Index Member Comment - May 4, 2012: GMEL publishes PFS that turns Kvanefjeld into a rare earth supply contender
Greenland Minerals & Energy Ltd published a prefeasibility study on May 4, 2012 for its Kvanefjeld rare earth -uranium project in Greenland. The new study incorporates metallurgical work done during the past couple years which boost the projected rare earth recovery from 34% to 44.6% while uranium recovery stands at 45.2%. In an unusual deviation from Australian Stock Exchange disclosure standards GMEL's 63 page report contains considerable detail, though in an ode to Australian perversity GMEL does neglect to provide details of the individual rare earth grades in the ore it has targeted for production. Furthermore, while disclosing that recoveries differ for the light and heavy rare earths, GMEL does not disclose the respective recoveries, choosing instead to break down its projected 40,800 tonnes annual REO output as 26,200 tpa of "light" rare earths as a carbonate, 10,400 tpa "mixed" rare earths as a carbonate, and 4,200 tpa "heavy" rare earths as a hydroxide. Nevertheless, I am impressed by the disclosure detail, and have added Kvanefjeld to my field of serious potential supply contenders for 2016 and beyond.
GMEL thinks it will be able to start construction in 2014 and commence production in 2016. However, I assign a low probability to this timeline because of the enormous scale of the mining plan, the high capital cost of $1.53 billion for a facility that does not include a separation plant, and the fact that uranium is a substantial and economically critical by-product of the mining plan which will require that Greenland suspend its ban on uranium mining. In its discounted cash flow analysis GMEL applies a 40% discount to the separated rare earth oxide price deck it has adopted, but the scale of output is so large that GMEL will need a dedicated separation plant for its rare earth output. It will need to secure an offtake arrangement with an end-user that has the capacity to build and operate a separation plant that can handle the 3 concentrate streams GMEL plans to produce, or it must produce a feasibility study for such a plant and secure a location. GMEL has not provided an estimate for the cost of the feasibility study that will be needed to raise development capital. GMEL had AUD $9.5 million working capital as of December 31, 2011, which is prior to the AUD$39 million it must pay to vest for a 100% working interest and resolve underlying legal disputes. During the past year GMEL has resolved the complicated underlying title disputes through a series of deals that simplifies ownership so that GMEL ends up with a full 100% title subject to a 2% net profits interest. This deal is expected to close in mid June 2012, failing which the Kvanefjeld project will not be financeable. GMEL will have 465 million shares fully diluted if the deal closes, but not including shares that may have to be issued to raise the AUD $39 million payment. At the current stock price of $0.47 this would boost fully diluted to 550 million.
Although GMEL received a goahead from the Greenland government to proceed with a feasibility study that will become the basis for applying for an "exploitation license", this deal with the government is merely an accommodation that gives GMEL a chance to demonstrate the viability of mining Kvanefjeld in a commercial and environmentally responsible manner. If Kvanefjeld were a rare earth deposit similar to Hudson's Sarfartoq where radioactive by-products such as thorium and uranium qualify as impurities whose removal costs more than its resale value, the project would not collide with the ban against "uranium mining". Although U3O8 currently has a spot price of $52/lb, GMEL assumes a future price of $70/lb, which would give the annual uranium production a revenue value of $182 million. The uranium reports to the same minerals that carry the rare earths, and ends up in solution after the concentrate produced by the flotation stage is subjected to atmospheric leaching using sulphuric acid. The uranium and thorium have to be removed as impurities; because of the substantial U3O8 grade GMEL has no choice in producing 2.6 million lbs of uranium. Approval of Kvanefjeld will ultimately require a political decision by Greenland which hinges on the will to subordinate the moral opposition to nuclear energy and weapons to the benefits of Greenland becoming a major supplier of rare earths whose applications generally serve "clean energy" goals. As the Kvanefjeld rare earth supply distribution chart above demonstrates, Greenland will have to think hard about its priorities if a feasibility study shows that all environmental and safety issues can be dealt with. On the negative side, the 11.8% share of REO output attributable to the supply challenged heavy rare earths is modest, and it is questionable to what extent the world needs 36,000 tonnes of extra light rare earths before 2020. To its credit GMEL has successfully shifted the focus of its mining plan from uranium to rare earths, but there may not be any urgency among the Greenland regulators to approve this project and ditch their philosophical opposition to uranium mining.
