since September. We’ve always been big fans of this space.
We saw the long-term picture early on, or our Chairman and CEO Sheldon Inwentash did. This is a very simple macro argument—the world needs more electricity, especially clean power, and nuclear is in the best position to provide that. With that in mind, we wanted to have a big exposure to the uranium space, especially after the price pullback from $138 to $40. There were junior explorers and developers whose stock prices went so low that their value was basically being discounted to almost nothing. At that point, we decided to take a very proactive position in the space and rebuild the portfolio. We sold quite a few of our uranium names at the peak in 2007. We made a strategic decision to return early to the space and identified a number of juniors that were well positioned. I think our thesis has proven correct to this point.
TER: What are some of your more promising uranium holdings?
PW: We have a number of names. We focus mostly on the junior and the development-stage companies. We like names that have great assets but have been mispriced in the market and good management teams that can see those assets forward. Some of companies we are most bullish on would be names like Mega Uranium Ltd. (TSX:MGA), a long-held holding. It’s an Australia-focused uranium developer, and Australia has the most uranium of any country in the world. There are some mines in production now. A change in politics and philosophy in the country called for even more uranium mines. Mega’s Lake Maitland Project could be the very first, or possibly second, new mine to be developed. It’s in the feasibility study stage and soon the company will have some detailed information about the economics of that project.
TER: And it has a Japanese partner at Lake Maitland Project, correct?
PW: Yes, Mega has a very strong partner in the Japanese group JAURD (the Japan Australia Uranium Resources Development Co. Ltd.). And shortly it will be in a position to capitalize on the increasing price and shortage of advanced-stage uranium projects and companies. We’re excited about that one.
One of our names that’s had a tremendous amount of success in the last few months and really has just started to get a following is a company called Rockgate Capital Corp. (TSX:RGT). It has a growing resource in Mali, West Africa. We’ve seen a number of African names build and be taken over, including Mantra Resources Ltd. (TSX:MRU), which was taken over by Russia’s AtomRedMetzoloto (ARMZ) Uranium Holding Co., a Russian uranium miner that is wholly owned by Atomenergoprom OAO—a subsidiary of Rosatom and an extension of Uranium One Inc. (TSX:UUU) for a very attractive premium to the price that Rockgate’s trading at now. We’re starting to see monies that were invested in Mantra start to shift over to Rockgate as the company grows its resource. Rockgate’s recent financing puts the company in a very strong position to expand its resource and move its project ahead through economic studies.
One of the geographic regions we focus on that a lot of people have not is in South America. One of our key positions there is a company called U3O8 Corp. (TSX.V:UWE). U308 has projects in Guyana, Colombia and Argentina. This year, U308 is slated to expand its NI 43-101 resources at all of those projects by almost tenfold. We think there’s a lot of upside as other investors start to see South America the way we saw it two years ago—as the next frontier for uranium development.
One company in the U.S. is Energy Fuels, Inc. (TSX:EFR). We’ve been around that story for quite some time. What we saw last year was a very strong management team moving toward a new license to permit and build a mill in the U.S.—something that hasn’t been done for a long, long time. It paid off when the company successfully got that approval earlier this year. We think Energy Fuels is well ahead of the pack in terms of conventional uranium mining in the U.S. In the U.S., there’s a scarcity of uranium supply. We see Energy Fuels as a consolidator in the space. It’s just in a tremendous position to capitalize on what we think is a very strategic place to be in the U.S.
TER: And there’s some vanadium in the mix there on the Colorado Plateau.
PW: Yes, these Colorado Plateau projects, and even those in Utah contain certain ratios of vanadium to uranium. So, you get a nice kick from the vanadium byproduct, even though they’re still fundamentally uranium projects. Energy Fuels is well positioned to deliver new production and the first new mill permitted in the U.S.
Another one that we’re quite keen on right now is a company called Mawson Resources Ltd. (TSX:MAW; OTCPK:MWSNF; Fkft:MRY). This is in an interesting story because it’s much like Energy Fuels, but it’s actually uranium and gold. I would say almost freakishly high-grade gold and uranium. The company acquired a portfolio of projects in Finland from AREVA (PAR:CEI) last year. In prospecting at one of the projects, the company found probably the highest-grade gold and uranium anyone has ever seen on surface—over 20,000 grams per ton (g/t) gold in some places and more than 40% uranium in some places. It’s very early stage exploration at that project, but the company’s been able to delineate a 6 km. strike length to the trend at over 200 meters in width. These high-grade showings are pervasive across the trend and it’s never been drilled. It’s a new discovery with very limited work; but when you see those kinds of results on surface, it’s very, very encouraging.
