Connecting the Dots: The Stock Market Hot Potato: Volatility, the VIX, and You!

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Connecting the Dots: The Stock Market Hot Potato: Volatility, the VIX, and You! By Tony Sagami   “When did Noah build the Ark, Gladys? Before the rain, before the rain.” —Nathan Muir (Robert Redford), in Spygame If you’ve ever walked a dog, you know about the zigzag path that dogs take down a sidewalk. After all, there are great odors to sniff on both sides of the sidewalk so your dog will veer far to the left, take a few deep sniffs before veering off to the right to see what olfactory surprises the other side holds. About the only thing that’s certain is that once your dog reaches the far end of his leash, it will swing back to the middle of the sidewalk before taking off for another trip to the extreme ends of the leash. Human psychology, when it comes to investing, isn’t so different. Investor sentiment … Continue reading

The Secret of Success in Mineral Exploration

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The Secret of Success in Mineral Exploration By Louis James, Chief Metals & Mining Investment Strategist As an investor, I want to bet on the jockeys who win the most races, not just the best-looking horses. So, while I’m no Tom Peters or Stephen Covey, I’ve made a study of success over the last decade. The critical question for a metals investor: what does it takes to be a serially successful mine-finder? Before I give you the answer, let me give you a little context on just how difficult this is. It’s not as simple as looking for a needle in a haystack; it’s more like looking for a needle in a vast field of steel haystacks, each one of which will give your metal detector false positives. And it’s very expensive to drill holes into them, which is the only way you can test for a needle’s hidden presence. … Continue reading

Outside the Box: US Dollar: American Phoenix

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Outside the Box: US Dollar: American Phoenix By John Mauldin    “Just a little patience, yeah…” – Guns N’ Roses Lastweek the FOMC essentially removed forward guidance and placed all options back on the table, and at the end of the day they’ve opened the door for further tightening. As Yellen recently explained in advance, the removal of the word patience from the Fed’s guidance amounts to fair warning to the rest of the world’s central banks: an interest rate hike is on the horizon. Govern your actions accordingly. (My personal guess, for those interested, is September, with the Fed proceeding exceedingly slowly and cautiously thereafter.) The bigger story here is the sustained strength of the US dollar, which has traded wildly in the FOMC’s wake. A correction to the one-way trading prior to the meeting was well overdue and could last some time, but then the dollar strength will … Continue reading

CNG:TSXV – Supports Catalytic Ozonation Study

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Cdn Mining supports catalytic ozonation study 2015-03-26 09:08 ET – News Release Mr. Ray Paquette reports CANADIAN MINING SIGNS LETTER OF SUPPORT FOR NSERC STRATEGIC PROJECT GRANT APPLICATION Canadian Mining Company Inc. has signed a letter of support for a Natural Sciences and Engineering Research Council of Canada strategic project grant application with Dr. Rajesh Seth of the department of civil and environmental engineering, Centre for Engineering Innovation, University of Windsor, Ontario. Dr. Seth is applying for work financing on a project entitled “Modified Natural Zeolite-Assisted Catalytic Ozonation for Removal of Organic Contaminants from Water.” The project will test the feasibility of using natural zeolite-based catalytic ozonation to enhance the cost-effectiveness of ozonation to deal with select challenging contaminants of concern in Canada, both from industrial and agricultural sources, as well as the urban environment. Ray Paquette, chief executive officer, stated, “This project is of great interest to the company … Continue reading

With Expertise and a Little Luck, East West Petroleum Reels in Profits Despite Oil Price Plunge

The Energy Report: When was East West Petroleum Corp. (EW:TSX.V) founded, and where do you operate?

David Sidoo: East West was formed in 2010 on the back of the award of four exploration blocks in Romania’s prolific Pannonian Basin. Following the award, we raised $30 million ($30M) to fund a work program and future business development. We then entered into joint ventures on these blocks with NIS (Naftna Industrija Srbije), the Serbian subsidiary of Gazprom. NIS is committed to funding Phase 1 exploration of €60 million (€60M) in exchange for 85%; we retain an interest of 15% carried through to commerciality.

