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Express 2010-01
March 30, 2010
Understanding why Rare Earths are such a Big Deal
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Since early 2009 the media has lavished a surprising amount of attention on the rare earth sector, which has helped elevate the profile of the more advanced rare earth juniors featured in the KBFO Rare earth Index. The rare earth sector has been in a holding pattern since early 2010 after a strong rally best described as the rare earth sector's "awakening". Others have called it a "bubble" and made dire predictions about an imminent collapse even though the "bubble" is less than a year old and the participants have traded a fraction of the value traded by members of the uranium bubble which ran from late 2004 until mid 2008. The uranium bubble attracted more than 200 juniors, many of them with pounds-in-the-ground projects, thanks to a soaring uranium spot price manipulated from $10/lb to a peak of $140/lb by hedge funds who raked in profits by blowing off their positions in juniors supposedly poised to benefit from soaring uranium demand as all those drawing board reactors came on stream. Oddly, one of the commentators quick to "spot" the rare earth bubble did not "spot" the uranium bubble until 2007, presumably because it took until then for his account to be empty of uranium paper.
The rare earth sector has a premature lineup of detractors because the story resonates and the number of eligible contenders is very limited. The "awakening" of the juniors who had acquired an advanced rare earth project when few people knew how to pronounce the names of rare earth elements, let alone spell them, was too fast to allow for strategic positioning, and when the big players rummaged around in the private sector for advanced rare earth projects they could slip into their shells, they came up empty-handed. Nevertheless the media interest in the rare earth story prompted a large number of juniors to come up with early stage rare earth projects, 190 according to Intierra's database. Some jumped into the rare earth sector in the misguided hope that a bubble was indeed underway and that the mere mention of "rare earths" in a news release would attract buyers. And some were juniors run by toiling geologists who recognized that here was something very similar to the early nineties when a major diamond deposit was discovered in Canada for the first time despite decades of fruitless exploration, and that in the modern context of escalating global demand the bar for what deserved exploration follow up was lower than in the past when only a handful of specialized majors looked for rare earth deposits. This proliferation of rare earth juniors has prompted some commentators to betray their ignorance through irrelevant proclamations such as "we do not expect this demand (rare earth) to support anything like 190 companies", by which reasoning the 200 juniors that joined the diamond hunt during the nineties should have tanked the diamond market. Some of the juniors with early stage projects may indeed discover a major rare earth deposit, and will attract considerable market attention when they do, especially if the concept of non-Chinese rare earth mines has meanwhile gained serious traction. The projected rare earth supply shortage problem will not be definitively resolved during the next five years because it will take at least that long for major new rare earth mines to demonstrate their commercial feasibility, and because in the meantime new demand projections may repeatedly outstrip the projected supply structure. As long as the big question remains whether or not a non Chinese rare earth mining industry is at all feasible, the early stage rare earth juniors will viewed by the market as a novelty, and not as a destination for speculative dollars. Despite the mainstream media hoopla, there is nothing no-brainerish about the rare earth sector, which, of course, is why there remains substantial upside. Between the sour grapes of the excluded street smart and the inanities of the ignorant the rare earth juniors have to scale a considerable wall of skepticism. But that may soon change.
The relevant question is not about a bubble popping, but whether or not the interest in the rare earth sector will progress to the next level where the market starts treating the more advanced rare earth projects as "mines to be made" rather than flavor of the month promotional vehicles to be pumped and dumped. The market certainly has reason to be wary about "weird metals". During the past year the lithium sector had a good market run that benefited from Detroit's misery and a groundswell of optimism about electric vehicles as the future of the transportation industry. Lithium, however, is in considerable danger of being discarded as last month's flavor because the electric vehicle adoption curve needs another decade before it is ready to go exponential, the rollout of commercial electric vehicles such as the Chevy Volt promises to be a fountain of bad press next year, it is not at all clear that the lithium ion battery will be safe and effective at the car scale and thus a critical input for electric cars, and lithium security of supply is not currently a problem, and will not in future be a problem if the Bolivians work out a deal with the Chinese to develop their brine ponds. Furthermore, lithium is a dull story that only the technical and financial media will touch, though this may explain why lithium caught on with the financial sector quicker than rare earths.
The mainstream media loves the rare earth story because it is complex and nuanced. Rare earths have become the locus of a far-reaching debate on nationhood in a global economy where capital is free to deploy itself into jurisdictions with the lowest cost structure. Through a confluence of circumstances China has emerged as the region with the lowest cost structure, made possible by a very large population base, a historic migration by the peasantry from the hinterland to the coastal factories, and a hybrid political system which has combined authoritarian rule with capitalist methods. China has used cheap labor, weak health and safety standards, non-existent social security costs, weak or un-enforced emission standards and centralized control to turn itself into capital's preferred manufacturing base courtesy of a China Price no other nation can beat, including India which by virtue of being a democracy lacks the administrative machine to make things happen. This narrative maps beautifully to the rare earth story, because the same reasons that have made China the corporate world's favorite place to create manufacturing jobs have helped China become the dominant supplier of rare earths. Furthermore, just as there are lots of people in the rest of the world who are willing to work for a living, so there are plenty of rare earth deposits outside of China waiting to be developed.