TER: Does that mean Mawson is putting some of its other projects next door in Sweden aside for the moment?
PW: To a certain extent, yes. There’ll be some money spent on those projects but the bulk of the funds will be directed toward the Rompas Project, the high-grade uranium/gold project in Finland. Why? It’s the results. Mawson is waiting to get the final permits for a drill program that could commence as early as February. There’s just a lot of blue sky in that story and a lot to be learned about what could be there.
TER: Let’s move away from uranium, toward another clean energy commodity that’s getting a lot of play—lithium. Increasingly, lithium is being used in batteries to power electric vehicles (EVs). Those were nickel-metal hydride batteries just a few years ago, but now they’re mostly lithium-ion batteries. Lithium is also finding its way into some other new technologies. Judging by the number of investments that you have in lithium plays, Pinetree is betting heavily in its investment potential. Why did you get into lithium?
PW: A couple of years ago, we saw the potential in this space in terms of electric cars. Our analysis showed that even though some other battery types would fit into the mix, lithium would ultimately be the dominant player. There are a very small number of players that dominate on the production side; in fact, there’s a lot of room for juniors to come in and acquire projects—brine, hard rock or clay projects. You can acquire projects for relatively low costs and add a significant amount of value through exploration and development. We saw that as a great opportunity to make some very strong returns.
TER: Does Pinetree show a preference for brine versus hard rock lithium plays?
PW: We have in the past but we don’t like to make general statements about one type of project versus another. We really look at the individual investment opportunity. In some cases, the hard rock assets might be so mispriced that you could make a much better return even if you took a stance ideologically that the brines were going to be the better projects overall. For example, we’ve been quite positive on Canada Lithium Corp. (TSX:CLQ; OTCQX:CLQMF) even though we’ve spent most of our time focusing on the brines and names like Lithium Americas Corp. (TSX:LAC), Orocobre Limited (TSX:ORL; ASX:ORE) and others in South America. But really we try to find those mispriced or misunderstood assets where management has the wherewithal to move ahead, add value and realize the right price in the market.
TER: Yes, but some of those brine lithium deposits have potassium in the mix. If your processing circuit is developed properly, you could get potash as well as lithium.
PW: Absolutely. There’s tremendous opportunity in those kinds of plays.
TER: What are some that Pinetree is rather bullish on?
PW: Lithium Americas is at the top of our list. We’ve been involved in that story from the very early days, and it’s just blossomed into a tremendous story. It’s one of the largest brine deposits on the planet. The company’s made tremendous strides on the technical side, as well as understanding the economics. We’re going to see two major studies published this year with a prefeasibility study first, and then a feasibility study by year-end. The story has come together in a very short amount of time, but we see tremendous upside.
TER: And Lithium Americas’ Salar de Cauchari lithium project is not far from one owned by another company you mentioned, Orocobre.
PW: In fact, Cauchari and Orocobre’s Olaroz project are abutting each other.
TER: Given the proximity to each other, did Pinetree make its investment in Lithium Americas with an eye toward potential consolidation?
PW: In general, we always look for assets that we think will ultimately be consolidated or could be the consolidators. We certainly see that as something that should happen in that particular region. We’re not sure whether Lithium Americas will be the consolidator or not, but the company has tremendous partners and could easily go it alone. As I said, it’s one of the largest brine resources on the planet; so, it’s not a requirement but it’s certainly an exit that’s possible for LAC.
TER: Are you vested in Orocobre, too?
PW: We’re not a disclosed holder of Orocobre.
TER: Could you leave us with thoughts on how these clean technologies are influencing the mining sector and some of the opportunities they are creating?
PW: One area that we didn’t touch on is rare earth elements, which are used in a lot of cleantech applications. We also have quite a few investments in that area. We believe there will be strong opportunities in the cleantech space over the next few years for many reasons. China is dominating rare earths production, and finding supply outside of China is an absolute must for companies that want to be in those cleantech spaces. We’re tremendously bullish on rare earths, at least for the next year or two. Clean energy is certainly one reason we’re in the uranium space. When you stack up nuclear versus coal-generated power, uranium is a hands-down winner. We see more and more people getting behind nuclear energy, and it’s a great place to be vested.
TER: Thank you for talking with us today, Philip.
Philip Williams joined Pinetree Capital in January 2009 and was appointed to the position of resources analyst. Philip brings almost 10 years of financial market experience to the company. Prior to joining Pinetree, he spent five years working for several institutional brokerage firms in the equity research department. Most recently, he was a uranium analyst focused on companies with advanced development projects in Australia, the United States and Namibia.