Solving Critical Rare Earth Metal Shortages: Dr. Michael Berry and Chris Berry
Source: Brian Sylvester of The Critical Metals Report (1/10/12)
Years of supply mismanagement have left the U.S. dependent on foreign sources for critical metals like graphite, vanadium and manganese. In this exclusive interview with The Critical Metals Report, Dr. Michael Berry, publisher of Morning Notes and a former portfolio manager, and Chris Berry, founder of House Mountain Partners and co-author of Morning Notes, discuss what early-stage mines close to home could be the first to bolster the supply in U.S.
The Critical Metals Report: In a presentation at the China Investment Conference in December, you said that over the last 20 years the U.S. government has mismanaged its supplies of critical metals to the point where it depends almost exclusively on foreign sources. How did this happen?
Michael Berry: It's just now starting to dawn on Washington that we don't have a stockpile. We had a stockpile through World War I and World War II (WWII) that was necessary to our national security. The U.S. was the biggest producer of rare earth elements (REEs) in the 1970s and 1980s. But then we allowed China to undercut our prices and we shut down the Mountain Pass mine, which was one of the largest if not the largest producer of rare earths in the world. We lost not only production and access to REEs, which are critical for weapons systems, automobiles, alternative energy and a number of other applications, but we lost the processing chain that actually integrates and creates the metal, creates the alloy and magnets, and integrates it into material. China now controls these markets. There are four or five pieces of legislation pending in Washington, but it will take a decade or more to replace and rebuild these crucial supply chains.
Chris Berry: When the Soviet Union collapsed in 1991, the idea of a unipolar world came into vogue and I think the United States took its eye off the ball by selling off stockpiles of numerous metals. Security of supply was not viewed in the same light as it was during the Cold War. Labor was offshored, which minimizes costs and fattens balance sheets. But the U.S. made a strategic mistake when we offshored technology as well. Other countries around the world now have access to this intellectual property and are using it to build their own industrial and manufacturing bases. It's going to be quite a while before the United States regains its footing, but we are seeing moves recently to rectify this situation.
TCMR: How involved should the U.S. government be in the metals supply chain?
CB: There is a lot of mistrust and antipathy toward the government getting involved in what are traditionally viewed as private-sector activities. But there is a role for the government to encourage investment with respect to critical and other metals, whether or not it centers on loan guarantees or tax breaks, for instance. Government-run and private-sector defense companies require these raw materials that we are depending on foreign countries to supply us with. However, I'm not entirely convinced as to how involved government should be. It's a very slippery slope.
TCMR: Over the last 50 years, Japan built what is now the third largest economy. It did so by importing almost all of its raw materials and metals from foreign countries. Why is what's good for an economy like Japan's bad for America's economy?
CB: The difference now is that there are more people competing today for a finite amount of resources. Today, there are 3.5 billion (B) people in the emerging world who are striving for a higher quality of life, which is underpinned by resource demand. In this environment, a sensible natural resource policy is an absolute imperative. World War II was fought for many reasons, but one of those reasons was Japan's dependence on natural resources to power its economy-for example, rubber. When viewed through this prism, it's not hard to view future conflicts over resources as a given.
TCMR: Chris, what are some examples of metals that the U.S. is critically short on?
CB: Unfortunately, it's a rather lengthy list. In 2009, the U.S. Geological Survey compiled a list of a select grouping of non-fuel minerals to demonstrate U.S. import reliance. The U.S. was 100% dependent on imports of 19 of them and at least 75% dependent on 31. Some of them are front-page news, like rare earth elements, but others are more obscure but just as important, such as manganese, vanadium, tungsten, antimony and graphite.
TCMR: What are these metals' primary uses in the new economy over the next decade?
CB: Graphite, for example, is currently used in steel making, brake linings, lubricants and refractories. There are uses for graphite where I expect supernormal growth, however, such as in lithium ion batteries, nuclear reactors and fuel cell technology. It's by now a well-known fact that there's between 10 and 20 times more graphite in a lithium ion battery than there is lithium and you need large-flake, high-purity graphite. Based on what I have seen in my travels recently, I think vehicle electrification is here to stay. More graphite is going to be needed for vehicle electrification, whether it's used in traditional automotives like the Chevy Volt or in electric bicycles, which are seeing explosive demand in countries like in China.