The media has also latched onto the rare earth theme because it recognizes rare earths as a minor but critical factor in transforming the world's energy basis, be it to reduce the dependency on oil overly concentrated in unstable regions, or to avert the climate change consequences arising from carbon dioxide loading of the atmosphere through fossil fuel consumption. The rare earth connection to climate change is one reason apocalyptic gold bugs and tea baggers are not fans of the rare earth story. There are also a surprising number of geologists who question the link between climate change and fossil fuel combustion who not surprisingly are being courted by creationists as recruits for the intelligent design camp. These geologists who nevertheless like the rare earth sector tend to ignore the climate change topic and instead focus on geo-politically grounded security of supply concerns.
The toughest objection for the rare earth juniors to overcome is the small size of the rare earth sector. The estimated value of the annual rare earth oxide market is less than $2 billion, a fraction of the estimated $440 billion value of the 2009 metal market based on average spot prices and production estimates provided by the USGS. Dudley Kingsnorth estimates that the value in 2008 was $1,285,000,000, and substantially lower in 2009 as the economy recovered from the financial crisis in 2008. When you compare the puny size of the rare earth oxide market to the $81 billion value of copper production and the $73 billion value of gold production, it is easy to understand why observers like Rick Rule sneer at the sector, and why the major mining companies have shown little interest in rare earths.
Not only is the value of annual rare earth production small in the overall metal market, but it is completely dominated by China. About 97% of the annual rare earth production is supplied by China, with 80% coming from two large light rare earth dominated mines in Inner Mongolia and Sichuan, and the rest coming from a hodge podge of "ion adsorption clay" deposits in southern China. But China does not have a monopoly on rare earth deposits. What China has is the lowest cost structure for mining and processing rare earth ores, which has enabled it to sell rare earth oxides at a much lower price than is economically feasible for deposits in the rest of the world. Since the mid eighties China has aggressively subsidized the cost structure of rare earth production and processing. It has been so successful that major non-Chinese rare earth mines such as Lovozero in Russia, Kutessay in Kyrgyzstan, and Mountain Pass in the United States were forced to shut down more than a decade ago. And where Chinese price competition had no effect, namely the production of monazite concentrates from heavy mineral sands, "not-in-my-backyard" aversion to the radioactive thorium by-product from monazite processing killed that source of supply, or at least reduced it to 3% of the global market fed by India, Brazil and Malaysia.
Gold and copper juniors need to worry mainly about whether or not their project is economic at the prevailing spot price, though since the last decade they also have to worry somewhat about the future commodity price. What a typical junior does not have to worry about is whether or not mine supply from its own production would affect the future price of gold or copper. These markets are so deep that the addition of one typical mine at the largest scale is unlikely to affect prices. What copper producers do have to worry about is their collective supply response, and decision making is thus geared toward putting the lowest cost mine into production so that the mine can keep operating during a cyclical downturn exacerbated by too many new mines brought on stream during the boom. Rare earth juniors have to worry about the size and value of the future rare earth market and what impact each mine's supply would have on prices. They have to deal with a scaling up of the minimum development threshold required by the permitting regime outside of China. Furthermore, the need to process complex minerals and separate individual rare earths with what amounts to a chemical plant further boosts the minimum scale of an operation. During the eighties mining companies such as Unocal (Molycorp) and Hecla never considered mining scenarios greater than 2,000 tpd. Today, except in the rare case of very rich rare earth ore, 2,000 tpd is the starting threshold for a rare earth mine. The complexity of rare earth mines rules out the sort of small scale mining operations gold and silver juniors can entertain. A rare earth deposit has to be big to allow a long mine life, and rich enough to meet the requirements of strategic logic, if not economic logic. A chart such as the above supply-demand forecast by Dudley Kingsnorth is thus of utmost importance to the rare earth juniors.
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Dudley Kingsnorth, whose company Industrial Minerals Company of Australia Pty Ltd (IMCOA) published An Overview of the Rare Earths Market in October 2009 containing a wealth of hard to assemble statistics about the rare earth sector, is the widely acknowledged expert on the rare earth sector. He is the primary author behind the highly detailed 2007 Report on the Economics of Rare Earths and Yttrium published by Roskill Information Services. Most of the graphics in this article relating to rare earth supply and demand and usage are based on the recent IMCOA report. Kingsnorth tends to very cautious in his projections, in part because his knowledge depends on sensitive contacts throughout the rare earth based supply chain. Nevertheless, he explicitly states that China is moving downstream with the goal of dominating the supply chain all the way through to end-products, which goes well beyond component production. He also readily admits that his projections through 2014 do not account for a scenario where the world adopts a massive commitment to the implementation of green energy technology. His October 2009 report indicates he will revisit this topic after the December 2009 Copenhagen Climate Change talks, though in light of their murky outcome it is unlikely he will revise his demand projections upward. However, it is interesting to note that a Roskill speaker at the recent 30th Industrial Minerals Congress in Miami offered a 205,000 tonne demand projection for 2014, 14% higher than the 180,000 tonnes Kingsnorth projects.