In 2012, East West entered New Zealand’s Taranaki Basin with the award of three blocks held jointly with TAG Oil Ltd. Ten wells were drilled initially, and production and cash flow from New Zealand began in 2013.

TER: What was your experience before you started East West?

DS: I studied at the University of British Columbia (UBC) in Vancouver and played on its Thunderbirds football team. In 1982 we took home, for the first time, the Vanier Cup, the Canadian interuniversity championship. I then played professionally for six years in the Canadian Football League. After retiring from football in 1988, I entered the brokerage business and worked at Canaccord and Yorkton Securities for 11 years.

TER: What did you learn from football that is applicable to business?

DS: I learned that you can’t build companies and achieve success on your own. You’ve got to have a good team around you. That’s what we’ve assembled at East West. Most important, members of the team have to have strong technical knowledge. Next comes a good management squad that knows how to run a company, and has the expertise and connections to raise capital.

TER: What was your experience in oil before East West?

DS: More than a decade ago, I became involved in a company in the Pannonian Basin called Gasco Energy Inc. We secured acreage and raised over $150M. Gasco has some very good reserves and is doing well.

We then formed a company called American Oil & Gas Inc. in 2013. We worked in the prolific Bakken fields in North and South Dakota, and sold the company to Hess Corp. for $630 million ($630M) in 2010.

TER: What is your philosophy of building an oil company?

DS: Our model has been to enter highly prospective areas early to build a material position, and then find companies with operational capabilities that complement our technical expertise. Our goal is to complete successful partnerships and maximize value to shareholders.

As far as exploration goes, we’re not interested in moose pasture. We want decent acreage in proven areas with infrastructure.

TER: How does your management team give East West a competitive advantage?

DS: We have the experience and the technical expertise. Aside from my own track record, Dr. Marc Bustin, a director who’s our technical advisor, is a professor of petroleum and coal geology at UBC. He was awarded the Canadian Society of Petroleum Geologists’ Stanley Slipper Gold Medal in 2013. He is world-renowned and has examined source rocks all over the world. He can quickly evaluate assets when we look for new opportunities. We’re agile and nimble, and we can pull the trigger quickly.

TER: What are the advantages of working in Romania and New Zealand?

DS: Both have proven histories of oil production, which significantly derisks exploration. And both offer stable political environments with attractive fiscal terms. The netbacks in Romania and New Zealand are quite high, unlike many other places in the world. Working in these countries is quite similar to working in the United States or Canada.

TER: What are the advantages of the joint venture (JV) model?

DS: It allows explorers and producers like East West to diversify and hold a larger portfolio. JVs make our money go further. By partnering with professionals in the areas we operate, we benefit from their local expertise, while they gain access to our technical team’s track record and history of reviewing many different projects around the world. You can never get enough trained eyes to evaluate projects.

“Our goal is to complete successful partnerships and maximize value to shareholders.”

We have a substantial and successful history with this model. American Oil & Gas worked with Halliburton Co. This allowed us to monetize assets that were sold for $45M, which gave us the capital to develop our Bakken play.

TER: What do your partners in Romania and New Zealand bring to the table?

DS: In Romania, our partner NIS has extensive success operating in the Pannonian Basin. The company has been the leading oil producer for many decades in Serbia, which is just across the border from our southern two blocks.

In New Zealand, TAG Oil is one of the leading operators and most active drillers in the Taranaki Basin. The company has a well-earned reputation in New Zealand for great community relations. We had long-term relationships with senior members of their team, which greatly facilitated our deal there.

TER: How soon after you began exploration in New Zealand did you begin production?

DS: We were awarded three concessions in New Zealand in December 2012, and began drilling our first well, E1, in August 2013, nine months later. We achieved our first production by year-end 2013. This was our first JV well, and it is still flowing naturally today, with little decline to date. I’ll tell you something my wife always says I shouldn’t say—you need to be a bit lucky. Some guys have a lot of luck and do well in business, and some don’t.

We’re now producing about 330 barrels of oil equivalent per day (330 boe/d) at a cost of about $22 per boe, and that includes all royalties. With the Brent price at about $56 per barrel ($56/bbl), that makes our operations profitable, and allows us to fund the rest of this year’s capital expenditure (capex) from cash flow without using any of our $8.1M cash balance. Our rapid progress in New Zealand is a testament to TAG and to the country, which is very supportive of oil and gas development.

