In studying the rapidly growing graphite market and the junior companies that hope to be its leaders, it quickly becomes apparent which attributes are of paramount importance. It largely comes down to security of supply, jurisdiction, economies of scale, in-situ grade, suitability for high-technology applications, time to first production, position on the cost curve and access to project financing.
Of the dozens of publicly-listed graphite juniors, less than 10 have projects that score high on a significant number of these metrics. [Note: A lot of the companies don't make my list of contenders simply because they are 5 years + from production]. A U.S. graphite junior that rises to the top of the pack is Graphite One Resources (OTCQX:GPHOF) & (GPH.v). Graphite One has an Inferred resource of 12.76 million metric tonnes, "Mt" of in-situ flake graphite (includes 8.6 million Mt @ 12.8% Graphitic Carbon Grade, "Cg" at-near-surface or 1.1 million Mt of graphite) on just a quarter of its deposit's strike length.
Not only does Graphite One stack up well on some key fundamentals, it trades at a cheap valuation of just US$ 19 million, (C$0.175/share on 5/6/14). This for a company that I believe is sitting on a highly economic deposit with a Net Present Value, "NPV" possibly reaching into the hundred(s) of million(s) of dollars. [Note: This is my opinion only] Graphite One is committed to releasing a Preliminary Economic Assessment, "PEA" by early next year. Reviewing peer PEAs from companies like Northern Graphite (OTCQX:NGPHF), Flinders Resources (OTCPK:FLNXF), Focus Graphite (OTCQX:FCSMF), Mason Graphite (OTCQX:MGPHF) and Energizer Resources (OTCQB:ENZR) as a rough guide, Graphite One could be looking at a project with industry-low operating costs due to its high-grade, at surface deposit and the economies of scale from a large operation.
Graphite One's Graphite Creek deposit could become a very large producer, with 285 million Inferred Mt at a Cg of 4.5%, (including 37.7 million Mt at 9.2% Cg and 8.6 million Mt at 12.8% Cg). That combination of a high-grade, near-surface, long-term production profile, in the safe jurisdiction of Alaska, USA, places the company's project as one of the top in 5 in the world. First production is expected in 3-4 years, coinciding with the opening of Tesla Motors' (TSLA) giga-battery factory in the southwestern U.S. Please see Graphite One's Corporate Presentation.
Security of Supply
Deemed a, "supply critical mineral" in the U.S. and a, "strategic mineral" in Europe, graphite is increasingly valued for both existing and future high-technology applications. Yet future supply of this mineral is far from certain and the U.S. imports 100% of its graphite needs. Further, China currently produces 70% + of the world's flake graphite, but is consuming more and more of it domestically.
Resource nationalism is growing threat to the supply of globally traded commodities. Gold, copper and uranium are the commodities perhaps best identified with supply challenges, but all high-value, materials are at heightened risk. At roughly $1,500/Mt, flake graphite is a valuable and sought after commodity. By comparison, bulk commodities such as potash, iron ore and coal trade at prices ranging from US$50-US$350/Mt.
Today, a large majority of global graphite comes from China. However, this dynamic is rapidly changing. China's mines are mostly small, inefficient and environmentally unfriendly. China is closing a significant number of graphite mines and keeping an increasing proportion of its production for domestic uses. Consider the following quote from this Industrial Minerals, April 17th article.
"Industrial Minerals' Simon Moores reported that China's Heilongjiang province, the world's top flake graphite-producing region, has officially announced plans to start consolidating graphite mines in the next 18 months."
Security of supply for North American end users will increasingly revolve around sourcing a lot closer to home. In fact, Tesla announced plans to source as much raw materials as possible from North America going forward. Graphite One is gearing up to be the ONLY U.S. junior of scale positioned to meet North America's rapidly growing demand.
Not to mention, anodes in Aluminum Smelting. Anodes are large carbon blocks which act as electrical conductors, allowing the smelting process to take place. The anodes weigh approximately one tonne each. What this means? Chinalco is looking to use flake graphite as a substitute for petroleum coke and anthracite in its aluminum production. This is a really important development because this end-use was largely not factored into graphite industry growth models. Further, this new segment (anodes in aluminum smelting) is a 14 million Mt/year market. That's 10 times the size of the existing flake graphite market!!
Graphite One's deposit is located in the State of Alaska, ideally situated for sales into the incredibly important southwestern U.S. How important is the southwest turning out to be? Given last month's giga-battery factory news, the U.S. could become one of the largest end markets for flake graphite on the planet. Importantly, jurisdiction is more than just a geographic location.