The projected supply-demand structure of the rare earth oxide market is very controversial because of the layers of complexity involved. According to Kingsnorth the world produced 124,000 tonnes in 2008 which had a total value of $1,285,000,000. The "weight" chart reveals how much of the 124,000 tonnes of rare earth oxides produced in 2008 was used by each application, while the "value" chart shows how the applications carved up the value pie. The projections look simple enough when expressed as tonnes of total rare earth oxides. But as the two REO Applications by Weight and Value charts for 2008 demonstrate, rare earth applications break down into 8 distinct groups, each of which has an independent end-user demand dynamic, and each of which is served sometimes interchangeably by several rare earths. Furthermore, because the 15 rare earth oxides occur in different natural relative abundances, and each possesses properties that lend themselves to specific applications for which there is variable demand, the pricing of specific oxides varies widely. As the bar chart above shows, magnets and phosphors are the big demand value drivers, and the rare earths that provide this functionality have the highest per unit value.
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The 2007 production value and weight charts above represent production data for the individual rare earths provided by China. The tonnage figures have been converted into value figures by multiplying the weight by the four year average rare earth oxide price. What emerges is a refutation of the common myth that the value resides in the so called "light" rare earths, which these days are defined as cerium, lanthanum, praseodymium, neodymium and samarium while the "heavy" rare earths are defined as europium, gadolinium, terbium, dysprosium, holmium, erbium, thulium, ytterbium, lutetium and yttrium. As the charts show, the "heavies" represent 39% of the value and only 14% of the weight, while the "lights" represent 61% of the value and 86% of the weight. The "heavies" are thus not just more valuable than the "lights" on a per unit basis, but they also represent a significant portion of the total value of the rare earth oxide market. The charts below represent IMCOA's 2014 forecast for individual rare earth oxide demand based on overall demand of 180,000 tonnes. By applying the current four year average prices to the 2014 demand we get a forecast market value of $2,120,000,000. That value figure is pleasing enough, but with what justification can the 4 year average prices be applied to 2014? Furthermore, it looks like IMCOA has pretty much assumed that the "heavies" will maintain a relative percentage of total volume fairly close to that of 2007. This implies that one should not give too much weight to speculations that the "heavies" are becoming the preferential subject of technology innovation and green energy policy driven demand growth. As Dudley Kingsnorth cautions, much depends on the outcome of the Copenhagen Climate Change talks, which was sufficiently unclear that nearly anybody can give the demand projections a shot.
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If the size and value of future rare earth demand is anybody's guess, perhaps the supply structure offers greater clarity? The gorilla of Chinese rare earth supply is the Bayan Obo deposit, a giant iron deposit of several billion tonnes in Inner Mongolia which grades 35% iron in the oxide forms of magnetite or hematite, with TREO grades ranging from 2%-6%. IMCOA lists the resource as 1,460,000,000 tonnes of 3.9% TREO. If we assume the bastnaesite distribution the USGS lists as representative of Bayan Obo, we end up with a rock value of $325 per tonne, which jumps to $498 per tonne if we boost the grade to 6%. We often hear that Bayan Obo could supply centuries of conceivable global demand for light rare earths, which claim can be easily substantiated through a bit of math. The 1.46 billion tonne resource at 3.9% computes into 57 million tonnes of contained TREO, which could supply the 180,000 tonne demand projected by IMCOA for 2014 for more than 300 years. So why do we need to worry about rare earths, in particular the light rare earths?
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Bayan Obo may not be the invincible warhorse the Chinese have led us to believe. The technical paper about the geology of Bayan Obo linked above paints a complex portrait of the deposit's geology, whose rare earth content can take the forms of bastnaesite, monazite and apatite, each of which has a different rare earth distribution and associated "cracking" process. Worse, it is not at all clear how the rare earth mineralization is spatially related to the iron ore, which has the "rubbish grade" Phil Newman of the UK consultancy CRU Strategies Ltd used to describe Chinese iron ore deposits during his PDAC iron ore commodity talk on March 7, 2010. Concerns have also been raised that Bayan Obo is running out of tailings disposal space. The 2010 production quota for Bayan Obo is 50,000 tonnes of REO, which works out to a mining rate of about 3,500 tpd which seems quite modest for an open pit mining operation. Logistical limitations such as grade control and processing bottlenecks may, however, prevent scaling Bayan Obo production higher. If that is the case then the Chinese government has a right to be concerned about its own long term security of supply.
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China is also becoming very concerned about the environmental destruction inflicted by rare earth production and practices that are very wasteful, particularly with regard to its ion adsorption clay deposits in southern China. After decades of not caring that China was subsidizing its rare earth industry by allowing production and environmental standards that are unacceptable in the rest of the world, people are starting to notice the damage done by the "green" rare earths. Perhaps it is a function of emerging "footprint consciousness", though more likely it is driven by self-preservation instincts triggered by growing awareness of the dependency created by addiction to cheap rare earth oxides. Photo-journalist Richard Jones managed to visit the Bayan Obo Mine and the surrounding industrial wasteland in late 2009 and published Inside China's secret toxic unobtainium mine on January 10, 2010 in the Guardian Mail Online. Several weeks earlier on December 24, 2009 Keith Bradsher of the New York Times published a scathing article on the south China clays, Earth-Friendly Elements Mined Destructively.
