Straight Talk from the Graphite Express

Tue, May 8, 2012

In early May, the Graphite Express Conference rolled in to Toronto for a date with investors looking to punch a ticket to big returns. Twelve companies and two speakers made their pitch to roughly 300 investors at the Sheraton Center, curious to see if the graphite train would indeed pick up pace, and which companies look ready to jump aboard.

Straight Talk from The Graphite Express

The first speaker, Chris Berry, founder of research firm House Mountain Partners and co-author of Morning Notes by Dr. Micheal Berry, shared an index of 21 companies in the different phases of graphite exploration and development.

Berry used a slide to illustrate his index’s progress since June 2011.

After some heady spikes in July and August, the index sunk to around 2.7 in mid-September and then started a relatively consistent climb upward until it peaked at 10.089 on March 29, 2012. But by the time another month had passed, the index had slipped to 7.9118—nearly a 22% hit. Was the first wave of the latest graphite boom over?

“I think it is. We hit a high at the end of February, then things took a slight breather, and then it shot up again right around March 29th,” Berry explained. “It has slowly trended downward since then. So we’ve been in a downward trend in graphite junior share prices for about the last five weeks.”

Others aren’t quite as convinced. Simon Moores, a graphite market specialist with London-based Industrial Minerals and the conference’s other keynote speaker, said that while it was a quiet April, the cycle still has lots of momentum left.

“It’s still rising,” Moores said. As of May 2, 37 publicly traded graphite companies were working on 98 different projects. The sector has added an average of 12 graphite projects a month since November 2011, which would seem to indicate the early stages of the cycle, the sector watcher concluded.

Recent rises in graphite prices are what’s underpinning the sector’s frothy growth. The price for large-flake graphite, coveted for its nominal weight and resistance to high temperatures, has soared since about mid-2009, when prices dipped to about US$1,000/ton (1,000/t) from US$1,500/t a year earlier.

A ton of large flake graphite now fetches about US$2,500, a price that has remained fairly flat since about May 2011. Amorphous graphite, or low-quality graphite, is selling for around US$600/t, up from about US$300–U$400/t a couple of years ago.

Moores pointed to the opportunity in graphite fines, a powdery byproduct that can account for as much as 70% of a graphite mine’s production. It generally fetches a US$200–$300 premium above amorphous graphite prices.

But both retail and institutional investors are wary. They witnessed this type of commodity price growth in the rare earth elements (REE) space and watched helplessly as their shares in REE companies gave back their gains and more in the fall of 2011. Many are still licking their wounds.

Kiril Mugerman, an analyst with Industrielle Alliance in Montreal, one of a growing group of analysts covering the graphite space, said the comparison between what’s happening in graphite and what happened in rare earths is invalid. “Rare earths collapsed because the prices collapsed due to what was happening in China. The [REE] prices were not sustainable, so they dropped. I think graphite will stabilize at around US$2,000/t. It’s not going down,” Mugerman said.

He added: “(The boom) is not over because it can’t be over. You’re going to have some companies that will succeed, some companies that will be bought by those guys and there will be a big percentage that will just fail, that won’t be able to advance to anything.”

Berry said that the graphite space holds one other key advantage over other recent “critical metal” bull runs. “Graphite is unique in that it’s much easier to understand than rare earths or some of the other recent investment phenomena like lithium and vanadium,” Berry said.

Industrial Minerals reports that graphite demand in 2011 totaled 1.14 million tons (Mt) but is expected to dip slightly to 1.01 Mt this year. However, that goes against a decade-long pattern. Graphite demand has grown by roughly 5% per year over the last 10 years and the worldwide market is now not much smaller than that of nickel, which boasts annual production of about 1.3 Mt.

Junior Lomiko Metals Inc. (LMR:TSX.V) estimates that the worldwide graphite market in 2011 was worth about US$12 billion, which has it and other juniors scrambling to get a slice of the pie.

The Graphite Express Plays

Focus Metals Inc. (FMS:TSX.V), soon to be Focus Graphite, was first out of the gate at Graphite Express. Focus owns the high-grade Lac Knife graphite project in Quebec and plans to be the world’s lowest-cost producer at US$350/t. It’s also trying to become a large-scale commercial producer of graphene, an ultra-thin single layer of graphite that is 200 times stronger than steel and carries 1,000 times the density of electrical current versus copper.

Next was Lomiko Metals, which owns the Quatre Milles graphite property in Quebec. The property has seen some historical drilling, most of which occurred within 100m of surface. Quatre Milles is close to infrastructure, imperative for a bulk commodity, and should have its maiden resource estimate by December 2012.

Standard Graphite Corp. (SGH:TSX.V), number three on the list, has a 13-property portfolio, the most recent of which is the Mouseau East graphite deposit near TIMCAL Graphite and Carbon’s (private) Lac des Iles graphite mine in the Mont Laurier area of Quebec. The company also has some much-needed graphite experience in geologist Antoine Fournier, who helped discover the Lac Knife deposit, and Benoit Gascon, who spent about 20 years working for TIMCAL, a division of Imerys.