Rule of law, resource nationalism, indigenous people, environmental concerns, access to water, power and transport infrastructure- all of these and more are increasingly essential factors to consider. Suffice it to say that the State of Alaska, USA, ranks high on these measures compared to countries like China, India, Mozambique and Sri Lanka, where some peer junior graphite companies hope to do business. According to this website, North Korea! is currently a top 5 producing country. Recently, the Fraser Institute ranked Alaska #1 on a list of jurisdictions as ranked by, "Mineral Potential Index."
Economies of Scale
As mentioned, of the major projects slated to come online by the end of the decade, some are in sketchy countries, have deposits located far from key end markets or will be logistically challenged in any number of ways. Graphite One's proposed Alaskan project is not without challenges and risks. However, economies of scale play a very decisive role in any project's economic viability. Said another way, large scale can make up for potential shortfalls in other areas of a project.
In my opinion, (not necessarily that of management) Graphite Creek could produce 100,000 tonnes of graphite annually. Why do I think this? As mentioned, the company has already identified 37.7 million Mt of near-surface, 9.2% Cg, including 8.6 million Mt of 12.8% Cg material. To be clear, this deposit is currently defined as Inferred resource, not the better defined Measured and Indicated resource categories (an upgraded NI 43-101 report is expected within 9-12 months).
As it stands, 37.7 million Mt @ 9.2% Cg is already approximately 3.5 million Mt of graphite- enough for 35 years of production at 100,000 Mt/year. Further, the company's resource is found on just 27% of the deposit's strike length. Therefore, it's possible that over the next year or two that the size of the deposit could double or triple as it also migrates to a NI 43-101 compliant Measured & Indicated resource. Regardless, the deposit is almost certainly much larger than reported.
Graphite One's in-situ grade is one of the most compelling parts of the story. The company's deposit is the largest in North America, but large scale alone is meaningless without a viable in-situ grade. The majority of existing mines in China are lower-grade than what Graphite One will be mining. In fact, the first 8.6 million at-to-near-surface Mt have a grade of 12.8% Cg, (using a 10% Cg cutoff, which is higher grade than most other deposits). While most in-situ grades can be upgraded through processing to 90%+, the mining costs can be daunting. For example, it takes the movement of six times the volume of material to mine a 2% Cg deposit as it would a 12% deposit.
Suitability For High Technology Applications
Last month, Graphite One announced exciting news. As reported by the company,
"Graphite One Resources Inc. announced promising results from a second series of benefaction tests conducted at SGS Canada Inc. on samples taken from its wholly owned Graphite Creek Deposit. Using a leaching process, the trials yielded results from a rough concentrate exceeding 99.9 percent carbon."
It's vitally important to recognize that most, but NOT ALL graphite deposits have the exacting specifications that high technology applications, (most notably lithium-ion batteries) require. In speaking with industry experts and a number of company management teams, that realization will come as an unpleasant surprise to shareholders of a few companies. With last week's news, Graphite One has proven beyond doubt that it's deposit will stand up to the very highest specs.
Time to First Production
In the best case scenario Graphite One will be in production in about 3 years time, by mid-2017. Admittedly, that timeline could be stretched by 6-12 months depending on permitting and other factors. 3-4 years may seem like a long time, but it's not. In fact, Graphite One's timing could prove to be impeccable as China's exports continue to shrink and demand for graphite in batteries takes off due to Tesla's giga-battery factory.
The vast majority of emerging producers are still early-stage explorers 6-12 years from production. However, most of these projects will never get off the ground. There's only a handful of notable projects that could possibly be in production within 5 years. By notable, I mean projects of at least 15,000-20,000 Mt/year.
Position on Cost Curve
Before a PEA is released, (expected within 9 months), it's difficult to forecast exactly where Graphite One might sit on the industry cost curve. However, in my opinion, the deposit appears to be supportive of a low-cost operation. Several of the most important determinants of any mining operation are; strip ratio, in-situ grade and economies of scale. I've already touched upon the potential scale of the operation and the in-situ grade. In terms of the strip ratio, there's no question that it will be extremely low.
The strip ratio is the ratio of barren material to ore, a ratio of 1:1 means 1 tonne of waste needs to be removed to extract 1 tonne of ore. Depending largely on the depth of a deposit, strip ratios can be as high as 10 or 15 to 1, as can be seen in some of Queensland, Australia's mature coking coal mines. Since the Graphite Creek deposit outcrops, and its highest grade material happens to be nearest to the surface, mining will be at a strip ratio well below 1:1.
Access to Project Financing
A big mistake is made by investors who take project financing for granted. Since raising large sums might be a few years away, it's tempting to ignore that eventuality. However, access to project financing for natural resource companies has been extremely challenging to obtain. This situation cuts across geography and commodity. Emerging iron ore, potash, coal, gold, copper, uranium….almost any large-scale project is capital starved today. Many projects have been canceled, many more have been indefinitely delayed. In some resource sectors, the upfront capital required before first production runs into the billions.
