Index Member Comment - November 18, 2010: Molycorp affirms optimism about future cerium demand
Molycorp Inc has been in a downtrend since peaking at $40.90 on October 28, 2010 in what appears to be a dampening of market enthusiasm for the rare earth sector despite a growing sense of urgency about the rare earth security of supply problem. During the Roskill Rare Earth Conference held on November 9-11 in Hong Kong Molycorp rolled out its plan to build an entirely new mill for Mountain Pass capable of producing 40,000 tons of rare earth oxides per year rather than just 20,000 tons. On November 15 Molycorp released results for Q3 of 2010 and confirmed that it planned to build a new mill rather than refurbish the existing mill, a design modification that adds $20 million to the cost of restarting Mountain Pass for a projected total of $531 million. Although Molycorp still plans to initiate production at the planned output of 20,000 tons per year, the mill will have the capacity to allow 40,000 tons of annual production. Doubling production would cost additional capital and time; Molycorp intends to make that decision at a later date in response to demand conditions. One has to be careful interpreting Molycorp's figures which reflect REO output rather than ore throughput. In its prospectus Molycorp claimed that thanks to processing improvements it will be able to achieve its former annual output of 20,000 tons by processing only 1,200 tons of ore per day compared to 2,000 tpd. Despite these improvements Molycorp still expects to recover only 59% of the TREO head grade, which suggests that recovery at the mine before its shutdown in 2002 was below 45%. Given that the existing mill has 2,000 tpd capacity, which would get REO output close to 40,000 tonnes, why build an entirely new mill rather than refurbish the old one? Mark Smith did not mention that the old mill sits on part of the Mountain Pass deposit which would eventually have to be accessed at the scaled up production rate.
During the conference call Molycorp's Mark Smith gave strong reasons why preparing for scaled up production output is a good idea. Questions from analysts with firms that had underwritten Molycorp focused on cerium, which will be about half the output from Mountain Pass. Molycorp has completed its first commercial sales of XSORBX, a water filter product whose critical ingredient is cerium. Smith explained that Molycorp can produce two types of XSORBX, a liquid version (XSORBX 100) geared for industrial waste streams, and a dry version (XSORBX 200) that produces drinking water. As an example of demand potential, he stated that just three major mining or smelting facilities which adopted XSORBX would use up all of the Mountain Pass cerium oxide production (10,000 tons) at the current planned output rate. He did concede that at the current FOB spot price the industrial waste treatment version, which would have to be price competitive with alternative filtration technologies, would not have any profit margin and Molycorp would be better off selling its cerium oxide as a raw material. However, he insisted that even at the current FOB spot price the drinking water version would still provide a big margin. This is significant information for Molycorp shareholders because it implies that even if cerium oxide FOB prices sink from their lofty levels, Molycorp will still benefit thanks to its proprietary technology whose price is defined by the functionality it delivers, not its input costs. Strangely, Dudley Kingsnorth remains blind to this type of new demand for cerium or at least highly skeptical of Molycorp's claims. During the Roskill conference he scaled back his demand projections for 2015 from 200,000 tonnes to 180,000 tonnes and stated that cerium would be in significant over-supply with producers supplying 80,000-85,000 tonnes and the market demanding only 63,000-68,000 tonnes. His 2015 consumption table has no obvious slot for filter applications except perhaps "other" and "catalysts" whose consumption he predicts will grow only 2,500 and 4,000 tonnes respectively over the next five years. On the plus side, it is encouraging to see that the Wall Street analysts covering Molycorp do get the "wild dynamic" underlying rare earth demand and appreciate that Molycorp is much more than a raw material producer. It is very difficult to predict future demand for a raw material which is a critical but incremental input for all manner of innovative technologies whose commercialization is inconceivable without security of supply for the critical inputs.