The GMEL PFS base case generates a pre-tax net present value of US $4,631,000,000 with an internal rate of return of 32% using a 10% discount rate, and an after tax NPV of $2,947,000,000 with an IRR of 26%. The payback period from the start of production is 3-4 years. Capital cost for the 20,000 tpd operation is $1,534,000,000 and the operating cost is $55/tonne ore mined to produce 3 streams of mixed rare earth oxide concentrates and uranium. The life of mine strip ratio of waste to ore is 1.1:1. GMEL has adopted a base case basket price of $41.61/kg based on a separated rare earth oxide price deck projected for 2016 which conforms to the mid-point Roskill projection except for lanthanum and cerium for which GMEL has adopted Toyota's forecasts of $10/kg for lanthanum oxide and $5/kg for cerium oxide (Pr $100/kg, Nd $100/kg, Eu $1,100/kg), Tb $1,100/kg and Y $50/kg). GMEL applies a 40% discount to the separated oxide basket price, which reduces the basket price to $24.96/kg.
Simulating the discounted cash flow model used by the PFS is difficult because GMEL does not provide a breakdown of the individual rare earths. Fortunately GMEL has in the past published a breakdown of the rare earth distribution in the steenstrupine dominated ore that will form the bulk of a 33 year mining plan whereby GMEL would mine 20,000 tpd during a 360 day year from a resource of 232,600,000 tonnes grading 1.27% TREO and 0.0364% U3O8. The rare earth percentage distribution chart above shows the figures I have used to extract the theoretical output of the Kvanefjeld mine for all the rare earths. Although GMEL appears to include pricing only for lanthanum, cerium, praseodymium, neodymium, europium, terbium, dysprosium and yttrium in its cash flow valuation, it is not clear if the minor rare earths are included in the tonnage output figures, nor to what degree there are variations in individual rare earth recoveries.
I have applied the previously published rare earth distribution data for Kvanefeld to the rare earth price history to produce the Kvanefjeld basket price history chart below. The table above shows the prices effective as of May 3, 2012 plus the prices for holmium, thulium, ytterbium, and lutetium which prevailed in early 2009 and which were listed by Avalon in a study of its Nechalacho project. I have kept these prices constant while recording the mid-point of the range quoted by Metal-Pages every Tuesday and Thursday for the main rare earth oxides. Erbium oxide prices are obtained from weekly averages provided by MetalPrices. Because the grades for these obscure rare earths are very low, and the prices I use relatively low compared to current FOB and domestic spot prices, the financial impact of them is modest. I include them in my analyses so that readers can observe what sort of output is theoretically possible. These rare earths may have unusual applications sitting on research benches and in the heads of scientists that can go nowhere because there is no reliable and meaningful supply of these rare earths that would allow them as inputs in commercialized applications. If a new wave of non-Chinese rare earth mines come on stream that have a larger percentage of heavy rare earths than what comes out of China, we may see new demand for these "worthless" rare earth oxides evolve. As an aside, note that the basket price for Kvanefjeld's output is $32/kg using the 2016 price deck Toyota recommended Matamec use for its Kipawa PEA, and that when we reduce the most abundant rare earths, lanthanum, cerium and yttrium, to a zero price, the basket price for Kvanefjeld using domestic spot prices for the other rare earths is $29/kg.
GMEL does not specify its recoveries, but based on annual production of 7,200,000 tonnes of ore which contain 91,440 tonnes of rare earth oxides and 2,621 tonnes of U3O8 and which yields 40,800 tonnes of rare earth oxides in mixed form and 1,185 tonnes of U3O8 we can calculate the effective recoveries as 44.6% and 45.2%. The rare earth oxides break down into 35,986 tonnes of lights (88.2%) and 4,814 tonnes of heavies (11.8%). The PFS includes a table with a percentage breakdown of the minerals that constitute the ore, something I have not seen before with such a degree of detail in other rare earth project technical reports. The Kvanefjeld deposit contains 12 minerals that carry rare earth oxides, with phosphate-silicate minerals dominating in the upper portion of the 600 million tonne deposit that is slated for mining, while zirconium-silicate minerals dominate in the deeper portion. Steenstrupine and vitusite are the key phosphate-silicates from which rare earths will be recovered by the flow-sheet, with minor contributions from xenotime and monazite. Zirconium-silicates of the lovozerite group co-exist with the phosphate minerals in the upper part of the deposit, but will not yield any rare earth recoveries in the proposed flow-sheet. Zirconium silicates of the eudialyte group take over at depth, but will not be accessible for decades. Zinc is present as sphalerite throughout the system at a grade of 0.24%, of which 80% will be recovered through an initial flotation stage. Although the PFS is unclear about the revenue it hopes to get for the zinc concentrate, I have applied a 20% shipping/smelter discount to the value of the estimated annual 30,500 tonnes of zinc in concentrate priced at $0.90/lb zinc.
