There once was a farmer, let's call him Farmer Giles. He had a field which he didn't farm, and he decided to look at creating an orchard and selling apples. He figured out what equipment he would need, and how much it would cost.
The field wasn't in a great location, the soil was bad and it was too small an area to get any significant economies of scale. After doing his calculations he figured that he needed to sell his apples at $1.25/lb to make his project worthwhile. The problem was that the market price for apples was only $1.00/lb.
So he hit upon a great idea. He would bake apple pies. Fresh baked apple pies sell at the local farmer's market for $6, and he figured, even with the extra costs for the baking equipment, he could make them for $4.50.
Does that make his orchard project viable? No it doesn't. He could buy apples for $1.00 to bake his pies, instead of growing them himself for $1.25. He also restricting himself to a much smaller market, and he may not sell enough pies at the farmer's market to use up all of his apples. He could sell his pies to the local supermarket, but they will only pay $4.00 a pie. Their fresh baked products section is one of their leading money makers, and they don't want to give up the profit on the pies that they bake in the shop.
Either way, farmer Giles will be stuck with selling his apples at a loss if he can't generate enough sales at the farmer's market.
Two US based graphite companies, Graphite One (OTCQB:GPHOF) and Alabama Graphite (OTCQB:CSPGF) have recently completed Preliminary Economic Analyses for graphite mines. Both companies have included facilities for turning graphite concentrate into coated, purified, spherical graphite (also known as CPSG) for the fast growing lithium ion battery market. Those profitable downstream processing facilities make their overall project viable.
However, if you take a closer look at the components of the projects, the mines, like farmer Giles orchard, are not economically viable.
Graphite One Resources
According to the PEA, Graphite One's proposed Graphite Creek mine in Alaska will produce 18,000 tonnes per year of graphite concentrate in its first year of operation, rising to 60,000 tonnes per year in year 7 of the projected 10 year mine life. The plan is to ship that concentrate to a processing plant in Washington State where it will be purified by thermal purification to meet battery grade standards, and will be milled, spheronized and coated for sale to the lithium ion battery industry.
The picture below (taken from the published PEA study) illustrates the proposed plan:
Spherical graphite is made from natural flake graphite, by milling the graphite to give the flakes a potato like shape. This spherical shape is needed to maximize the amount of graphite that can be packed onto the anode. Yields of spherical graphite from this process range from 30 to 70% depending on the properties of the original flakes.
Graphite One's flake graphite concentrates are apparently well suited to spheronization. Graphite One claims that the flakes already have a rounded shape and therefore can be more easily modified for use as battery graphite, giving yields of about 75% versus average yields of around 50% for most graphite concentrates.
Flake graphite prices vary according to flake size and purity. Graphite One's PEA refers to a world average price of $1300/tonne for crystalline flake graphite. In our analysis, we have assumed that Graphite One's concentrate is worth 50% more than average because of the 50% higher than average yield on spheronization, so we have used $1,950/tonne to evaluate the viability of the Alaskan mine.
The mine and concentrator is the major component of the capital investment, accounting for $233 million of the total project cost of $363 million. However, the product manufacturing plant in Washington State generates most of the return in investment.
Splitting out the cost and benefits of the Alaskan mine and concentrator, using a price of $1,950/tonne gives the following results:
For the mine and concentrator alone, the Internal Rate of Return (Pre-tax) is only 10.8% and the Net Present Value (NPV 10) is only $11.8 million. That kind of return is not good enough to offset the risks involved in a mining project. Graphite one's mine is not economically viable without the downstream processing facility.
Alabama graphite's PEA for the Coosa graphite project proposes a mine and concentrator producing 5,500 tonnes per year for the first five years, expanding to 16,500 tonnes per year for the remainder of the 27 year mine life.
The concentrate will be purified (using a low temperature thermal chlorination process), spheronized and coated for sale to the battery industry. Assumed yields on spheronization are similar to those used in the Graphite One PEA. However, Alabama Graphite's higher than average yield appears to be a result of an improved process for spheronization, rather than a unique property of the graphite itself. That process could presumably also be applied to a purchased graphite concentrate costing $1,300/tonne
Using data from the published PEA, we have calculated the return on investment for the mine as a stand-alone project, using a pricing of $1300/tonne for the graphite concentrate:
The IRR works out to just below 10%, and the NPV 10 is slightly negative. The table above only shows the first ten years, but the calculations include the full 27-year mine life.
Both Graphite One and Alabama Graphite have used value added products to create the illusion that they have viable mining projects. In the case of Graphite One, the high capital and operating costs of mining in Alaska make the mine non-viable, and in the Alabama Graphite case the low head grade is a serious handicap. Neither mine is viable without the downstream processing plant.
In planning their facilities to include downstream processing, both companies restrict themselves to the battery market, which is growing but is still only a small portion of the overall graphite market. And both companies would have to market at least a portion of their product to the big battery companies such as Panasonic or LG Chem. In doing so, they would come up against another barrier. Just as farmer Giles could not sell his apple pies to the supermarket at retail prices, so the two graphite companies will not be able to sell to the big battery makers at quoted market prices. The reason is that the battery makers generally buy uncoated spherical graphite and use their own proprietary coating methods. Quoted market prices for CPSG include profit on the coating process, which the battery makers are not likely to give up. This applies in particular to Alabama Graphite who have assumed a significantly higher price for CPSG in their study. ($8165 vs. $6200/tonne)
Both companies have done what farmer Giles did to justify his orchard, and just as our good farmer would be better off buying apples on the market, the two potential graphite companies would be better off operating their proposed value added products plants on purchased concentrates.
However, there is a problem with doing that. There is no barrier to entry when building a plant to make battery grade graphite from purchased concentrates. Anyone could propose such a plant, irrespective of whether or not they own a mine. There is no reason to suppose that Graphite One or Alabama Graphite could do a better job than an experienced graphite processing company such as Imerys, Asbury or AMG.
You could point to Tesla's (NASDAQ:TSLA) commitment to source raw materials from the USA as a possible reason for opening a mine in the USA. However, the manufacture of the battery components for the Nevada giga-factory seems to be under the control of Panasonic who have made no such commitment. In addition, it has been stated by Tesla CEO, Elon Musk, that the Tesla batteries will primarily use synthetic graphite. Any anticipated demand for US sourced natural graphite for the Tesla giga-factory would therefore appear to be highly speculative, rather than fact based.
Without a viable mine, there is no reason for investors to be interested in either Graphite One or Alabama Graphite.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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