Index Member Comment - June 23, 2011: Arafura delays bankable feasibility study another year
Arafura Resources Ltd, whose published project economics I view with great skepticism because, in accordance with the minimal disclosure requirements of the Australian Stock Exchange, ASX listed resource companies are not required to file technical reports containing details that support the broad-brush numbers management bandies about in news releases and corporate presentations, announced on June 23, 2011 that it will take an extra 9-12 months to complete a bankable feasibility study for the Nolans Bore rare earth project in Australia, and that the junior will need to raise another AUD $50-$60 million on top of the AUD $79 million it has in the treasury in order to complete the BFS. In Index Member Comment - February 8, 2011 which includes a sensitivity analysis of Nolans Bore using Arafura's numbers, I questioned the reliability of Arafura's disclosures and timeline projections, suggesting that production if all goes well will not occur until 2015. Arafura has ambitious plans to produce 20,000 tonnes of rare earth oxides annually through a processing facility in Whyalla on the coast of South Australia to which it must ship concentrates 1,500 km by rail. Metallurgical studies have enabled Arafura to boost the Nolans 3.2% TREO head grade to only 4.6%, with the market still awaiting confirmation that the target 6% has been achieved. Rare earth mineralization at Nolans is associated with a phosphate deposit where 30-35% of the rare earths are contained in the fluorapatite lattice and 60-65% is associated with cheralite which infills fractures and veinlets within the deposit. These minerals are tough nuts to crack, which is why there is considerable skepticism within the rare earth industry that Arafura has a viable recovery process.
Although the ASX rules allow its listings to snow shareholders with vague declarations, the qualified professionals responsible for signing off on a "bankable" feasibility study have their careers to worry about, and it looks like they have balked at delivering the BFS by the end of H2 2011 as Arafura has promised. While one can speculate that the engineers are uneasy about the viability of Arafura's flowsheet, the trigger for the delay may have been the June 17 announcement that the South Australian government has declared the Whyalla processing complex a "major project" for which an "environmental impact statement" must be completed. A feasibility study has no chance of being "bankable" until it quantifies the cost of all measures required to secure a development permit, which measures will only become apparent when an EIS has been completed. From the sounds of it Arafura started addressing EIS related requirements only a few months ago. That an EIS is required should not come as a surprise, because Arafura is planning to process what amounts to nearly original ore 1,500 km from the mine site, which means that the processing site will have to deal with the waste products. The current flowsheet envisions Arafura producing 20,000 tonnes of rare earth oxides along with 500,000 tonnes of gypsum, 150 tonnes of uranium, and 80,000 tonnes of 61% phosphoric acid as by-products for which it hopes to get credits. The citizens of Whyalla, who no doubt would welcome high-paying chemical plant jobs, are unlikely to be less ticklish about hazardous waste disposal issues than the citizens of Malaysia are turning out to be with regard to the LAMP facility to which Lynas plans to ship Mt Weld concentrates. Lynas is currently awaiting a report from the United Nations on whether or not its waste disposal plans for LAMP are sound. The Malaysians have already had a bad experience as being the dumping ground for radioactive wastes by a previous processing operation, and the Australians already have an anti-uranium sensibility which has resulted in restrictions on the development of new uranium production. The 150 tonnes of uranium by-product will have a value of less than $20 million; but it could become a hot button permitting issue.
Arafura management has tried to put a positive spin on the BFS delay with claims that it will result in a simplfied flowsheet that focuses primarily on rare earth products, but what this really means is that its BFS engineers doubt the existing flowsheet is viable even though rare earth oxide prices are higher today than ever before. Given that there is a significant gap between projected supply and demand during the next five years which will result in high rare earth oxide prices that can be captured by anybody who manages to bring new mine supply to market during the interim, why would a company choose to spend an extra AUD $60 million on optimizing a flowsheet that already had supposedly robust project economics at comparatively lower rare earth oxide prices when the cost will result in a delay of at least a year in bringing new supply on stream? The NPV sensisitivity chart above which uses Arafura's published cost assumptions and some reverse engineered recovery rates suggests an NPV per share of nearly $25 using current domestic China spot prices for rare earth oxide prices. Even at 3 year trailing FOB price averages the NPV works out to $4.46 per share, getting feeble at $1.40 only when we use the 3 year average for domestic prices. A year ago both the domestic and FOB basket prices for Nolans were low and delays related to tweaking the recovery process would have been entirely understandable. Today it makes no sense for Arafura to delay the bankable feasibility study and eventual production unless there is something seriously wrong with the cost assumptions of Arafura's "published" financial model, or there is something seriously amiss with the recovery process Arufura has developed. It is normal that as a project progresses from PEA through PFS to BFS that costs go up, recoveries go down, and the overall project economics weaken. In owning a resource development junior, particularly a rare earth one, one hopes that the project is still robust and economic at the end of the cycle when most of the uncertainty has been removed. The Australian regulatory system does not require proper disclosure of this "detail discovery" process, which is why Arafura is shaping up to be a disaster for JP Morgan's German clients who have placed their faith in Arafura's unsupported claims. I continue to dismiss Arafura as a contender in the rare earth race to production, though I am maintaining it in my rare earth supply evolution profile as coming on stream in 2015 at its projected 20,000 tpa output (JP Morgan's analysts as of their June 20 report on Molycorp listed Arafura as achieving production in H2 of 2013 - of course, they also think GMEL will have the recovery challenged Kvanefjeld project in production by 2015, though to their credit they have Steenkampskraal and Hoidas Lake pegged as post 2015).