Jon Hykawy: Offtake Agreements Rule REE Market
Source: Brian Sylvester of The Critical Metals Report (8/2/11)
End-users are emerging as key players in the rare earth space. In this exclusive interview with The Critical Metals Report, Jon Hykawy, head of Global Research with Toronto-based Byron Capital, shares his views on where this trend is headed and what it means for REE producers who don't have offtake agreements in place.
Companies Mentioned: Dacha Strategic Metals Inc. - Frontier Rare Earths Limited - Great Western Minerals Group Ltd. - Lynas Corporation - Molycorp Minerals - Rare Element Resources Ltd. - Tasman Metals Ltd. - Ucore Rare Metals Inc.
The Critical Metals Report: End-users are entering the primary rare earth elements market to secure future supplies of rare earth elements (REEs). Recently, state-owned Korea Resource Corp, KORES, proposed the purchase of up to 10% of Frontier Rare Earths Limited (TSX:FRO) and up to 20% of Frontier's Zandkopsdrift mine in South Africa. Should investors follow the big bucks flowing from these end-users?
Jon Hykawy: Yes and no. We are seeing much the same thing shaking up REEs that we saw in lithium. The people most interested in securing supplies are starting to learn about the market, but they are not necessarily completely educated regarding the market, not yet. We have a Speculative Buy recommendation on Frontier and a CAD$4.80 price target. So, we think KORES made a reasonable choice.
TCMR: Are these agreements becoming "must haves" in the junior REE sector? Is the market starting to discount companies without offtake or ownership agreements?
JH: Last year, anyone who claimed to have REEs was headed for glory and success. This year, the investment community-certainly the institutional investors-seems to recognize that there is no point in these companies building a mine if they can't get into production quickly or if they don't have a customer.
TCMR: China controls close to 98% of the REE market and has quotas on terbium and dysprosium. If China decides to flood the market with heavy rare earth elements (HREEs), wouldn't that throw the internal rate of return calculations and the bankable feasibility studies right out the window?
JH: You're probably right. However, the Chinese quotas don't differentiate among different types of REEs. The quotas allocate a certain number of tons to a certain number of companies. As far as the quota system is concerned, it doesn't matter what they export.
It's as if a storeowner decided to sell only 300 products a day. If you came to buy a loaf of bread, you would be competing against the store trying to push out the 300 steaks it's allowed to sell. The price of your loaf of bread just rose dramatically.
Western buyers are effectively competing against the price of some of the rare heavy oxides. That is why prices have vaulted; you're competing against something that's far more expensive.
Plus, China can't just turn on the tap, especially for HREEs. China is already having difficulty finding HREEs. Given time, China will likely become a net importer of the heavy and rarer REEs.
TCMR: What sort of timeframe?
JH: We're probably looking at 2014 or 2015 before China starts looking for cheaper sources elsewhere.
If anything, China is likely to segregate the quota and allow the export of far more lanthanum and cerium. If the prices of lanthanum and cerium are driven down dramatically, that affects the profitability of the Western companies. So, yes it does affect rate of return calculations and market valuation. We believe that end-user agreements, offtake agreements, will become more valuable with time.
TCMR: Who are the frontrunners in the race to become the first Western REE producer?
JH: The companies that are the furthest down the permitting curve and the closest to being fully funded would be Molycorp Minerals (NYSE:MCP) in California, Lynas Corporation (ASX:LYC) in Australia and Great Western Minerals Group Ltd. (TSX.V:GWG; OTCQX:GWMGF) in South Africa. All three are likely to come to market between the end of 2011 and the end of 2012.
TCMR: Of those three top companies, you have Sell recommendations on two. Why?
JH: Because I'm a realist. Our Sell recommendation and US$42.25 target price on Molycorp recognizes that the company will be in production and gives them a healthy market cap approaching US$4 billion. It also recognizes that Molycorp will be producing a very large amount of lanthanum and cerium. So will Lynas and Great Western Minerals Group. Together, the three of them should serve, along with the Chinese, to push the price of lanthanum and cerium down in 2013 and beyond.
Once Molycorp has significant production, its after-tax return is likely to be well below what most people expect. We see the price of light REEs (LREEs) dropping from the current FOB (freight on board) Chinese prices of about US$150/kg. down into the historical band for lanthanum and cerium, which is in the US$4 to US$5/kg. range. We see those prices collapsing as we get closer to 2013.
Lynas is only going down the value chain to the point of producing separated and purified rare earth oxides. That limits the revenue the company can garner. That's why we have a Sell on Lynas, along with an AUS$0.35 target price.