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China has good reason to be concerned about depletion of its ion adsorption clay deposits because these low grade deposits were formed by weathering and where preserved are a laterally extensive "skin" only 15-20 metres thick. Although low grade, these clay deposits are valuable because they are dominated by the more expensive "heavy" rare earth elements and because they can be mined and processed easily and cheaply. The "ore" is simply shoveled into large vats of acid which readily dissolves about half the rare earth content. The contaminated remainder is flushed into local rivers or the surrounding land, wasting half the resource and polluting the environment. Criminal organizations apparently have a major hand in the mining and processing of the clay deposits, and about 20% of the heavy rare earth production is smuggled out of China, with much of it ending in Japanese end-user hands. A few years ago it was estimated that at current production rates the clay deposits had about 20-30 years left. A recent Roskill report suggests that life has shrunk to 15-20 years. The Chinese have justifiably become alarmed about running out, because unlike the peralkaline intrusive systems such as Strange Lake, Nechalacho and Norra Karr which can host high heavy rare earth grades in large tonnages that can be delineated through drilling, the South China clays are a thin skin that is gone once it has been skimmed away.
While the cynics may scoff that China will never crack down on wasteful and polluting mines, recent history suggests otherwise. The chart above for annual molybdenum production shows a pattern of long term demand growth similar to that of rare earth oxides and includes a graph depicting the value of each year's production based on the average price of molybdic oxide during each year. Demand underwent a sharp increase in 2003 that was accompanied by an even sharper price rise toward which Chinese supply did not respond until 2007. The reason for this delayed reaction was that in 2003 China embarked on a campaign to consolidate its molybdenum mining industry which consisted of numerous small scale inefficient and often grossly polluting operations. The inability of China to boost supply just as molybdenum demand spiked turned a modest annual market worth less than $2 billion into a $10-$15 billion market between 2004-2008 before demand and prices collapsed due to the financial crisis. Since the meltdown molybdenum prices have recovered and we are now looking at a market worth $5-$10 billion, which is substantially better than the $2 billion value that prevailed during the nineties and eighties. The sustained boost in market value was achieved because molybdenum is a minor but critical input to steel and during 2003-2008 the world, led by China, underwent a major infrastructure buildup.
The similarity with the rare earths situation today is remarkable. China appears to be on the threshold of cleaning up its own inefficient and polluting rare earth mining and processing industry just as the world is gearing up for some major long term structural changes in the way it generates and uses energy. Furthermore, while molybdenum's contribution is largely as an alloying agent that hardens and provides corrosion resistance, the rare earth elements possess an intriguing range of magnetic and spectroscopic properties that can find their way into any number and variety of technological innovations. While it is easy to sneer at the rare earth sector's modest past, and argue that this space offers no meaningful profit opportunities involving the development of new supply outside of China, the stage is in fact set for a double whammy of soaring demand AND sharply higher REO prices during the next decade. In terms of global resource base distribution rare earths are very similar to molybdenum, but while molybdenum production is distributed evenly between China, the United States, Chile and Peru, with a handful of other countries such as Canada also producing molybdenum, in the case of rare earth oxides production is completely dominated by China. The IPV Chart below depicts the implied project values for the members of the KBFO Rare Earth Index which have advanced rare earth projects. About half of them have published 43-101 or JORC resource estimates whose contained rare earth oxides have a nominal value of $50 billion. The other half are working on resource estimates which within two years could double the nominal value to $100 billion. The combined market capitalization of these rare earth juniors is less than $2 billion, with almost half that amount represented by Lynas Corp whose Mt Weld deposit is the most advanced rare earth project outside of China owned by a publicly traded company. Soon we will have a new addition to this group if Molycorp delivers on its plan to conduct an IPO in 2010. These companies represent the solution to the problem of rare earth production being concentrated in China, a problem China also wishes to solve because it does not want to bear the cost of trashing itself forever. Unfortunately, the current rare earth oxide prices do not give economic logic much wriggle room. However, we may get a perfect storm that produces sharply higher prices that may help out investors concerned with economic logic, and that will certainly embolden end-users driven by a strategic logic which calculates its economic return in complex indirect ways. The forces driving higher rare earth prices and market interest in the rare earth sector will be a Chinese currency revaluation, supply shortages created by China's rationalization of its rare earth industry, timeline disappointments involving some of the more advanced non-Chinese rare earth projects, and a demand growth whose wild dynamic will make a shambles of rare earth supply-demand forecasts.
The spark which could very well set the rare earth sector on fire is the return of Molycorp Inc and its Mountain Pass Mine to the public market after a three decade absence. During PDAC in March 2010 I had a chance to sit down with Ross Bhappu and discuss Molycorp's plans with regard to its Mountain Pass rare earth deposit and a possible IPO. Bhappu is a partner at Resource Capital Funds which spearheaded an investment group's purchase of Molycorp and its Mountain Pass related assets from Chevron in late 2008, and he is a director of Molycorp. When I separately talked to Molycorp's CEO Mark Smith and Ross last May both were of the view that any talk about an IPO was premature by several years. When I chatted with Ross at PDAC this year he admitted that Molycorp management was quite surprised at the speed with which the mainstream media picked up on the rare earth theme and the level of market interest the rare earth juniors had attracted. Molycorp is now considering an IPO this year and is exploring the best listing venue.