China produces 75% of global graphite supply (in a total market of 1.2 million tons (Mt) per year) and so as the country continues to build its own industries that require more graphite, an increase in domestic consumption must ensue, to the detriment of those companies outside of China. There is no U.S. graphite mining currently taking place and there are only two mines in Canada that are producing on a small scale. There are a couple more projects potentially coming onstream in a couple of years in Canada, so it's a very good place to be going forward as the twin avenues of demand of industrial applications and vehicle electrification combine to increase the appetite for graphite.
TCMR: You follow a couple of companies working on graphite projects. Why do you believe these particular companies in the graphite space are good investments?
CB: Northern Graphite Corporation (NGC:TSX; NGPHF:OTCQX) has exceptionally experienced management, both in the mining sector and in the graphite sector. It owns the Bissett Creek deposit in Ontario, which continues to get larger as exploration continues. We anticipate a bankable feasibility study in Q112, which should help cement some already strong fundamentals in place for the company.
The project is very close to the TransCanada Highway with solid infrastructure. There's a great deal of historical work that's already been completed on the property and Northern Graphite has received favorable metallurgical results from the deposit from work done in 1989 and 2007, which revealed recovery rates of 95%. Bisset Creek should initially produce 20,000 tons/year (Ktpa) of high-purity, large-flake graphite like that used in lithium-ion batteries.
The company is anticipating very low capital expenditures (capex) of between $75-80 million (M) to get into production. The potential exists to expand the size of this deposit and, as such, expand production, perhaps doubling it. Obviously, that would cut down on the mine life but with the potential for resource expansion, I am not concerned here. There are all sorts of economic questions that come into play when you alter the mine life-where graphite prices will be in the future as well as managing any increase in operating costs or capex. A sub-$100M capex for a large-flake graphite project in Ontario is very appealing to me. The stars are aligning for this company in 2012.
TCMR: The internal rate of return (IRR) on the project in the first preliminary economic assessment (PEA) was estimated at about 24%, but it used a pretty low price for flake graphite. What are you expecting the IRR to be in the next study?
CB: Previously the company used $1,700 as an average graphite price, and its cash costs were $1,000. The new graphite price it is using is $2,000 per ton (t), which I think makes sense given the current price for large-flake graphite between $2,500-3,000/t. The higher price will substantially affect and increase the IRR if all else stays constant. Going forward, the company must think about what other graphite projects are going to be coming onstream outside of China in the next few years, because additional supply can push the price down. Regardless, it appears that Northern Graphite can be one of the first new producers of high-purity, large-flake graphite outside of China and that first-mover advantage will definitely help generate cash flow from an all-around attractive project.
TCMR: Northern Graphite is currently trading at around $0.85. Do you think of that as a good entry point?
CB: Yes I do. Almost any deposit outside of China that can demonstrate solid economics should be awarded a share price premium, in my opinion.
TCMR: Focus Metals Inc. (FMS:TSX.V) has the Lac Knife graphite project in Quebec. Tell us about that one.
CB: Focus is an interesting case. It's run by Gary Economo, who has been involved with graphite for a long time on the technology side. The company has chosen a different angle in telling its story to the investing public. It is very focused on future end products involving graphite and specifically graphene. It has done quite a bit of research on graphene, which is a one-atom-thick layer of graphite with potentially wide-ranging applications. Once Focus builds out the Lac Knife deposit and brings it into production, its goal is to capture additional margin along the value chain by creating next-generation clean-tech and green-tech applications. This has similarities to the mine to magnet strategy, which we see some rare earth companies employing today.
Focus plans to bring Lac Knife into production in 2014. It just released a NI 43-101 report that delineated a very high-grade resource that appears to be open in all directions. In 2012, one of the main catalysts will be a broader drilling campaign to fully delineate the size of this resource and push it toward a production decision.
TCMR: Let's move on to vanadium. Are there other ways that vanadium use will grow?
CB: Vanadium today is primarily used as a strengthener of steel and an alloy with titanium. The vanadium market is an oligopoly in the sense that three countries-China, Russia and South Africa, produce nearly all of the world's 61 Ktpa vanadium, and production is concentrated in three major companies: Panzhihua New Steel & Vanadium Co. in China, Evraz Highveld Steel and Vanadium Ltd. (EHS:JSE) in Russia, and Xstrata PLC (XTA:LSE), which is based in Switzerland, but it has operations in South Africa at its Rhovan mine.
