Over the past year and a half the planet has become aware of the fact that the world’s supply of rare earth elements is controlled by the Chinese and the marketplace is no longer run on pure economics but rather quota announcements and security of supply issues. During this time investors have flocked to the rare earths arena to place their bets, and to this date there have been many winners, including Rare Element Resources (NYSEMKT:REE) with its Bear Lodge deposit in the United States. Recently we had an opportunity to talk with Mr. Mark Brown, director and CFO of Rare Element Resources.
As our readers know, many of the industries we follow are niche industries with few producers with tight supply/demand fundamentals. Rare earths are no different and according to Mr. Brown, China, the world’s main supplier of rare earths, produces about half of the world’s supply from one mine, the Bayan Obo Mine. This was one of the reasons REE acquired the Bear Lodge project about 10 years ago along with its thinking that down the road large quantities of rare earth consuming hybrid vehicles would be produced for eco-conscience and gas price fearing consumers.
The Bear Lodge project has been explored since 1949 when the U.S. Geological Survey found thorium and rare earths while looking for uranium. Four companies before Rare Element searched for rare earths and gold on the project and in each case they increased the known mineralization. Duval Corporation, searching for base metals, found rare earths in a drill core, and due to this the company brought in Molycorp (MCP) to assist in the exploration as a joint venture partner. Exploration was carried out from 1978 to 1980 but they did not hit the high grades Rare Element has today. Hecla Mining (NYSE:HL) then consolidated the land position in 1986 and until 1991 it drilled for rare earths and gold, drilling 12 holes, some of which discovered some of the high grade mineralization that Rare Element has been expanding through its drill programs. Finally Phelps Dodge staked the property and Rare Element (via a company subsidiary) later optioned the exploration project from them and began a modern search for rare earths and gold.
Rare Element believed that based on the historical data that the surface had only been scratched so they were very intrigued by the project. In the early part of the decade budget constraints kept them from heavy exploration. However the company kept the claims in good standing and when financing was available they raised the necessary funds to move forward with drilling plans. All of this time and work helped the company understand the deposit, which undoubtedly led to the company hitting on almost 100% of the holes they drilled in the 61 hole program in 2010.
Mr. Brown explained to us that although Rare Element, dually listed in Canada and the United States, is a relatively new issue to U.S. investors, the company has been traded on the Canadian exchanges for some time. The company was however one of the early movers in the industry. They literally had no competition for the current project, even dropping some of the claims when times were tough to save on expenses, which they later re-staked. The company also visited many other deposits and developed working files on deposits around the world. Mr. Brown stated that the company has, “had a hard time finding any projects that we would want to acquire but have a short list of projects if they come available.” He stressed that the company is focused upon Bear Lodge, however if the right project became available at the right price, they most certainly would be buyers.
During our interview, we were most impressed by Mr. Brown’s honesty when discussing his company against its peers in the industry. Rare Element Resources is currently in the pre-feasibility Stage along with several other companies with projects in Australia and Canada, and REE is, “working hard to advance our project toward our stated goal of producing rare earths by 2015.” Mr. Brown went on to say, “several of us have the target of going into production by 2015 and my view is that there will still be shortages of rare earths at that time.” If Mr. Brown is correct in his estimates, the rare earth bulls could run much further than many market commentators currently believe.
When we asked Mr. Brown about his company’s prospects and timeline to get to production, he acknowledged that Rare Element will not be one of the first two to production. Lynas (OTCPK:LYSCF) and Molycorp he states will be in production years before Rare Element and the rest of the juniors. However 2015 is when the first wave of junior miners should hit the market with their production. According to Mr. Brown, the timeline looks like this:
2011 – Complete our pilot plant test, update our resource calculation, begin permitting processes, continue to confirm and improve our metallurgical process, complete additional exploration and in-fill drilling, and complete our pre-feasibility study.
2012 – Continue with many of the same items from 2011 plus complete our full feasibility study.
2013 – Finish permitting, metallurgical testing and prepare for financing construction. Also, complete anything that is unfinished from 2012 in case of delays.
2014 – Begin and complete construction of the mine and mill.