The NYSE ranks high on the list because Molycorp's primary asset is the Mountain Pass rare earth deposit and facility in California, and, because its business model involves using its own rare earth oxide supply to feed downstream value adding operations. Molycorp will thus be more than a mining company selling its output into a commodity market at the best price it can get; it will be an industrial business that can leverage its in house supply of rare earths to acquire and develop technologies that have rare earths as critical inputs. The latter is key because if Molycorp were just a mining company, the market would price the stock as a multiple of cash flow based on commodity price projections. And unless there is a sharp increase in the price of rare earth oxides, this valuation model might not generate a big number. The open-ended revenue growth potential of the downstream business will be closely linked to "cleantech" and "green energy" trends, making it harder to quantify the upside price limit of the stock, a key to becoming a market darling for investors. And if management pursues its goal of becoming a technology innovator, and not just a "mine to magnet" producer of generic components, as it seems to be doing with its water filtration system, Molycorp could become a major player in the nascent materials science boom into which Silicon Valley is edging itself as it frets that China is making a serious play for America's mantle as the world's leading innovator.
A NYSE listing would make Molycorp a no-brainer buy for any fund manager seeking exposure to the rare earth sector and its downstream market. While the re-emergence of Molycorp as a major rare earth producer might put into question the need for additional rare earth mines, the proposed scale of the Mountain Pass operation would only replace the current American import need. It would not take care of optimistic demand growth or pessimistic Chinese supply response capacity. And since the relevant questions about future rare earth supply and demand will not be answered for several years, the arrival of Molycorp as the leading "mine to magnet" rare earth producer-industrial would encourage the capital markets to invest in other advanced rare earth projects.
Of great interest to the rest of the rare earth sector is the size of the IPO and the market capitalization of Molycorp implied by the IPO price. Given the conservatism of RCF, and indications that management does not quite appreciate why the media is obsessed with the rare earth story, the IPO will likely have a reasonable price. And that would make it a hot IPO in the sense that the stock opens at a substantial premium to the IPO price. Molycorp management has told the press that it will need to raise $400-$500 million to refurbish the existing Mountain Pass mill and upgrade related facilities, though in the same breath it suggests that a good portion may be raised through debt financing. A market capitalization of $1 billion is a plausible. As far as timing is concerned Bhappu did tell me that Molycorp is preparing an S-1 registration form which he hinted could be filed as early as May. Depending on SEC feedback Molycorp could be in a position to conduct an IPO during June, though I suspect that the timing will be pushed to September when everybody has returned from vacation and there is greater clarity on the direction of the global economy.
The obvious comparable publicly traded rare earth stock is Lynas Corp which has a market capitalization of about $800 million based on its fully funded Mt Weld deposit in Australia and processing facility in Malaysia currently under construction. The Central Zone at Mt Weld that is targeted for production has a measured+indicated+inferred resource of 4.7 million tonnes grading 13.8% TREO whose distribution implies a rock value of US $1,300 per tonne using the 4 year average benchmark Wardrop adopted in February 2009. The gross value of the Central Zone's mix works out to $9.41 per kg and the overall resource has a US $6.1 billion in situ value. Lynas plans to be in production by the second half of 2011 and will initially produce 11,000 tonnes of rare earth oxides per year before ramping up to plant capacity of 22,000 tonnes per year.
The Mountain Pass mill is permitted to produce 2,000 tpd and has a capacity for 3,500 tpd, though the initial plan is to process only 1,000-1,200 tpd which would generate 18,000-20,000 tonnes of rare earth oxides annually. Molycorp has not disclosed 43-101 compliant resource figures for Mountain Pass, but Bhappu suggested that the head grade will average 8.5% TREO and referred me to the USGS Fact Sheet 087-02: Rare Earth Elements---Critical Resources for High Technology published in 2002 just before Mountain Pass shut down mining operations. It lists a resource of 20 million tonnes of 9.3% TREO dominated by bastnaesite, a mineral which hosts primarily light rare earth elements and for which Molycorp has a proven processing technology. The weight and value distribution charts below indicate a US $577 per tonne rock value at 9.3% on a 100% recovery basis when I apply the 4 year average rare earth oxide prices Wardrop Engineering used in February 2009 for its Avalon resource estimate. The rock value drops to $526 at the 8.5% head grade suggested by Bhappu. Molycorp believes it could be back in full mine production by 2011 and processing concentrate into separate rare earth oxides and metals by 2012. And that implies an IPO sooner than later.
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With the caveat that actual recoveries will be lower, a 1,200 tpd production rate would mine 438,000 tonnes of ore per year with a gross metal value of $230 million. Bhappu indicated that the existing Mountain Pass resource could feed a mine for 30 years, though at some point this would require moving the mill. When Mountain Pass was put into production the deposit was so large relative to global demand that the mill was constructed where it was most convenient, namely on part of the orebody. The overall in situ value of the 20 million tonne Mountain Pass deposit works out to $10.5 billion. In reality the Mountain Pass resource may be substantially larger. On March 1, 2010 Molycorp announced that it was initiating an exploration program to assess other rare earth zones known to exist on the property, in particular zones dominated by the phosphate mineral monazite which has a better distribution of heavy rare earths than bastnaesite, with emphasis on dysprosium and terbium. Molycorp seems a little miffed that the street dismisses Mountain Pass as just another "light" rare earth deposit and appears eager to set the record straight. The Mountain Pass deposit is one of 8 alkali plugs that make up a large carbonatite complex whose geology is described by Cal Poly's David Jessey. Should Molycorp succeed in this regard it would be in a position to produce the smaller amount of heavies the world currently needs, and potentially put it into position to supply all of the current rare earth needs of the United States.