One of the most exciting potential uses for vanadium is the vanadium redox battery (VRB). This dovetails nicely with the idea of increasing renewable energy capacity in the form of wind and solar throughout the world. One of the challenges with renewable energy is its intermittency. When the sun is not shining or when the wind is not blowing there is no way to store that energy effectively right now. The VRB, which was developed about 20 years ago, is already used on a small scale to store electricity generated from both renewable and traditional sources like coal. It will be used going forward to store renewable electricity as the gigawatts that are forecast to come onstream in the U.S., Europe and China do so. The VRB is one angle for vanadium that could potentially explode its usage and adoption.
TCMR: It's ideal for that use because the properties in vanadium allow the load change to occur in those batteries as power comes in and out of those batteries. It's used in the acid, right?
CB: Yes, in the electrolyte. What makes the VRB unique is that vanadium electrolyte is used in the anode and the cathode-a difference from most batteries. VRBs allow for greater energy storage, a faster recharge time, and a much longer life cycle. A drawback of lithium ion batteries is that they eventually lose their capacity to hold a charge. VRBs have issues with energy density, but offer more benefits than a purely lithium-based battery. There are billions of dollars going into research and development in China alone, focusing on innovations like VRBs. China's 12th Five-Year Plan released in 2011 has been regarded by many as the greenest in China's history. There are seven strategic foci, including efficiency in energy generation and storage. My bet is that vanadium will be one of the ultimate winners. That makes a case for finding additional sources of vanadium.
TCMR: There is a made-in-America play in this space, appropriately named American Vanadium Corp. (AVC:TSX.V).
CB: Just like many juniors, American Vanadium's share price has taken it on the chin, but it's still full steam ahead in terms of being able to produce about 11 million pounds/year vanadium pentoxide by 2013 at its Gibellini deposit in eastern Nevada. The company plans to construct an open-pit heap-leach mine. The next catalyst for the company is locking in the permits in 2012 and continuing to delineate and increase the size of its resource. This is a deposit of a strategic metal in one of the best mining jurisdictions in the world, with very sound geological characteristics.
TCMR: A new feasibility study on Gibellini, based on a $10.95/lb vanadium oxide price, figures at 43% IRR and a net present value (NPV) of about $170M. What stands out about that project?
CB: The geology really jumped out at me. The ore body is right on the surface, so the higher costs associated with an underground mine are not an issue. The strip ratio, 0.2:1, is incredibly low. It's a relatively low-grade resource, but I think this is somewhat negated by the low operating expenses, straightforward metallurgy and geology and potential for expansion of the size of the resource. Projected capex is low at roughly $95M. It's a very straightforward project.
TCMR: It's trading around $0.80. How does that look as an entry point?
CB: This is a good time to get in. The stock hit a high of about $1.90 earlier in 2011, and it's been beaten up since. The company is keeping its head down and is moving through the steps to obtain the necessary permits to move towards a production decision.
TCMR: I think most of our readers would be surprised to learn how big the manganese market is internationally. Tell us about that metal and its future uses.
CB: Manganese is a metal that is just not as sexy as lithium or vanadium, yet it's a critical component used in the manufacturing of steel. Manganese is the fourth most-traded metal at about 30 billion pounds/year (Blba).
Manganese can also be used in the cathode of lithium ion batteries. It provides a much longer, stronger, powerful charge than almost anything else in the anode. The Chevy Volt and the Nissan LEAF use lithium-ion batteries known as lithium manganese spinnel, or nickel-manganese-cobalt for short. This is where I expect to see the real growth in manganese use in the future. Global electrification is a powerful force and manganese should be a big part of this phenomenon.
American Manganese Inc. (AMY:TSX.V; AMYZ:OTCPK; 2AM:FSE) is trying to position itself to be the first producer of electrolytic manganese outside of China by 2014. It is developing the Artillery Peak deposit in northwest Arizona, which is 13.8 billion pounds (Blb) low-grade (2.84%) manganese in the indicated category and about 3.5 Blb in the inferred category (also at 2.84%). American Manganese is aiming to institute a patent-pending process that it developed with Kemetco Research Inc. where it will produce electrolytic manganese for about $0.70/lb. Electrolytic manganese sells on world markets right now from between $1.80 and $1.50, which creates about a $1 margin. Given that China produces roughly 98% of world Electrolytic Manganese Metal (EMM) supply and costs of production appear to be increasing there, American Manganese is well positioned to compete in this market.