TER: How much of your production is oil, and how much is gas?

DS: Oil is 73%; 27% is gas. Right now we’re only selling the oil; we’re flaring the gas. But in about three months, a gas pipeline will be completed. That should reduce our cost per barrel to about $18.

TER: What do you anticipate East West’s year-end daily production to be?

DS: We have one commitment well to drill later in 2015. Production should remain fairly steady, but we hope to raise it to perhaps 400 boe/d.

TER: You announced the successful recompletion of your Cheal-E2 well in mid-March. How significant is that?

DS: When E2 was drilled initially, in 2013, it did not produce. So its recompletion demonstrates the technical abilities of both TAG and East West. It provides the JV with an additional 100 boe/d for relatively low cost, and greatly improves our bottom line.

TER: What’s the status of your Romanian operation?

DS: We are fully approved by the National Agency of Mineral Resources. Our JV has four blocks in Romania, and NIS has done seismic work to identify two drill locations on block number 7. NIS is permitting for one location as we speak, and we’re hoping to drill by the end of the year.

TER: You mentioned that East West is profitable, even with Brent at $56/bbl. How low would Brent have to fall before that profitability is threatened?

DS: Breakeven for our operations is $35/bbl. That includes opex, salaries and all expenses. Today, many petroleum companies are shutting in oil wells or not completing them. They’re waiting until oil rises to over $60/bbl, which is their breakeven cost. We’re safe and sound now, selling at a Brent crude price even as we benefit from the weakness of the New Zealand and Canadian dollars. But when the price does rise above $60/bbl, we can start taking risks again.

“When the market turns around, we are poised to respond quickly.”

We’ve had people approach us for financing, but this would create dilution, so we’re not interested. We’re making money in New Zealand and we’re carried in Romania, but the market isn’t giving us any credit for the latter. We are discussing some other locations at the E site in New Zealand, but right now we’re determined to focus on our bottom line and keep our general and administrative expenses low. When the market turns around—and this tends to happen fast in our space—we are poised to respond quickly.

TER: As you said, your cash balance is $8.1M. How much of a cash cushion would you like to maintain?

DS: I think a double-digit cushion never hurts. When you’ve got $0.10/share in cash in the bank, and you’re building reserves, you start to look quite attractive to the market.

TER: Despite your rapid advance to production and high margins, East West trades at only $0.15/share. What are you doing to persuade the market of the value of East West?

DS: We are continuing to spread the word that we’re a well-capitalized company, with profitable operations at current prices and meeting our financial obligations. It is our strong belief that when you build a good company, the stock price will follow.

We were at $0.50/share with no production; now we’re at $0.15/share with stable production. We’ll be doing $3–4M this year at current oil prices, and we’ll start selling our gas shortly. We have a strong shareholder base, and 15% of East West is owned by management. We are all shareholders here. I think there has never been a better time to buy this stock. We’re derisked in New Zealand, and our cards are on the table.

TER: Where do you see your company in three years’ time?

DS: We believe oil prices will likely stabilize in the next few years at $70–75/bbl. In three years, we would like to see production rise above 1,000 boe/d with no further dilution. We’d like to have $15–20M in the bank. We are already looking at increasing our acreage in New Zealand. Our operations in Romania should be well advanced by then. And then we’ll look at acquiring a couple of other companies, bringing in partners and getting carried.

Our shareholders have been really patient in Romania, which is great because we see real upside potential there. This is where we expect to get a big win in terms of developing toward that 1,000 boe/d.

TER: David, thank you for your time and your insights.