For the most part, large graphite projects can be put into production for less than $200 million. Several of the proposed projects by the short list of companies mentioned above show capital requirements in the $100-$200 million range. In the key area of project finance, Graphite One has an incredible opportunity to stand out. The State of Alaska (AIDEA) has a loan program for emerging natural resource producers that the company could apply for next year. The amount of the loan could be for well over half of the project's cost. Any questions? Ask Ucore Rare Metals what they think about the support of AIDEA and the State of Alaska! Ucore has been conditionally approved for a $145 million loan on a $221 million project.
Valuation & Peer Comparisons
Companies on my list that could be in production of meaningful amounts of graphite within five years are, Flinders Resources, Focus Graphite, Energizer Resources, Mason Graphite, Northern Graphite, Zenyatta Resources (OTCQX:ZENYF) and Syrah Resources (OTCPK:SYAAF). Big North Graphite (OTCPK:BNCIF) is a smaller company (of which I am a shareholder) with an exciting flake graphite project in Mexico that could reach initial production next year. I leave Big North out of the peer group only because its initial expected flake production is under 15,000 Mt/year.
Therefore, of the seven companies with notable projects, the average market cap is US$ 128 million. However, that average is skewed higher by Syrah Resources' market cap of US$ 525 million. Even without Syrah, the average market cap of the peer group stands at US$ 62 million, which is 3x Graphite One's market cap of US$ 19 million. Said another way, Graphite One is trading at a 70% discount. I believe this massive valuation gap is unwarranted and will close over the next 12 months. Don't get me wrong, since I love the fundamentals for graphite, I like 3 of the companies in the peer group, but I think that Graphite One's stock has the most upside.
Graphite One's Prospective Metrics:
295 million Mt Inferred Resource @ 4.5% Cg including,
37.7 million Mt @ 9.2% Cg (At-Near-Surface) including,
8.6 million Mt @ 12.8% (At-Near-Surface)
Strip Ratio: forecast to be among the best in the industry, well below 1:1.
With only the 3.5 million Inferred, in-situ Mt @ 9.2% Cg, a prospective project of 100,000 Mt/year for 35 years is possible. Again, just my opinion, subject to pending PEA.
Operating cost: Likely to be quite competitive, (subject to pending PEA), due to very low strip ratio, solid in-situ grade and strong economies of scale.
NPV: Graphite One's project, (in my opinion only), could have an NPV in the hundred(s) of million(s) of dollars. If true, the company's market cap is a small fraction of its prospective NPV. Support of an NPV possibly in the hundred(s) of million(s) comes from, large operating scale, low strip ratio and high grade. We know that each of these component factors is favorable, which just don't know yet how they all come together. The PEA will reveal the preliminary economics in due course.
Peer Project PEA Metrics:
Focus Graphite: Upfront Capital: $126 million, NPV US$ 316 million, proposed annual production 44,200 Mt, production within 2 years. 50% off-take agreement signed with Chinese partner.
Mason Graphite: Upfront Capital: $90 million, NPV US$ 364 million, proposed annual production 50,000 Mt, production within 2 years.
Energizer Resources: Upfront Capital: $162 million, NPV US$ 421 million, proposed annual production 84,000 Mt, production several years away
Northern Graphite: Upfront Capital: $102 million, NPV C$ 231 million, proposed annual production 33,200 Mt, production within 2 years.
Flinders Resources: Remaining Upfront Capital: minimal, NPV US$ 27 million, proposed annual production 16,000 Mt. The company is fully-funded through initial production in July, 2014. Management states it could expand to 30,000 Mt/year if market conditions warrant. Interestingly, Flinders' valuation is at a premium to its projected NPV.
If, like me, one is bullish on the fundamentals of graphite, Graphite One's project in Alaska is a top contender to be a leader later this decade. Make no mistake, there are a small handful of peer junior graphite companies that will also be successful, but with a market cap of just US$ 19 million, Graphite One has the most upside. Today, the company is trading at roughly a 70% discount to the above mentioned companies.
I believe that the stronger graphite plays will increase in value and that Graphite One will close the valuation gap, leading to a large increase in the share price in the next 12 months. To reiterate, Graphite One is not without risk. The biggest risk is that the company is still 3-4 years from production while 2-4 peers will likely be in production within 2 years. However, if one is bullish on graphite demand, this risk is somewhat muted.
In the next 12 months Graphite One will release a PEA and upgraded NI 43-101 report in which a majority of the current Inferred resource should migrate to the Measured & Indicated categories. Later next year, discussions regarding off-take agreements should begin, samples of graphite will be sent to potential end users and the company will be talking to Alaskan officials about State sponsored loans. The next 12 months will be an exciting time for graphite investors and especially for Graphite One.
Disclosure: I am long GPHOF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
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