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Mountain Pass is similar to Mt. Weld in revenue potential, with the added benefit that the process technology has a history of working with Mountain Pass ore. Although the rare earth distribution at Mt Weld is similar to that of Mountain Pass, Mt. Weld's grade is higher because the mineralization has undergone a supergene enrichment process that has made the mineralogy more complex than the bastnaesite ore at Mountain Pass. Molycorp at one time owned Mt Weld and abandoned it after concluding that it was not possible to establish an economic recovery process on a commercial scale. Mineralogist Tony Mariano who worked on Mt Weld will spit fire and brimstone about the intractability of Mt Weld ore at any opportunity he gets. To solve this problem Lynas is building a facility in Malaysia which will have 64 km of piping and 1,000 tank vessels; until the facility is successfully commissioned the jury will be out on its viability. For an example of what can go wrong with commercial scale "chemical plants", just look at BHP Billiton's $3.7 billion Ravensthorpe nickel laterite plant which worked fine at the pilot plant scale but got horribly gummed up at the commercial level due to "mineralogical control" issues of the sort one must worry about in the case of rare earth deposits.
Another factor that will determine the pricing of a Molycorp IPO is how much the current investors paid for the Mountain Pass project, which to understand requires a bit of history. Rare earths were discovered at Mountain Pass in 1949 by uranium prospectors who submitted unusual radioactive rocks to the USGS which identified the presence of rare earths and the radioactive element thorium often associated with rare earth systems. A predecessor of Molycorp called Molybdenum Corporation of America acquired the project and put the deposit into production in 1952. The oil producer Unocal acquired Molycorp in 1977 and expanded throughput so that Mountain Pass became the world's biggest producer. Mountain Pass started to lose ground during the early nineties when Bautou Iron & Steel ramped up rare earth production from its Bayan Obo iron mine, and the ion adsorption clays were discovered in southern China. Unocal shut down Mountain Pass in 2002 because of weak rare earth oxide prices created by a glut of material from Bayan Obo and because a key water license was not renewed after a 1998 wastewater spill.
In March 2005 the Chinese National Offshore Oil Corporation (CNOOC) made an unsolicited $67 per share takeover bid for Unocal that valued the company between $16-$18 billion. This caused a "national security" uproar" in the US House of Representatives which prompted the Bush administration to persuade Chevron to make a competing bid for Unocal that was initially below that of CNOOC but eventually sweetened to $69. In August 2005 CNOOC withdrew its bid and Chevron acquired Unocal's extensive oil assets as well as a subsidiary called Molycorp Inc which owned the dormant Mountain Pass rare earth mine in California. There have been media suggestions that CNOOC, controlled 70% by the Chinese state, was really trying to secure control of one of the world's best rare earth deposits, but this is nonsense given the overwhelming relative strategic value of Unocal's offshore oil assets, including those in Myanmar, the pariah state which has developed a cozy relationship with China in the face of western sanctions over human rights violations committed by its numerology obsessed military junta.
Although mining at Mountain Pass stopped in 2002 sufficient ore and concentrate had been stockpiled to allow Chevron owned Molycorp to resume separation activities in 2007 on a small scale producing several thousand tonnes of TREO per year dominated by lanthanum, praseodymium and neodymium. Molycorp had also secured a renewal for a 30 year mining plan in 2004, which prompted Chevron to come up with a plan in 2008 to restart the Mountain Pass Mine. At the same time Chevron put Molycorp on the block and attracted a number of private bids, one of which I understand offered to pay $200 million for the project. Chevron instead sold Molycorp for undisclosed terms to a different group headed by Denver-based Resource Capital Funds which included Pegasus Capital Advisors, a private equity group focused on "green" businesses, Traxys, a metals trading firm whose management buyout in 2006 was bankrolled by Pegasus, and Goldman Sachs, which had already demonstrated its interest in the rare earth sector through its stake in Lynas. So if we assume the RCF group paid at least $200 million, allow a $300 million "founder" markup reflecting the "cleverness" of the asset purchaser's vision of Mountain Pass's potential value versus that of the seller's more pessimistic outlook, and assume a minimum $500 million IPO to fund the Mountain Pass modernization plan, we end up with a $1 billion market capitalization for Molycorp on a post-IPO basis. Rumors do suggest that Molycorp will seek to raise a lot more than $500 million, which is conceivable if it packages its game plan as a mine to market solution to America's rare earth security of supply problem, and has ambitions to own and operate other non-Chinese rare earth deposits.