David Sidoo is president, CEO and a director of East West Petroleum Corp. Mr. Sidoo is a successful businessman based in Vancouver, where he oversees a successful private investment banking and financial management firm. Upon graduating from the University of British Columbia in 1982, where he held a four-year football scholarship with the UBC Thunderbirds, he was drafted to play professional football with the Canadian Football League. Mr. Sidoo retired from football in 1988 and was introduced to the brokerage business. From there he became a broker with Yorkton Securities, where he quickly became one of the company’s top revenue generators. He went on to become partner and advisory board member at Yorkton Securities, consistently generating commissions that ranked in the top five nationally. In 1999, he left Yorkton to pursue private investment banking. He was founding shareholder of American Oil & Gas Inc. (AEZ:NYSE), which was sold to Hess Corporation in 2010 for over US$630M in an all-stock transaction. In 2008, The Vancouver Sun voted Mr. Sidoo one of the top 100 South Asians making a difference in British Columbia. In 2014, Mr. Sidoo was appointed by the British Columbia government to the board of governors for the University of British Columbia.

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DISCLOSURE:
1) Kevin Michael Grace conducted this interview for Streetwise Reports LLC, publisher of The Gold Report, The Energy Report, The Life Sciences Report and The Mining Report, and provides services to Streetwise Reports as an independent contractor. He owns, or his family owns, shares of the following companies mentioned in this interview: None.
2) East West Petroleum Corp. paid Streetwise Reports to conduct, produce and distribute the interview.
3) David Sidoo had final approval of the content and is wholly responsible for the validity of the statements. Opinions expressed are the opinions of David Sidoo and not of Streetwise Reports or its officers.
4) Interviews are edited for clarity. Streetwise Reports does not make editorial comments or change experts’ statements without their consent.
5) The interview does not constitute investment advice. Each reader is encouraged to consult with his or her individual financial professional and any action a reader takes as a result of information presented here is his or her own responsibility. By opening this page, each reader accepts and agrees to Streetwise Reports’ terms of use and full legal disclaimer.
6) From time to time, Streetwise Reports LLC and its directors, officers, employees or members of their families, as well as persons interviewed for articles and interviews on the site, may have a long or short position in securities mentioned. Directors, officers, employees or members of their families are prohibited from making purchases and/or sales of those securities in the open market or otherwise during the up-to-four-week interval from the time of the interview until after it publishes.

( Companies Mentioned: EW:TSX.V,
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Five Companies in Australia’s Cooper Basin Worth Watching: Canaccord Genuity’s Johan Hedstrom

The Energy Report: Johan, please give us an overview of the shape of the oil and gas industry in Australia.

Johan Hedstrom: The Australian oil and gas industry is dominated by a series of big investments in new liquefied natural gas (LNG) projects. Our industry is building seven new LNG projects, costing $240 billion ($240B). The biggest one is Chevron Corp.’s (CVX:NYSE) Gorgon project, which is projected to cost $55B. The BG Group Plc’s (BRGYY:OTCQX; BG:LSE) Gladstone project in Queensland is now selling LNG. A couple more LNG projects will go online this year, a couple more next year, and the rest of the projects will go live in 2017. This gargantuan investment sector is dominating the Australian energy industry and—it must be said—driving up costs in the field as energy services are in great demand.

TER: How is the Australian energy sector affected by global oversupply and falling prices?

“The Australian oil and gas industry is dominated by a series of big investments in new LNG projects.”

JH: The high level of LNG activity and the competition for energy services in Australia—plus a high Aussie dollar—means that Australia is simply an expensive place to operate. If West Texas Intermediate stays at about $50 per barrel ($50/bbl), it will be difficult for companies to generate the elevated returns they had projected at high prices. They can still make money with Brent at about $60/bbl, but not as much as they had hoped. On the other hand, the industry is irrevocably committed to bringing the new LNG projects onstream, and the investment is huge. But wherever the firms can save on expenditures, such as exploration, they do cut back.

TER: Major firms like Chevron are obviously in for the long term. But do low prices thwart the timely development of these mammoth LNG projects?

JH: No. Each of the projects will have sold a majority of their planned gas volumes at prices set for 15- to 20-year contracts. When firms commit to multibillion-dollar investments, they lock in terms. They were probably hoping for the oil price to stay high and generate superprofits. That is not happening, and who knows where oil prices will go during the next 20 years. LNG prices are linked to the price of oil. The pressure on the oil price means that returns and paybacks are going to be lower and slower than originally anticipated.

TER: Is there a danger of the cost of production exceeding the possible profit margin?