The chart above is an analysis of Kvanefjeld's sensitivity to different basket prices using my discounted cash flow model which assumes all capital expenditure in year one and life of mine average parameters for each year of the mine's 33 year mine life. Revenue and cost side prices have been kept constant. I have assumed zero taxes until payback of capital costs. A 40% discount has been applied inside the model to the separated rare earth oxide basket price. It is interesting to note that the $41.26/kg pre-discount basket price that results from GMEL's 2016 price deck is almost identical with the current basket price generated by applying domestic spot prices to the Kvanefjeld rare earth distribution. My model closely matches that of GMEL except that I have used only $52/lb as a uranium price, and I am applying a 20% smelter-shipping discount to the zinc concentrate production which I price at $0.90/lb. At the domestic spot basket price of $41/kg Kvanefjeld as envisioned by the GMEL PFS would generate annual EBITDA cash flow of $765 million. Once the 32% tax rate kicks in the Greenland government would collect $245 million annually from the rare earth mine. In addition, the mainly Greenland based cash costs of the operation would be $400 million annually. At the domestic spot basket price the after tax net present value using a 10% discount rate works out to $3.5 billion in my model, somewhat better than the $2.95 billion estimated by the GMEL PFS. Using 465 million fully diluted shares as the base, the after tax NPV per share works out to $7.39 and $6.44 respectively. My internal rate of return works out to 42%, with payback occurring within 2 years. On a pre-tax basis the GMEL base case has an NPV of $4.63 billion while my model produces an NPV of $5.24 billion. GMEL does not provide sufficient detail in its PFS report to determine wherein the discrepancy rises; my suspicion is that the PFS model incurs capital costs during the two year construction period rather than just one year before the start of production, which would result in lower NPV numbers. If I incur capital cost in year one, and no costs or revenues in year two, with revenue starting at full capacity in year three, my numbers match the PFS numbers almost perfectly. When using the $32/kg Toyota 2016 price deck or the domestic spot deck of $29/kg where lanthanum, cerium and yttrium are assigned zero value, Kvanefjeld has an after-tax NPV of $3.92 and $3.08 per share respectively, well above the current stock price.
GMEL assigns an error margin of 25% to its prefeasibility study, so one could argue that the market is worried that errors will all swing in the negative direction and kill the project. While I have doubts about the $55/t ore mining and processing cost, the biggest obstacle, in my view, assuming the ownership consolidation is resolved by mid June 2012 as described, is the fact that GMEL only has permission to apply for an exploitation license whose granting is still subject to a political event that suspends Greenland's ban on uranium mining. Such an event is not possible until GMEL has completed a full-blown feasibility study that addresses all stakeholder concerns and reduces the error margin to 10%-12%. Given the unusual nature of the key rare earth bearing minerals at Kvanefjeld, GMEL will need to conduct a pilot plant scale metallurgical study to confirm the recoveries and costs associated with the flow-sheet it has adopted. Combined with the $39 million GMEL needs to raise to complete the ownership consolidation, it may need to raise $100 million in order to deliver a feasibility study that will likely take two years to complete if it does not encounter devils in the details as happened with the Nolans Bore rare earth project of Arafura, which discovered it needed to raise an "extra" $100 million to complete a feasibility study on a project into which it has already invested $140 million. GMEL is juggling a system of circularly dependent outcomes which make me pessimistic that Kvanefjeld will be in production before 2020, but the company has made substantial progress in turning Kvanefjeld into a future supply contender, even if it is for 2020 and beyond.