The presence of Goldman Sachs has created speculation that this investment bank, which had also taken a stake in Lynas Corp before the financing syndicate it was part of pulled the plug on Lynas in January 2009, and was rumored to be a big supporter of cap and trade legislation, would eventually turn Molycorp into a Wall Street darling. But the presence of Goldman Sachs proved to be more a liability as Molycorp lobbied Washington to develop policies that would offset the predatory pricing power afforded to China through its rare earth supply monopoly. Molycorp's lobbying efforts attracted critical media coverage mocking the need of a private Goldman Sachs backed venture for yet another government handout or concession. Goldman Sachs has become synonymous with a self-serving "heads I win tails you lose" business philosophy successfully carried out against everybody ranging from clients to taxpayers in part because it has been able to rig playing fields in its own favor. The street perception today is that if Goldman Sachs is involved, count me out, because otherwise it will cost me. For those of us in the resource junior game, Goldman Sachs is equivalent to certain promoter groups whose deals are always structured to shift massive risk to others who do not have a compromised relationship with the promoter group. It was thus no surprise when Molycorp announced on March 26, 2010 that Goldman Sachs had sold its Molycorp stake to the other shareholders, ostensibly because the investment was too small to be of continuing interest to Goldman Sachs.
There may be far more to this turn of events than this explanation. Other investment banks have become big investors in advanced rare earth projects, including Morgan Stanley and JP Morgan who own large stakes in Lynas Corp. RCF and the other shareholders may have disagreed with Goldman Sachs on how to proceed with financing and developing Molycorp. Goldman Sachs, which has been a supporter of "carbon cap and trade" legislation, may also have soured on the whole green energy business now that the Henry Waxman "cap and trade" energy bill is being replaced by a simpler bill involving pollution credit auctions that are not a recipe for fraud, manipulation and subversion of the original intent. There is the opposite possibility that Goldman Sach has recognized the extraordinary symbolic role of Molycorp with regard to the vision of revitalizing America's economic future through a strategy of footprint conscious transformation of energy infrastructure. Goldman Sachs no doubt is aware that its brand name is poison across the political spectrum, and if it desires to be a big player in a "next big thing" that requires political support, it would be prudent to divest itself of a small investment because of a potential perceived conflict of interest. So for all we know Goldman Sachs might yet emerge as the lead in a Molycorp IPO. In any case, I regard the departure of Goldman Sachs as inconsequential at worst, and possibly quite positive.
When I talked to Mark Smith a year ago it seemed very strange that he was spending most of his time in Washington DC lobbying for government support for the revitalization of an American based rare earth mining, processing and downstream manufacturing industry. Today it seems odd that a company like Molycorp would waste any time on politicians. But two years ago there was hardly a mention of rare earths in the mainstream media and that was the reality to which Mark Smith, a lifer at Mountain Pass, had become accustomed. Now hardly a day goes by without somebody writing about this topic. Critics have responded that the media attention is much ado about nothing given the relatively small value of annual rare earth production. Demand growth rates are modest and China appears to have centuries of cheap supply in place, so why worry about rare earth supply? The debate between this type of critic and rare earth boosters centers on the accuracy of supply and demand projections, with conservatives such as Dudley Kingsnorth of IMCOA and climate change skeptics discounting exponential growth related to the implementation of clean energy related technologies, while optimists tend to believe that the world will pursue a serious shift away from using fossil fuel combustion as a direct transportation fuel. But there is another debate led by Jack Lifton which has intrigued the media, and that is the degree that the rest of the world has become dangerously dependent on China for minor but critical inputs for everyday applications. This security of supply discussion has emerged because the rare earth sector is complex and small compared to base metals, and thus is of limited interest to mining companies whose decisions are dictated by economic logic and not strategic logic based on futuristic speculations about whose outcome the miners have no control. The corporate culture at Molycorp reflects this cautious mining industry mindset, which is why Mr. Smith went to Washington.
The activity in Washington could pay off on April Fool's Day. During mid March the Investigations & Oversight Subcommittee of the House Committee on Science and Technology held a hearing on Rare Earth Minerals and 21st Century Industry where security of supply, technology innovation, and military vulnerability were among the topics discussed. The Government Accountability Office (GAO) is supposed to deliver a report on April 1 about the extent of American vulnerability to rare earth supply which lobbyists are waiting to seize upon as a tool to promote various government initiatives. Given that the military's defence contractors clearly need a certain amount of rare earth oxides and metals to construct sophisticated and classified hardware, one wonders if the GAO might not find it prudent to downplay such vulnerability, especially at a time when tensions between China and the United States over China's currency peg to the US dollar are mounting. Although the hearings looked like a "make life easy for Molycorp" show, the subtext in those hearings was that unless the United States picks up the ball and re-establishes a domestic supply chain from mine to market assisted by a renewed commitment to basic research and technology innovation, the economic death spiral now underway will continue unabated.
