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Gareth Hatch is a Founding Principal of Technology Metals Research, LLC. He is interested in helping people to understand the challenges associated with the growing demand for rare-earth elements [REEs] and other critical and strategic materials, and how those challenges affect market sectors... More
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  • The Goldilocks Mining Principle: Right-Sizing Rare-Earth Mining Ventures 0 comments
    Oct 7, 2010 11:39 PM | about stocks: TYHOFIQ, LYSCF
    Jack Lifton & I recently had a private discussion on the merits of a number of rare-earth mining ventures, and how the proposed size of each project (in terms of tonnage in the ground and / or production rate) might affect the overall probability of success. While we agreed on a number of the points discussed, our overall perspectives on the topic differed somewhat, and so we decided to summarize our observations and present them here.


    From Jack Lifton:

    I cannot see any practical, economically realistic way that a rare-earth mine, without participating in a distributed-overheads scheme, can be profitable at the point of selling ore concentrate into the market.

    I believe that this was the dirty little secret of why the rare-earth-mining industry failed in the non-Chinese world during the last generation. China’s secret of success was not brilliant market-entry timing or low labor costs, as the pundits have theorized, but rather it was state participation in absorbing overheads, either as direct grants or mandated, shared-infrastructure resources.

    There are only two ways to finance a rare-earth - or any other - mine. These represent the reaction of political/economic systems to demand for a natural resource. Capital to develop the production of a resource can come from either :

    1) Private equity (free market), or one of two types of

    2) State subsidy, either the

    a) Chinese model: direct government control and subsidization, or the

    b) Japanese model: indirect government control by the encouragement of private participation, through vertically integrating a mining / refining operation into a combined balance sheet, and thus distributing the mining / refining overheads. This model has been adopted by Toyota (OTC:TYHOF) for its Vietnam-based rare-earth and Argentina-based lithium mining / refining operations.

    Unfortunately the US Congress is being lobbied to utilize the Chinese model, rather than the Japanese version, and no rare-earth champion from private industry seems actively ready to carry the ball.

    But in any case, nearly any small rare-metal-focused mine, as a freestanding entity producing concentrates, will fail economically; it will either not make a return on the private equity, or will require permanent state subsidies, unless it is part of a vertically integrated supply chain, where there is a profit point with a high-enough selling price, at a high-enough margin, to cover the costs of the supply-chain steps, including the mining, occurring at earlier points in the supply chain.

    If my hypothesis is correct, then it is best to right-size the mining part of a rare-metal supply chain from the very beginning. This means that the production target for the mine must be in line with the least-necessary demand, and the most-likely growth of that demand for its product(s), in order to conserve and to maximize the efficiency of the deployment of the capital to get the fastest return possible. Thus it would seem that in the present situation of the potential global-supply imbalance among the rare earths, the smaller the non-Chinese mine, and the more heavy rare earths it can produce, then the more likely it can have a low-enough negative cash flow, so that an overall positive cash flow can be achieved, by integrating it into the closest point of the smallest-turnover supply chain possible.

    I believe that for the rare-earth supply chain, this point is the manufacture and sale of rare-earth permanent-magnet alloys of neodymium-iron-boron and of samarium-cobalt. For the magnets made from such alloys to be of the highest quality, they will need to be of the type utilizing dysprosium additions, to achieve the highest-temperature, high-efficiency operation. Dysprosium is a heavy rare earth that is currently the sine qua non for the most-valuable rare-earth permanent magnets.

    Dysprosium and another 'heavy' rare-earth metal, terbium, are today only produced in China. But China admits it is running out of both of them. Thus they are the most critical of all of the rare-earth metals. Few deposits are known that contain commercially recoverable quantities of either of them.

    The only US-located venture actively underway, that could meet the criteria discussed above - small size and commercial heavy-rare-earth content -  is Ucore Rare Metals' (OTCQX:UURAF) Bokan Mountain project in Alaska. Ucore is currently undertaking a drilling program there, to confirm and to verify the extent of a very significant occurrence of heavy-rare-earth-rich deposits at Bokan Mountain.

    Globally, two ventures with projects meeting these criteria, and of which I have direct knowledge, are Great Western Minerals Group (GWMGF.OTCBB) (GWMG) of Canada and Frontier Rare Earths, a UK-domiciled company. The former has potential right-sized assets both in Canada and South Africa. The latter has them also, but only in South Africa. GWMG is particularly attractive, because if it can add a small separation, refining and metal-production operation to its existing deposit and magnet alloys plants in the UK and USA, it can become one of the only viable freestanding rare earth operation outside of China to be profitable through vertical integration. GWMG’s business model shows that it is profitable at the stage in the supply chain where it is selling rare-earth permanent-magnet alloys.

    Disclosure: I have been, or am currently a paid consultant, to all three companies named above. I currently do not own shares in any of them.


    From Gareth Hatch:

    When it comes to considering the 'right size' for a rare-earth mining venture, I think that we first have to acknowledge that in the current and future evolution of the wider, global rare-earths sector outside of China, in simplistic terms there are at least two competing agendas.

    At the far end of the supply chain, we have end users of finished or semi-finished products, with a desire to have as much material available in the market as possible. Having strong supplies enables ready access at low prices, leading to good margins in the end products and technologies that the end users will ultimately sell. Supply surpluses also give companies the luxury of creating buffer stocks, to alleviate fluctuations in future supply or pricing of materials - albeit balanced with the desire to minimize the amount of cash tied up in such inventories, and to minimize exposure to future price decreases.