TCMR: That processing technology is a hydrometallurgical process circuit. What makes that so cheap to run?
CB: One of the themes I think you'll see in mining is the drive for sustainability and efficiency. The lowest cost producer almost always wins and these two factors can lead to attaining lowest cost status. This is what American Manganese is aiming for in instituting this process. The process the company proposes to use will use less water and electricity in the production of EMM. Recycling factors prominently here. Also, the low cost of electricity in Arizona adds to the strong economics of the project. The biggest win for the company has been that it was able to produce EMM with this process on a pilot scale. That was missed by the market. Until I see steel demand globally drop off or cost pressures in China begin to ease, I'm very comfortable sticking with my NPV for the company, which is substantially higher than where the share price is today at $0.35.
TCMR: Michael, is there anything you would like to share on American Manganese?
MB: It's all pliable ore, so the mining of it is oxidized, which makes it even cheaper. A mistake a lot of people are making now is assuming it's too low grade. The size of the ore body, the strategic significance of the resource and the low cost of production are the factors we are focused on here.
TCMR: You plan to launch the Discovery Investment Scoreboard at the Cambridge House International Conference in Vancouver in late January 2012. Tell us about what that software does and how it's going to be of interest to the average retail investor.
CB: For about 10 years, we have practiced Discovery Investing, which focuses on 10 distinct factors that every investor should look at when evaluating a company. We focus on microcaps, but Discovery Investing can be applied to mid- and large-cap companies as well. Micro-cap companies are famously difficult to evaluate because there is very little information out there, no earnings history, no cash flow and little liquidity. Investors can't use traditional valuation metrics with any level of certainty to get a price target. There is a lot of guesswork.
We partnered with Dr. Terry Rickard, a former Senior Fellow at Lockheed Martin and a currency consultant to several companies in the mining and financial industries. Dr. Rickard has developed an advanced mathematical algorithmic application that allows one to compute with words in a mathematically principled fashion. Essentially, we are putting numbers to words. Investors will be able to use our system to effectively rank companies by offering their subjective opinions of the Discovery factors. The real power here is that we'll be opening this up to the masses and leveraging what is commonly referred to as the wisdom of crowds. A user will rank each of the 10 factors from using a predefined vocabulary and see how the company ranks on a scale of 1 to 10, as well as how the crowd views the company. The user may be extremely optimistic about a company's prospects, but find that the crowd is not as optimistic. It's designed to get investors thinking, to deal analytically with the subjectivity of evaluation and make this a more exact science.
TCMR: That's pretty interesting. Thanks, Michael and Chris.
Dr. Michael Berry served as a professor of investments at the Colgate Darden Graduate School of Business Administration at the University of Virginia from 1982-1990, during which time he published a book, Managing Investments: A Case Approach. He has managed small- and mid-cap value portfolios for Heartland Advisors and Kemper Scudder. His publication, Morning Notes, analyzes emerging geopolitical, technological and economic trends. He travels the world with his son, Chris, looking for discovery opportunities for his readers.
Chris Berry, with a lifelong interest in geopolitics and the financial issues that emerge from these relationships, founded House Mountain Partners in 2010. The firm focuses on the evolving geopolitical relationship between emerging and developed economies, the commodity space and junior mining and resource stocks positioned to benefit from this phenomenon. Chris holds an MBA in finance with an international focus from Fordham University, and a BA in international studies from The Virginia Military Institute.
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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 the interview are sponsors of The Critical Metals Report: American Vanadium Corp., American Manganese Inc., Focus Metals Inc. and Northern Graphite Corporation. Streetwise Reports does not accept stock in exchange for services.
3) Dr. Michael Berry: I personally and/or my family own shares of the following companies mentioned in this interview: Northern Graphite. I personally and/or my family am paid by the following companies mentioned in this interview: American Manganese. Berry was not paid by Streetwise for participating in this story.
4) Chris Berry: I personally and/or my family own shares of the following companies mentioned in this interview: Northern Graphite. I personally and/or my family am paid by the following companies mentioned in this interview: American Manganese. Berry was not paid by Streetwise for participating in this story.
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