Galaxy Capital Corp. (GXY:TSX.V), which will soon morph into Galaxy Graphite, owns the Sun Graphite project in Quebec. The property boasts several large-flake graphite targets that were first identified by Finland’s Outokumpu in the late 1990s. It has just over 13 million shares outstanding.

Strike Graphite Corp. (SRK:TSX.V) has a couple of projects in Saskatchewan: Deep Bay East and Simon Lake, where it will soon start drilling. The company hopes to have its first resource estimate at Simon Lake by the end of the year.

First Graphite Corp. (FGR:TSX.V) also has a graphite project in northeastern Saskatchewan. The company’s flagship Henry project was explored by Hudson Bay Exploration and Development in the 1970s and has a non-43-101 compliant historical resource. Moreover, First Graphite owns the Mt. Heimdahl graphite property in British Columbia and the Montpellier property in Quebec.

Zenyatta Ventures Ltd. (ZEN:TSX.V) is the only company at the show that had found graphite in a vein/breccia deposit. The Albany project is 175 miles north of Timmins, Ont., and one hole into the property hit eight separate breccia zones consisting of “variably sized granitic clastic sediments set in a black matrix containing graphite.” A bulk sample has been sent to the lab for assaying. Zenyatta has about 39.5 million shares outstanding.

The other Z-company was Zimtu Capital Corp. (ZC:TSX.V), which holds equity positions in several mineral exploration companies, including Strike Graphite, Standard Graphite, Lomiko Metals, Galaxy Capital, First Graphite, Big North Graphite Corp. (NRT:TSX.V), Pinestar Gold Inc. (PNS:TSX.V) and Olympic Resources Ltd. (OLA:TSX.V). The company is led by the bombastic David Dodge, who deserves a spot among the industry’s great promoters.

Amseco Exploration Ltd. (AEL:TSX.V) owns the North Shore graphite project, which includes the Tetepisca Lake and Guinécourt Lake properties near the Manicouagan Reservoir in Quebec. The property is about 135 miles from the deep sea port of Baie-Comeau, Quebec, and is accessible via logging roads. The company has 61 million shares outstanding.

Energizer Resources Inc. (EGZ:TSX.V; ENZR:OTCBB) is one of the few companies working on a graphite project outside of Canada. Energizer is developing the Green Giant graphite project in southern Madagascar and plans to publish a PEA in October.

Another company working outside of Canada is Graphite One Resources Inc. (GPH:TSX.V). Its early-stage Graphite Creek property is on Alaska’s Seward Peninsula. The junior hopes to have a 43-101-compliant resource by December 2013.

Organizers evidently left the most advanced graphite junior until the end. Northern Graphite Corporation (NGC:TSX.V; NGPHF:OTCQX) CEO Gregory Bowes told the audience that he plans to build the Bissett Creek graphite project in central Ontario into the biggest graphite mine in the world. Bissett Creek is ridiculously close to infrastructure and a bankable feasibility study on it should be published in May. The company has 45 million shares outstanding.

Experience Is Key

Predicting which graphite play will move farther faster can often prove difficult, if not impossible, but experts at the conference provided some suggestions.

Mugerman, who was not among the presenters, divided the sector into three categories: Advanced companies with National Instrument 43-101-compliant resources, early-stage explorers who have done some drilling and perhaps some trenching; and companies that are still compiling data and flying electromagnetic surveys. In other words, very early-stage work. “If you separate (the sector into) the three levels, the companies in the midtier that are about to start drilling are still growing—they did not start crashing,” Mugerman noted meaningfully.

Moores believes that you need to look at more than just a certain segment of the graphite companies. “I like to see companies with graphite experience, particularly graphite processing experience,” Moores said. “The first thing a company has to do is get the raw graphite up to anything between 85% and 95% carbon. Those are your brackets of what people are going to buy. And to do that it’s a basic question of grinding, which is all mining, and then you’ve got your flotation. And those things are pretty well understood. These companies just have to master those steps and they will have a graphite product they can sell. That’s very important but that’s very doable. It’s not like rare earths, where there is this really complex system that separates light and heavy elements. In that case, it’s often unclear where these materials are going to. Whereas with graphite, if you can produce a consistent product, people will buy it.”

The market is also difficult to gauge. The price for graphite is not set on a transparent bourse like the London Metals Exchange or the NYMEX. Graphite prices are negotiated between the supplier and the buyer, a back-and-forth process that’s been going on for more than 100 years.

“There’s a reason many people haven’t gotten involved in (graphite mining) because it’s very complicated. The most complex thing is making a consistent product and finding people to buy it. You don’t have one customer that buys everything, you have a lot of customers who are used to getting graphite from one mine for generations. It’s a relationship,” Moores said.

Berry echoed Moores’ comments. “If I’m a retail investor, I want to know how much specific graphite experience a management team has. Yes, there’s dearth of graphite experience out there but are you going to invest your money in these uncertain markets with people that are staking a claim but that don’t have any graphite experience? No,” Berry said. “The other thing that I’m looking for is as much detail as possible around a given deposit. . .all graphite deposits aren’t created equal. Just because a certain flake size trades at US$3,000/t, for example, does not mean that is the price that you will get (for it),” Berry explained. “Maybe you’ll get a little more, maybe you’ll get a little bit less, but that makes it very difficult to nail down what the economics of a given deposit might be.”