    At the other end of the supply chain, we have miners and potential miners of rare earths, who, on an individual basis, need for the current and future prices of rare earths in all forms - ore concentrate, partially separated mixed oxides, fully separated oxides, metals or alloys - to be as high as possible, while simultaneously working to drive down the cost of production. They need this in order to make the projections for their projects work, and to give a return on investment at a favorable rate. Common factors that lead to favorable conditions are scarcity - either in terms of actual quantities of material in the ground, or in the production rates for exploiting these material - and increased demand.

    These competing agendas are of course by no means unique to the rare earths sector, although the latter scenario probably has few equals in terms of technical and financial complexity, outside of the rare earths.

    We also have to remember that unlike, for example, the gold market, significant increases in overall supply can put significant downward pressure on pricing. Without a commensurate surge in demand, the availability of resources from multiple channels of new supply, will affect the overall market pricing of those resources.

    So, returning to the original concept under consideration, let's think about how the above applies to individual mining ventures. If the production rate of a mine is too large, and the output is entering the open market, then we risk depressing the prices for the resources that are produced, and thus we risk the capital invested into the project in the process - which will likely be considerable in order to facilitate such a large production rate in the first place.

    On the other hand, if the size of the deposit or the production rate is too small, then we run the risk of not having a viable mine life, and not being able to get a return on investment quickly enough. So generally we're looking for something in the middle - akin to a 'Goldilocks' principle for right-sizing rare-earth-mining ventures.

    These two factors are not unique to rare earths, but there are two additional factors to consider here, one of which is unique to the rare earths and other polymetallic deposits. We have to consider the distribution of the individual rare earths in any given mineral resource, and the overall material grade of the resource, since rare-earth deposits are not created equally. A relative composition of total rare earths present that is skewed towards the heavy rare earths, is likely to be of particular interest because of the inherent higher market values of such materials in finished form. On the other hand, a resource with a high material grade of total rare earths, even if it doesn't have a relatively high distribution of heavy rare earths may still be attractive, because of the overall value of the rare earths per tonne of mineral resource. Of course, all associated valuations of mineral resources based on these factors, assume the cost-effective development and availability of an optimized metallurgical process for extraction, among other things.

    So again, there is a 'Goldilocks principle' at work with regard to the resource itself, as well as the subsequent production that exploits it.

    Given all of the above, I would agree that larger projects (those with high production rates) are going to be of less interest to companies who wish to vertically integrate rare-earth production directly into their supply chains, as a means of securing supply and lowering production costs. The capital required to facilitate higher production rates, and the relatively low amount of materials any one company, regardless of how large they are, can consume, are negative factors here. So this would indeed be where smaller mineral resources, or lower production rate projects could come in to their own.

    To those mentioned above by Jack, I would also add Alkane Resources' (OTCQX:ALKEF) Dubbo project to the list of potential "smaller" projects. At 23%, its overall relative distribution of heavy rare earths within the grade is greater than that of GWMG's Steenkampskraal (7.7%) or Frontier Rare Earths' Zandkopsdrift (7.8%) projects, both located in South Africa (Ucore's Bokan Mountain project has not yet been defined as a mineral resource using 43-101 or JORC-compliant guidelines, and is not a past producer of rare earths, so I won't comment on their data). The overall in-situ tonnage of total rare earths is in between those for the two South African deposits, and the metallurgical processing work is further along than either project. There are other factors too, but you can see that Dubbo is a candidate for the type of "right-sized" smaller project that we've talked about. It's not the only one either - projects such as Stans Energy's (RUU.TSXV) Kutessay II mine in Kyrgyzstan also fall into this category.

    Now all of that said, I would suggest that there is room for 2-3 'large' producers of rare earths in the marketplace outside of China (large, as in production rates of 10,000 tonnes per year or more), as that market place now stands, even if these projects are predominantly light-rare-earth deposits. The two leading projects of this type, Molycorp's (MCP) Mountain Pass and Lynas' (OTCPK:LYSCF) Mount Weld, each have plans to do something with the ore concentrates once produced, that will add further value to the resource. Not all of the details necessary to independently evaluate the plans that these companies have for their projects, are in the public domain yet.

    I would also argue that additional larger projects could still be viable, ahead of any future substantial increases in demand, if, for example, one or more centralized separation and refining operations could be developed, to whom these new entities could sell their ore concentrates, at prices greater than they would otherwise obtain on the open market (i.e. to Chinese companies). Of course, such centralized facilities would have to overcome significant technical and economic challenges to be feasible, but the concept is worth looking at as a means of producing materials, that could ultimately provide economies of scale to the producers, while maintaining reasonable prices for end users.

    Getting the right balance here between projects that are tightly integrated into existing supply chains, projects that are able to economically produce value-added products for sale in the open market, and those that could provide feedstock to centralized separation and / or refining facilities, could very-well lead to an incremental and profitable increase in demand for rare earths such as neodymium, used in permanent magnets, as the supply of such materials is secured.

    Of course, the corollary is that if the rare-earths sector gets it wrong (particularly if efforts are not coordinated in some way, without falling foul of anti-trust issues), then we could still be relying on China for our rare earths for many years to come…

    …not a good scenario.

    Disclosure: I am not now, nor have I been in the past, a paid consultant to any of the companies named above, nor do I own shares in any of them.
    Stocks: TYHOFIQ, LYSCF
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