Great Western, on the other hand, is going downstream, producing magnet alloy as a final product. The company has already signed a cooperation agreement with Aichi Steel, which is part of the Toyota Group. We have a Strong Buy on Great Western, and a CAD$3.50 target. We think there's an awful lot of room for that stock to move.
TCMR: The main concern with Great Western is the high levels of radioactivity at the Steenkampskraal Mine in South Africa.
JH: Great Western is the only player in the set that we feel has a completely defined plan for dealing with the radioactivity the operation will generate. Steenkampskraal was once a producing thorium mine. The mine is still a fully licensed and accredited thorium storage facility. The radioactivity liberated by the hydrometallurgy and separation process can be stabilized and put back into the mine under a plan approved by the South African government.
TCMR: Who are among the next tier of producers?
JH: We think a few names will be in pursuit relatively quickly. Frontier is one of them. We have a Speculative Buy rating on Frontier and a healthy price target. We think that that project is good enough to be a standalone.
Ucore Rare Metals Inc. (TSX.V:UCU; OTCQX:UURAF) definitely has a shot at becoming a relevant, near-term producer. It's the only HREE deposit located on U.S. soil. If there is one area of the REE space that the Americans have targeted as critical to future development, it would be the heavies, particularly dysprosium and terbium.
TCMR: You're talking about the Bokan Mountain project in Alaska.
JH: That's correct. Bokan will produce, in relative abundance, materials that are on the critical materials list published by the U.S. Department of Energy and the American Physical Society.
We also have a Speculative Buy rating on Rare Element Resources Ltd. (TSX:RES; NYSE.A:REE). We think Rare Element has a very good project in a very good mining jurisdiction with infrastructure in place. It will be developed relatively rapidly and is a relatively inexpensive project as these things go.
TCMR: There is thorium in the ore at Bear Lodge, which is Rare Element's major project. Will the radioactive tailings pose a problem?
JH: It will come down to local regulation. Molycorp may have come to a solution by creating a type of stabilized paste tailing that seems to be acceptable to the regulators.
TCMR: It may be a bit more of an issue in a place like Wyoming's Bear Lodge Mountains. Given its proximity to population, will the potential radioactivity face some opposition?
JH: After the tragedies at Fukushima Daiichi in northeastern Japan, any project that generates any sort of radioactivity as a tailings product will be scrutinized. But this level of radioactivity has been dealt with in mining projects for many years. It's neither ridiculously expensive nor technically difficult to solve those issues.
TCMR: Bear Lodge has gold mineralization in the area. Newmont Mining Corp. (NYSE:NEM) and Freeport-McMoRan Copper & Gold, Inc. (NYSE:FCX) have kicked the tires there. Now those options have reverted back to Rare Element. Could mining this gold add to the economics of this project?
JH: It's possible. A number of things could be produced as byproducts. But Bear Lodge has high enough grade and what we believe to be a low enough capital expenditure requirement that it rates a Speculative Buy as a standalone REE project. We haven't included any byproducts in our calculations.
TCMR: What are your target prices on Rare Element and Ucore?
JH: We have a target of CAD$16.00 on Rare Element, and CAD$1.30 on Ucore.
TCMR: Could you pick a dark horse that could surprise?
JH: I think my dark horse candidate would be in clay. These deposits are heavily weathered and very heavily oxidized. They typically don't contain much REE as an in-situ percentage. But they tend to be very easy to mine and to process. It's surface mining; usually slurry or dredge mining, where you mix the clay into a high-solids fluid and pump it where you need it to be. In some cases you're looking at clays that mimic the soluble clays in Southern China. These clays can be heap leached and produce rare earths in that way.
No one's looked seriously for clays outside of China. But there's no reason why they wouldn't exist. We're looking at three clay projects in various parts of the world, trying to evaluate just how cost-effective they can be. They're very inexpensive and rapid in terms of development. One, two or even all three could be in production early in 2013.
TCMR: If end-users are locking up supply through offtake agreements and ownership stakes, how does that change the game for Dacha Strategic Metals Inc. (TSX.V:DSM; OTCQX:DCHAF), given that most of its sales are to end-users?
JH: In the scale that Dacha's been working, we don't think that changes their game particularly. They're dealing with materials that are generally bought and sold in smaller quantities; a few tons at a time rather than hundreds of tons. They sell to a group of customers who typically buy their material on a regular schedule. It's not the sort of material and not the group of manufacturers that are likely to sign a big-name offtake agreement. Dacha likely has a place in the market moving forward for a long time yet.
TCMR: Dacha recently reported the value of metals in its warehouses at about CAD$134 million. But, its market cap is about half that. Why is it trading at such a discount?
JH: There are a couple of reasons. Part of it is that there is always a holding company discount applied to something like this. The investors wonder whether Dacha management has picked exactly the right materials and what decisions management is going to make regarding the buying and selling of those materials. So far, company management has done very well.