Mark Smith also clarified the November 5 announcement that Molycorp had agreed to sell over 75% of its Mountain Pass lanthanum output to W.R. Grace & Company for five years after restarting commercial production. W.R. Grace is the primary supplier of fluid cracking catalysts to the petroleum refining industry in the United States. These petroleum catalysts boost refining efficiency by about 7%, which translates into a $28 billion saving when applied to the 20% American share of annual global oil consumption worth about $2 trillion. As already mentioned, Kingsnorth sees only modest demand growth for the catalyst application sector, which seems to fly in the face of 1) more sour crude will have to be refined, which requires a higher dosage of fluid cracking catalysts, 2) oil consumption will in the short term continue to rise even as we pass peak oil and transition towards electricity as transportation fuel, and, 3) reliance on platinum group metals emanating from South Africa is becoming increasingly tenuous as an autocatalyst for the car industry in view of power problems and rising resentment among young blacks who realize that BEE applied to the resource sector enriches and empowers only a minority of blacks, 4) cerium and lanthanum are a potential substitute for platinum group catalysts, 5) only a fraction of the Tea Party is too stupid to eventually figure out that when oil sector billionaires from Kansas bankroll a push for the reduction of emission and fuel efficiency standards it does not actually deliver any benefit to Tea Party members, and, 6) the Chinese do get it that air pollution is an equal opportunity evil which it must stop. Cerium and lanthanum FOB prices are not sustainable at current levels, but demand growth for these less glamorous rare earths has much better potential than Kingsnorth is extrapolating from past trends. The news release did not say anything about the price WR Grace will pay for the lanthanum, but Smith did clarify that the price will be the FOB spot price with a protective floor price whose level he understandably did not specify and which we can assume is higher than the 4 year FOB average. In recent days the FOB prices for cerium, lanthanum, and yttrium oxide have shot higher, confirming rumors that the second half export quotas have been exhausted or are very close to being so. Smith discussed the question of the 2011 export quota and pointed out that in January when the first half quota is announced it may look like China has relaxed the quota because it will be higher than the 7,976 tonnes set for the second half of 2010, but unless the quota is 15,129 tonnes or more, namely half the total 30,258 tonnes set for all of 2010, it will represent a further reduction. The word in Hong Kong was that China will reduce the quota for 2011 by another 20%, which would drop the overall quota to 24,206 tonnes. It is possible that China will announce a higher quota for the first half, but unless it also announces the quota for the second half, there will be suspicion that China will repeat the skewed quota distribution of 2010 when it allotted 22,282 tonnes for the first half and only 7,976 tonnes for the second half.
Mark Smith also touched upon the topic of illegal smuggling, and suggested that the range of 20,000-30,000 tonnes is very likely the real amount that is illegally mined and smuggled out of China. He suggested that the "customs inspections" that have effectively stopped shipment of rare earth oxides to Japan have more to do with the desire to crack down on smuggling than to foster a geopolitical agenda. Dr Chen Zhanheng of the Chinese Society of Rare Earths presented a brief paper at the Roskill conference in which he stated that China's official production target for 2010 was 89,200 tonnes, down from 127,300 tonnes in 2009. It is unclear if the 20,000-30,000 tonnes of smuggled rare earths existed on top of the 127,300 tonnes he says was the target for 2009 or if it represented a good part of the difference between the 2009 figure and the 2010 target. (Dr Chen tipped us off in April about what has unfolded during the second half of 2010 through a paper whose implications I discussed in Express 2010-02.) In any case, it is clear that China is drastically cutting back production by shutting down both polluting and illegal operations. Thanks to the dramatic difference between FOB and domestic spot prices that has emerged since the end of June there is even more incentive to smuggle rare earths out of China, in particular the volumetrically more significant light rare earths and yttrium. The Chinese have been working overtime to stop a stepped up smuggling effort with the result that nothing moved out of the ports. All indications are that while the wording of next years quotas may reduce security of supply anxiety, the reality will be that much less rare earths will be produced in 2011 than the world needs, and Chinese policy will be geared to favoring domestic end-users with adequate supply.