2015 – Begin production at the mining rate of 500 tons per day which will produce about 5,000 tonnes of REOs in the first year.
2016 – 2017 – Increase production to our life of mine rate of 1,000 tons per day to produce about 10,000 tonnes per year REO. We initially plan to produce a concentrate for sale but then after a few years construct a separation plant to produce the individual elements in the form of the individual oxides (REO).
We find a few interesting points here, the first is that the company indicates they will not raise capital until 2013, thus dilution to the shares over the next 12-18 months should be minimal at worst. Second, the company is going to spend the next three years improving its metallurgical process, otherwise known as hydrometallurgy in the industry. The fact that they acknowledge that initial results are not their final process gives us comfort. It takes time, money and a lot of energy to perfect these processes and Rare Element is one of the few companies publicly stating they have a process but know they can improve upon it. Not many others are willing to admit this at the current time.
Mr. Brown also acknowledged that, “it is pretty normal for complicated mining projects to take a year or two longer than plans call for. If that happens to a few of us, the market will be even more desperate for rare earths.” Once again, some realism for those thinking all of the executives in the industry are pie-in-the-sky kind of people.
At the time of the interview, Mr. Brown indicated that the company was very pleased with the composition of the Bear Lodge deposit and indicated that 61% of estimated revenues would be, “made up from europium, terbium, dysprosium, neodymium and praseodymium.” These are the metals most sought by rare earth consumers due to their uses in high-strength magnets, currently the largest and fastest growing market.
Last year the company’s shares took off after the release of its PEA (Preliminary Economic Assessment) which indicated that the capital costs to build the mine and mill would be an estimated $87 million. Mr. Brown stated that although the operating costs were estimated at $213 per ton of ore that the company expects, “to be able to reduce this as we do further optimization work and have already made some progress on this.”
Throughout our conversation the fact that the company was extremely conservative in its pricing and models was repeatedly stated. Even with those numbers, which we have been over numerous times, the internal rate of return is estimated at about 40% with the payback of capital estimated to take about 3.1 years, which factored in the three-year scaling up to full production. In the PEA the company used a $5.51 price per kilogram for the concentrates produced versus the price at the time of interview of $38. The company was very conservative on the price assumptions, more so than some of its peers, which should pay off for investors moving forward should prices of certain REEs begin to pullback as more production enters the marketplace.
One of the most important aspects of our conversation that we took away from the prices used in the PEA is that Mr. Brown expects when the dust settles the REE prices will still be 3-4 times the historic prices which were used in the PEA. Also important for investors is that Mr. Brown confirmed our suspicions that when Molycorp and Lynas are in full production that those two companies alone will create a surplus of cerium in the market.
Management believes in the mine and thinks that it can stand on its own merits. In other words they will not seek a mine to magnets strategy currently being either employed or contemplated by their peers. Currently the management team owns about 2.5 million shares or 5.8% of the company.
Looking forward over the next five years, Mr. Brown said he expected the company to either be in production or very close to it, “along with the likes of Molycorp and Lynas, and hopefully two or three others, maybe Arafura (OTCPK:ARAFF), maybe Quest and/or Avalon (NYSEMKT:AVL) and one other Australian company, on top of small production from India, Africa, and maybe Vietnam.”
It is not often that we come away from an interview impressed. Over the years we have talked to many company executives in varying industries, but Mr. Brown and his company’s prospects stand out as some of the brightest we have seen among any of the advanced exploration/development companies. It appears that the PEA was just the tip of the iceberg and over the next few months and years the company will build upon its current gains. Mr. Brown pointed out that the company has a tight float with a market cap much less than Avalon’s and only a fraction of Molycorp’s which he said leaves, “a lot of room to build the value of our company for our shareholders.”
With China’s insistence on higher REE pricing and a growing desire among the world’s REE consumers to create stockpiles for these metals, investors could see prices continue higher. If large consumers of REEs enter the market to purchase miners in order to secure supply, as Mr. Brown indicated might be the case in coming years, investors could quickly see takeover premiums added to these companies with enthusiasm pushing the industry as a whole higher.
If you would like to view the entire interview transcript it can be found here.
Disclosure: I am long ARAFF.PK.