TCMR: Dacha has had a three-fold increase in their share price over the last three months or so. Now it's trading at around CAD$1.00. Is that a good entry point?
JH: You know, we don't cover it, and I don't have a target on it. I certainly believe that the FOB China prices for REEs will continue to rise given the Chinese announcement of second-half quotas. There is no reason to believe there will be anything but continuing pressure on REE prices and supplies outside of China.
I'm a bit less optimistic with respect to the REE pricing within China. I think the industry consolidation announced by the Chinese and the establishment of REE exchanges as the only official sellers-both internationally or domestically-are designed by the Commerce Ministry in China to moderate, and even reduce domestic Chinese REE prices. Material within China may be under a bit of price pressure.
But I'm not sure whether that price pressure will extend to the heavies. I think the heavies may still run, and that's really what Dacha has. Inside or outside of China, we're likely to see continued price appreciation in the materials that Dacha holds through most of 2012.
TCMR: Your research shows the Tasman Metals Ltd. (TSX.V:TSM; OTCPK:TASXF; Fkft:T61) Norra Karr deposit in Sweden as having the greatest ratio of HREE to total REEs. Why isn't Tasman among your Strong Buy or Speculative Buy ratings?
JH: For a very simple reason: I can't sell a ratio. We argued in a June 9 note that Tasman has the highest ratio of HREEs to total REE oxides at around 52%. The problem is, because of the low grade of the ore at Tasman, the overall amount of saleable REEs within a ton of mined ore is quite low. Tasman drops back to middle-of-the-pack levels in the amount of heavy earth oxide per ton of mined ore.
TCMR: At the same time, the Norra Karr deposit isn't that far via shipping lanes from Molycorp's Silmet separation plant in Estonia, which is primarily a LREE separation plant. Does a business combination between Molycorp and Tasman make sense?
JH: I would say no. Certainly, some feedstock will have to be sent to the Silmet plant. Molycorp has stated its goal to put its own concentrates through that plant and hasn't stated any plans to alter the facility to separate other materials. It appears that a number of separation plants will go into operation within the next two years: one in Malaysia owned by Lynas and the Molycorp plant in California. You are likely to hear an announcement from Great Western about a solvent extraction partner before the end of July.
TCMR: Who might that be?
JH: It's likely that the partner will be Chinese. The only other player that has the technology and wouldn't be constrained by existing business arrangements would be Neo Material Technologies, Inc. (NEM.TO) in Canada.
The plant will likely operate near the Steenkampskraal mine in South Africa. So, you'll have regional processing centers scattered pretty evenly across the globe. By that measure, any deposit will be close enough to a processing plant for a possible business arrangement.
TCMR: Before we let you go, can you give us some parting thoughts on consolidation in the REE space?
JH: We believe there will be a consolidation, largely because we can see room for only five or six players outside China, once everything shakes out. The consolidation is likely to be driven by the companies that have offtake agreements. Great Western has an announced agreement with the Toyota Group to work toward supplying Toyota with hundreds of tons per month of magnet alloy powder. Steenkampskraal alone won't be able to supply that much material. Great Western will have to do the analysis on the least expensive course to follow. Can the company expand Steenkampskraal dramatically? Will it open up another property as a mine with all the expense that entails? Will it buy material from another group like Lynas? Or will it buy another project as good or better than what it has?
I think Molycorp and Lynas will be doing the same analysis. There will be an emphasis on finding ready supplies of HREE oxides in easily accessed, easily processed deposits, perhaps in ionic clays outside China. It is going to be a very, very interesting year.
TCMR: Jon, thank you for your time and insights.
Jon Hykawy is currently with the research team at Byron Capital Markets, with a specialized focus in the lithium and clean technology/alternative energy industries. Jon holds both a Ph.D. in physics and an MBA from Queen's University and has been working in capital markets as a clean technologies/alternative energy analyst for the last four years. He began his career in the investment industry in 2000, originally working as a technology analyst. His current area of focus is the lithium sector, ranging from availability and production to lithium battery technology. He has extensive experience in the solar, wind and battery industries, conducting significant research in the areas of rechargeable batteries-ranging from rechargeable alkaline to lithium-ion to flow batteries.
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1) Brian Sylvester of The Critical Metals Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in this interview are sponsors of Critical Metals Report: Ucore Rare Metals Inc., Rare Element Resources Ltd., Dacha Strategic Metals Inc., Tasman Metals Ltd.
3) Jon Hykawy: I personally and/or my family own shares of the following companies mentioned in this interview: None. I personally and/or my family am paid by the following companies mentioned in this interview: None.
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