JH: Yes. Let me explain: The cash cost of production in the field is low, and that will generate cash flow. But taking into account the very high capital cost of developing these LNG projects, leading to high depreciation and amortization charges, if the oil price stays at $50–60/bbl, the projects will probably not cover costs of production in the short term.

TER: What does the cutback on exploration mean for junior firms in Australia?

JH: There are about 45 onshore rigs in Australia. Half of them are drilling coalbed methane (CBM) gas wells, and they should be OK. Three of the new LNG projects will source CBM gas rather than conventional gas. The industry will require thousands of CBM wells to keep the LNG plants in Queensland going for a number of years. But, at the same time, there is a cutback in the number of conventional oil and gas drilling rigs due to falling oil prices.

TER: Anything brewing with shale plays?

JH: The Cooper Basin in central Australia is the most active area for oil and gas drilling. Quite a few wells drilled in the deeper parts of the basin were looking for shale gas or, more correctly, tight gas. The shale programs are now ending or being deferred, partly because of the oil price collapse, which has tightened cash flows for the companies. Also, the shale and tight gas results are not encouraging. The Cooper Basin is not going to be the next Eagle Ford.

TER: Is the Australian energy market aimed at producing for domestic consumption or for export?

JH: The gas market has been oriented to domestic sales in the past. Now, with the LNG projects, it is more export-oriented. Not all of the LNG projects enjoy full reserve coverage for 20 years; they are keen to buy up any spare gas. Long-term contracts are expiring, and the recalibration to export is driving up domestic gas prices. A year ago, the domestic gas price was $4/gigajoule. New contracts in the domestic market are between $6–8/gigajoule. That is a 50–100% increase in domestic gas prices.

TER: What countries are buying Australian gas?

“If WTI stays at about $50/bbl, it will be difficult for companies to generate the elevated returns they had projected.”

JH: Japan is the world’s largest buyer of LNG, and is Australia’s biggest customer still, but China is signing more of the new contracts. The global gas market is broadening: New gas buyers include South Korea, Thailand, Singapore and India. The demand is primarily for power generation, but there is also industrial and residential utility demand. China and other Asian countries are trying to increase the gas proportion in their energy mixes because they have been heavily reliant on coal, oil or nuclear energy. Each of these energy sources has environmental issues. Gas is not totally clean, but it is cleaner than coal, and it is certainly cheaper than oil.

TER: Is Australia competing with North American exporters?

JH: There’s no direct competition with North America, but LNG buyers are effectively using the expansion of North American gas production to put pressure on price negotiations with Australian suppliers. Because of the lower oil prices, and the high cost structure in Australia, the window of opportunity to finance yet another LNG project has closed, in my view. However, we did quite well to launch the seven projects that are on the boards.

TER: Is now a good time to invest in the junior energy sector in Australia?

JH: In my opinion, this year is a good time to invest in Australian oil and gas stocks, including some juniors. The macroeconomic environment will remain uncertain for the near term, but some firms are better positioned than others—and they are worth buying today.

TER: Who do you favor in the Cooper Basin?

JH: Drillsearch Energy Ltd. (DLS:ASX) has a $488 million ($488M) market cap. It is a strong oil producer in the Cooper Basin with low operating costs. Its cash costs are about $25/bbl. After adding on depreciation and amortization charges at $20/bbl, Drillsearch is making money at the current price of $55–60/bbl for Tapis crude, which is used for Cooper Basin oil pricing.

“The Cooper Basin in central Australia is the most active area for oil and gas drilling.”

Drillsearch has a solid drilling program with successful reserve extensions on the western flank of the Cooper Basin. It also has a small gas business, and has drilled a series of new conventional gas discoveries with a high content of natural gas liquids—condensate, propane and butane. With rising gas prices, and fixed contracts to $8/gigajoule for gas and liquids, Drillsearch is very attractive. The company is financially healthy, and it is well placed to grow its gas business. The oil side will depend on ongoing drilling success. And Drillsearch’s balance sheet is in good shape, with zero net debt. It has $150M of debt through a convertible note listed in Singapore, but it also has $150M in cash and a positive cash flow.

TER: How do companies like Drillsearch relate to the large LNG development projects? Is Drillsearch an acquisition target?