The price for good-quality flake graphite is hovering around US$2,500/t and Moores said that price should remain relatively stable in the near term.

“Even though demand softened this year, the price is still staying at a high level, which means graphite is keeping its value. That’s very important because if the situation (changes) and (companies) are producing too much graphite, then the price should collapse or trend down. But it’s not; it’s remaining pretty flat. We’ll see by the end of the year if it does come down or if there’s more (supply) squeezing and it goes up,” Moores said.

He added that companies applying methods that usually work in other mining sectors isn’t necessarily a recipe for success when it comes to graphite. “I don’t think a lot of companies understand the complexity of it because they’re just focusing on the resource, which is what they do. They look at the basics like ‘Do we need more? ‘Yes’ so let’s drill some more, get the resource up, publicize it and go from there. But they don’t look at whether or not they actually have a product and how to sell that product and who to sell it to. One of the biggest gaps is marketing and that’s where they’re going to have a problem. That’s where they should employ some big graphite traders who specialize in this.”

Graphite Production

Graphite production is basically split between amorphous graphite (micro-crystalline) and flake graphite, with less than 1% coming from vein production—nature’s purest form of graphite. Moores said that about one-third of all graphite is used in refractory materials, which must be chemically and physically stable at high temperatures.

Graphite has tremendous heat-absorbing qualities, which make it ideal for lining bricks in the ultra-hot furnaces used to make steel. Anything molten steel touches needs to be lined with some form of refractory or the liquid metal will burn through it. Industrial Minerals estimates that between 380,000 and 430,000 t of graphite are used annually to make refractories.

Moores said graphite is the anode material of choice for battery makers and that about one-quarter of the world’s graphite is used in batteries. It is estimated that there is between 10% and 20% more graphite in a lithium-ion battery than there is lithium. Even the average smartphone battery uses 15 grams of graphite. The graphite used in these batteries is high-purity, crystal flake graphite, which is in short supply at the moment.

Perhaps the greatest potential use of graphite lies in electric cars. A Chevrolet Volt uses around 28 kg of graphite, whereas the 24kWh battery pack in a Nissan Leaf uses roughly 38 kg of graphite and 19 kg of lithium carbonate. The slender Tesla Roadster, meanwhile, uses more than 100 kg of graphite. With as many as 3 million electric vehicles expected to be on the road by 2017, the United States Geological Survey says that fuel cells have the potential to use as much graphite as all other uses combined.

Another potential demand driver is the Pebble Bed nuclear reactor. In April 2011, China started building a fourth generation 210-megawatt nuclear reactor using high-temperature, gas-cooled pebble-bed technology. Each Pebble Bed reactor would use about 3,000 t of graphite and China plans to boost its nuclear power capacity to 150 gigawatts by 2030. Its current capacity is less than 50 gigawatts.

Other uses include lubricants, brake linings and, of course, pencils.

Industrial Minerals says the top graphite flake and amorphous graphite producing country is China, which accounts for roughly 79% of global production. The other significant graphite-flake-producing countries are Brazil, India, Canada and, somewhat surprisingly, North Korea.

China has remained in the driver’s seat for graphite supply since the early 1990s, when it boosted graphite output to eliminate much of its competition. Almost overnight graphite prices fell by half and the companies developing graphite deposits as part of the last graphite boom were left holding the bag. Those without cash went out of business and the handful with cash shifted their focus to other commodities.

What to Expect from Here. . .

Berry expects China to continue to quietly tighten the reins on graphite supply through higher export taxes and by keeping more flake graphite inside its borders. That could boost prices some, but Berry believes other catalysts are required for a big price spike. “To really push graphite higher, you need to see a couple of different things,” Berry said. “You need to see more economic growth coming out of China and you need to see some sort of black swan event where China really tightens the reins and all of a sudden all this supply that the end-users thought was going to be there, isn’t there anymore.”

What About Consolidation?

“I think it’s a ways off,” Berry predicted. “A lot of these companies are still learning about what they have. If there’s any consolidation to be had, I think it would come from the end-users that want to be an entire supply chain and not have to worry about security of supply.” He added: “If you look at industrial production data in the U.S., in the Eurozone and in China, it seems to be slowing down. It’s not increasing and with graphite you’re dealing with an industrial mineral. So if you’ve got industrial demand that is slowing or stagnant, you need to be extremely cautious about where you invest in the junior graphite space.”

Want to read more exclusive Critical Metals Report articles like this? Sign up for our free e-newsletter, and you’ll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators and learn more about critical metals companies, visit our Critical Metals Report page.

DISCLOSURE:
1) Brian Sylvester of The Critical Metals Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Critical Metals Report: Northern Graphite Corp., Big North Graphite Corp., Energizer Resources Inc., Standard Graphite Corp, Lomiko Metals Inc. and Focus Metals Inc. Streetwise Reports does not accept stock in exchange for services.
3) Those interviewed within the article were not paid by Streetwise Reports for their participation.

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