The implicit political question is whether or not the United States should pursue policies that foster re-industrialization so that manufacturing jobs are re-established as a primary driver of productive economic activity. A move in this direction would fly in the face of the free market ideology which underpins globalization, the strategy of shifting all production into the lowest cost jurisdiction regardless of the instability this creates in terms of the distribution of global economic activity. Within the United States rare earths are emerging as a proxy for the broader debate about what the Obama administration should do to stimulate jobs that enable the children of the boomer generation to support the boomers' social security entitlement through productive work. What is the sustainability of a society which represents the world's biggest economy and enjoys military supremacy despite a population base that is a fraction of the world's population, especially if it is no longer directly involved in the production of raw materials and the finished goods fabricated from them? On top of that sits the practical problem of hedging against a geo-political scenario where China thanks to its own doing suffers a civil insurrection that turns the world's manufacturing base into a basket case. It would take only a couple years to re-establish manufacturing capacity in the United States, a development that would be extremely helpful to the economy even as American consumers temporarily take an inflation hit on suddenly scarce "Made in China" goods. While China's possible implosion is thus not necessarily a bad thing for the rest of the world, the sudden cessation of rare earth production would not be a happy development for end-users that need these minor but critical inputs, including the US military. But the GAO is unlikely to dwell on short term vulnerabilities because what is the point behind highlighting vulnerabilities for whose eventuality there is not a short term solution? The GAO is more likely to focus on the longer term question of what happens to American security of supply if China becomes strong enough to push back against American goals or so strong it exhausts its own rare earth supply capacity? Neither of these is going to happen tomorrow, but a decade down the road both are conceivable, and to head off that scenario there is time, provided the process is set into motion immediately.
But wherein does American's security of supply vulnerability reside? The charts above break down rare earth demand by application and region. It is clear that magnets and phosphors are the big value drivers, and that, as shown by the charts below, China and Japan/SE Asia are the big end-users. Europe, which is lumped in with "others", the smallest end-user group, is not a big manufacturer of magnets which require the light rare earths neodymium, praseodymium and samarium, and the heavy rare earths dysprosium and terbium as inputs. Nor is Europe a big producer of displays and lighting systems whose colors require the input of phosphors provided by the heavy rare earths europium, yttrium and terbium. In so far that China keeps reducing export quotas each year and is even considering all out export restrictions on certain heavy rare earths, Japan and China's other southeast Asian competitors stand to lose market share for their end-products if this trend of supply reduction continues.
The United States is less threatened by reduced rare earth exports because it imports only 18,500 tonnes of which 68% goes toward catalysts, in particular the fluid cracking catalysts used by the oil refining industry. This functionality is provided mainly by the light rare earths lanthanum and cerium, both of which are relatively abundant and cheap. For this reason US consumption in 2008 had a value of only $94 million, whose low value raises the question about why everybody is so worked up about the rare earth situation. It also explains why simply replacing America's rare earth import dependency with Mountain Pass production is not going to generate sufficient revenue to allow Molycorp to break even, let alone turn a profit. Molycorp needs the United States to embrace policies which re-establish the rare earth based manufacturing industry that fled to China during the past decade. Mr Smith has the thankless job of telling Washington that to save the nation it must flush three decades of neoliberalism down the toilet.
It is thus almost comical to watch Molycorp's Mark Smith argue in Washington that the United States should adopt policies which encourage the resumption of rare earth mining in the United States and the redevelopment of a product supply chain in the United States. He is in effect asking that the United States set aside its commitment to unfettered free market capitalism and instead enact policies which serve the interest of all American people, not just a handful of wealth concentrators whose allegiance to any nation is purely opportunistic. In the process Mr Smith is waking up Washington to the reality that China has already won the battle to become the world's leading provider of clean energy technology, and, despite the brush-off given President Obama in Copenhagen, is already committed to dealing with the environmental impact the collective footprint of a significantly higher Chinese standard of living will have on the planet.
Mark Smith would probably have a bigger impact in Washington if he simply pointed out that America's addiction to oil is threatened less by oil supply disruptions than by the catalysts required to refine 20 million barrels into gasoline each day. Although a very good case can be made why we should shift transportation fuel away from gasoline to an alternative fuel, of which electricity generated by a wide variety of "fuels" is the best answer, it will still take 15-20 years for such a transformation to be complete during which the United States can ill afford to have its gasoline refining capacity disrupted by a sudden lack of rare earth oxides.
The White House, however, is no longer controlled by the Bush administration, and the best way to approach the Obama administration is to point out that China has adopted a policy of treating its rare earth supply as an input earmarked exclusively for domestic demand, a policy it is able to enforce through export quotas that shrink annually. China has rejected the "globalization" idea that it will be the world's exporter of rare earth oxides to the highest bidder. Instead, it wants to capture the value added by downstream manufacturing of products which require rare earths as a critical input. So, indirectly, China is insisting that western manufacturers of any technology or product that requires rare earths move their production facilities to China. This strategy collides with fiscal stimulus programs geared toward developing clean energy in the form of capital intensive technology such as wind and solar power. Clean energy policies are supposed to create tax payer funded jobs that transform the future in positive ways and get the economy rolling again with the result that rising tax revenues will eventually pay off the fiscal stimulus debt. Investigations, however, are now revealing that 80% of the taxpayer dollars earmarked for these clean energy capital expenditures flow to China, which appears to have already achieved its goal of becoming the world's leader as a clean technology provider. And while that makes a lot of sense to fiscal hawks who insist that functionality be achieved at the cheapest price possible, it isn't doing much to create "domestic" jobs beyond some assembly and installation quickies. It is a paradox for which the Obama administration has not yet tabled a satisfactory resolution. For a detailed discussion of the steps China has taken to dominate the future of materials science based technology while the American or European hamster spun its wheel I recommend Cindy Hurst's article China's Rare Earth Elements Industry: What Can the West Learn? published by the Institute for the Analysis of Global Security. Whichever way you look at it, rare earths are part of a history shaping discourse.
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