Spec Value Hunter Comment - June 27, 2012: Reuters tries to rattle Brazilian resource stocks with alarmist talk about resource nationalism
Just when I was beginning to think that Brazil was one of the few remaining parts of South America not besieged with geopolitical, title or resource nationalism related issues, Brazilian resource juniors were set up for a potential bear attack on June 27, 2012 when Reuters published an article on the possibility that Brazil may decide to nationalize strategic assets in the resource sector, with specific mention of potash, rare earths and phosphate (Brazil may canel, pay for 'strategic' mine rights). Brazil is working on a new mining code which is expected to become law later this year and which is being designed to give the government greater control over energy and natural resources. The Reuters article has two sub-texts, one suggesting that the new mining code will allow the government to expropriate any deposit which is not being developed, including iron deposits, while the other suggests that certain metals or minerals will be deemed "strategic" and expropriated from the owners with reimbursement of sunk costs.
The first issue is a tricky one because much of Brazil's known resources discovered in past exploration cycles are owned by the private sector but are not being developed for a range of reasons such as poor economics and the desire to not glut the market with over-production. Sometimes it is the remote location and high cost of building energy and transportation infrastructure that keeps deposits undeveloped. Or it can be metallurgical issues that have not been solved. Confiscating these deposits and putting them into a mineral reserve from which their development can be auctioned to the highest bidder will hurt mining giants and Brazil's industrial complex more than resource juniors in the short run. However, it will inhibit the flow of exploration capital into Brazil if a junior cannot use assessment work to hold a near success as inventory for a future bull market, or at least have it bought out by a major who intends to mothball the project as long term asset. The article suggests that the current system of "first apply first receive", equivalent to Canadian map staking, may be abolished whereby all applications need to be negotiated, a recipe for the sort of corruption that clouds title in sub-Saharan Africa. This makes it difficult for a clever junior to develop an interesting geological idea and secure title to the prospective land. For example, Verde Potash Inc would never have succeeded in acquiring most of the Verdete slate belt once held by partly state owned Vale. "Why does an obscure junior want title to all this land? It must be worth something so let's see who else might be interested and possibly pay more." The new mining code will not be a problem for the juniors if it simply beefs up assessment work requirements or in the case of large licenses requires periodic partial relinquishment of the land position.
The second issue is potentially problematic for Verde Potash Inc and other juniors such as MBAC Fertilizer Corp which is developling a phosphate deposit and recently announced an initial rare earth resource for its fragment of the Araxa carbonatite complex, most of which is controlled by CBMM and operated as the world's biggest niobium mine, though apparently the substantial rare earth portion is now the subject of a $30 million pilot plant study. The Reuters article suggests that the new mining code may decree potash, phosphate and rare earth deposits "strategic", and thus subject to expropriation by the government with compensation consisting of sunk exploration and development costs. This would appear to be a major threat to Vale, which owns and operates phospate and potash mines in Brazil. One has to wonder also what this implies for CBMM's ownership of the Araxa niobium mine. Of particular relevance to Spec Value Hunters would be the status of Verde Potash's 10 billion tonnes of Verdete slate which runs 9%-11% K2O but in a silicate form that has a much higher processing cost than conventional potassium chloride. In Spec Value Hunter Comment - March 27, 2012 I offered an analysis of Verde Potash's PEA base and upside case development scenarios which suggested substantial upside value, provided the long term price of KCl stays above $300/t FOB Vancouver. I also made the case that the Verdete slate is critical to Brazil reducing its dependency on imported potash, especially if it seeks to grow its agricultural industry. Now Reuters seems to be sounding the alarm that Brazil heard me and is taking steps to confiscate this strategic asset.
If only this would come true. Developing the Verdete slate potash into a conventional KCl mine will cost billions in capital costs and plenty in per unit operating costs. The Verdete slate is worthless without the proprietary process Verde Potash has developed and which is the focus of a feasibility study for which Verde Potash raised $24 million earlier this year (not entirely worthless, because the production of ThermoPotash as a fertilizer blend supplement could become a viable business, though not one which it is easy to see the government salivate over). Brazil could conceivably get away with making an argument that it has a right to control the development of "strategic" resources, but it will have much more difficulty asserting that it has the right to expropriate the intellectual property developed and owned by a private company. Brazil can easily "possess" the land that hosts the Verdete slate, but to illegally deploy somebody else's intellectual property it must first get hold of it, including proprietary details, and then it must defeat a lawsuit by Verde Potash asserting ownership to this intellectual property. It would make much more sense for the government just to buy out Verde Potash and in the process not just "recover" full title to something it already owns, but also secure the method by which its strategic potential can be turned into reality on behalf of Brazil. My Good Absolute Spec Value Buy for Verde Potash Inc remains in place, with the warning that once politicians have seized upon a bad idea, there is a risk that latent stupidity will transform the bad idea into reality. The downside for everybody would be that Brazil ends up with a worthless pile of green rocks, and Verde Potash ends up with intellectual property that has value only when applied to Brazil's pile of worthless green rocks. At one time I thought perhaps the technology could be applied to similar potassium rich silicates elsewhere in the world, but unfortunately, after understanding how the PEA's economics hinged on displaced shipping/import costs in manner that makes the Verdete slate situation unique, I doubt that Verde Potash's KCl conversion process has commercial applicability anywhere else. Given that the process is not as simple as making cement, I doubt very much the government would want to confiscate the Verdete project of Verde Potash.
*JK owns shares in Verde Potash PLC