JH: There is talk about mergers and acquisitions activity in the Cooper Basin. Drillsearch is not directly linked to any of the big LNG projects, but it has a joint venture (JV) with BG Group, looking for unconventional gas in the deeper part of the basin. BG has the first up-and-running LNG project; it relies mostly on CBM to supply the plant but has taken a position in Cooper Basin shale gas with Drillsearch. The JV has drilled four wells, but the results are not exciting and the drilling costs are high. Interestingly, BG is also Drillsearch’s largest owner, with an 8% shareholding. If BG needs more gas resources, it could move to acquire Drillsearch, although I do not think that is very likely at the moment. Maybe down the road a bit.

TER: Do you have a target price on Drillsearch?

JH: Our price target on Drillsearch is AU$1.18/share; it’s currently trading at about AU$1/share.

TER: Who else is active in the Australian oil and gas patch?

JH: Beach Energy Ltd. (BPT:ASX) and Senex Energy Ltd. (SXY:ASX) are also in the Cooper Basin. Beach is twice the size of Drillsearch, and Senex is of a similar size but is a smaller producer. We don’t like these two companies as much as we like Drillsearch: They have less financial flexibility and a less attractive growth outlook. They also look more expensive on valuation multiples. These three companies are the Cooper Basin small caps, in effect.

Origin Energy Ltd. (ORG:ASX) is also active in the Cooper Basin. Origin is a diversified gas utility, as well as an oil and gas producer, and it is vertically integrated.

“China and other Asian countries are trying to increase the gas proportion in their energy mixes.”

The biggest operator in the Cooper Basin is Santos Ltd. (STO:ASX). Its share price halved last year because of the drop in the oil price and cost overruns on its LNG project in Queensland. Santos’ balance sheet is a bit stretched due to the lower oil price and lower cash flows. Total S.A. (TOT:NYSE) and Petronas (PETRONAS) of Malaysia are JV partners with Santos in the LNG project, but they are not partners in the Cooper Basin, which is the gas supply element. Santos could be a takeover target, as could Beach. Santos’ LNG project will go live in H2/15, which is a big deal.

TER: Who would take over Australian companies of this size? Domestic firms? Overseas corporations?

JH: The Chinese are logical acquirers of these types of companies.

TER: Is China moving away from coal?

JH: China is trying to reduce its reliance on coal. Coal is a very big part of the Chinese economy and power supply, but pollution is a massive issue. China’s latest five-year plan calls for gas to power a larger section of the country’s energy grid. Worldwide, gas is typically 20–22% of the primary energy supply. In China, it is only 5%. The government wants to bring that ratio up to 10% by 2020—doubling the gas variable in the energy equation during the next five years. It will achieve that goal by increasing LNG imports from Australia and pipeline imports from Russia and Turkmenistan. Beijing is also encouraging development of the domestic gas supply.

TER: Are Australian explorers active in China?

JH: An Australian company called Sino Gas & Energy Holdings Ltd. (SEH:ASX) is in a tight gas play in China. It went there looking for CBM. It found CBM, but when it evaluated its leases, Sino Gas decided that the gas sands were better suited for tight gas production and commercial delivery. Sino Gas has drilled close to 100 wells in a JV with a Hong Kong-listed company called MIE Holdings Corp. (01555:SEHK). The JV is booking significant reserves of more than a trillion cubic feet of gas on a gross basis. It has neighboring gas fields with partners like Royal Dutch Shell Plc (RDS.A:NYSE; RDS.B:NYSE). Sino Gas’s pilot production is generating very attractive gas prices up to $9.50 per million British thermal units ($9.50/MMBtu). Sino just announced a second gas sales agreement, confirming a similar price level. This is significant because Chinese government has recently declared a 5% reduction in gas prices due to the oil price fall. But $9+/MMBtu for gas is very attractive. Sino Gas has stated that it can produce the gas for an all-in cost of $1.50/MMBtu, so there is a big margin to exploit.

The next two developmental stages for Sino Gas are vital. It must get a Chinese-approved reserves report, which should happen later this year. And it needs governmental approval for an overall development plan (ODP). That should happen in 2016. Then, Sino Gas will have to fund the development of hundreds of wells. Once the ODP is granted, Chinese companies will be entitled to become partners-in-operator with Sino Gas. Sino Gas and MIE will be diluted when the ODP is granted.

TER: Does MIE bring a capital commitment, or mostly political influence?

JH: MIE has useful political ties to China. Its capital contribution supports the evaluation and pilot production testing. It is not a significant amount of money. The project is in the range of $50–100M. When the ODP is given, there are two different licensees. China National Petroleum Corp. (CNPC), which is a large, government-owned Chinese corporation, will take one of the Sino Gas projects. The other project will go to China United Coalbed Methane Corp. Ltd. (CUCBM), which was the Chinese government’s designated CBM company. Even though it’s not a CBM project anymore, CUCBM has retained certain rights. The two Chinese companies will take 51% of the overall JV in return for providing a significant part of the funding.

TER: What kind of timeline are we looking at for that?

JH: We think that the ODP will be given in 2017 or late 2016, and that development will start in 2017. Production should ramp up in 2018 and 2019.

TER: Is now a good time to invest in Sino Gas?

JH: Yes. The pilot production is ramping up at very attractive gas prices. The share price has been underperforming all other oil and gas companies, despite its operations being largely unaffected by the oil price fall, and the stock is positioned for exciting growth over the next two years.

TER: Do you have a target price on Sino?

JH: We have a price target on Sino Gas of AU$0.48/share, and it’s trading at AU$ 0.19/share.

TER: Do you have any other exploration and production firms that you like in the Australian complex?

JH: There is an Aussie company called Sundance Energy Australia Ltd. (SEA:ASX), which is active in the Eagle Ford shale of the U.S. We have a couple of Australian-listed companies that focus on the U.S. Sundance looks very cheap against its Australian peer group, and also when compared against the U.S. Eagle Ford shale group. Sundance has some of the better properties in the Eagle Ford, with 33,000 acres. It is doing about 10 thousand barrels per day. It has a good balance sheet. Unlike many of the U.S. oil and gas companies that have borrowed too much money, Sundance has a debt:EBITDA (earnings before interest, taxes, depreciation and amortization) ratio of 1.1. It is undergeared compared to just about every other U.S. shale company, and it is financially healthy. Its costs are $15/bbl to produce oil. It is building up its drilling inventory, with 550 drilling locations yet to drill. Sundance will be increasingly attractive to the majors.

TER: Do you have a target price on Sundance?

JH: The target price on Sundance Energy is AU$1.31/share, and it is trading at AU$0.51/share.

TER: Thank you for your time, Johan.

Canaccord Genuity’s Johan Hedstrom is an experienced energy analyst, having started his career as a geologist. Since 1984 he has worked in funds management, stockbroking and independent research. After a period as head of research at two stock market research firms, he returned his focus to the research of energy stocks in 2006, and joined Canaccord Genuity in 2013.

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DISCLOSURE:
1) Peter Byrne conducted this interview for Streetwise Reports LLC, publisher of The Gold Report, The Energy Report, The Life Sciences Report and The Mining Report, and provides services to Streetwise Reports as an independent contractor. He 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 Streetwise Reports: None. The companies mentioned in this interview were not involved in any aspect of the interview preparation or post-interview editing so the expert could speak independently about the sector. Streetwise Reports does not accept stock in exchange for its services.
3) Johan Hedstrom: I own, or my family owns, shares of the following companies mentioned in this interview: None. I personally am, or my family is, paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I determined and had final say over which companies would be included in the interview based on my research, understanding of the sector and interview theme. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
4) Interviews are edited for clarity. Streetwise Reports does not make editorial comments or change experts’ statements without their consent.
5) The interview does not constitute investment advice. Each reader is encouraged to consult with his or her individual financial professional and any action a reader takes as a result of information presented here is his or her own responsibility. By opening this page, each reader accepts and agrees to Streetwise Reports’ terms of use and full legal disclaimer.
6) From time to time, Streetwise Reports LLC and its directors, officers, employees or members of their families, as well as persons interviewed for articles and interviews on the site, may have a long or short position in securities mentioned. Directors, officers, employees or members of their families are prohibited from making purchases and/or sales of those securities in the open market or otherwise during the up-to-four-week interval from the time of the interview until after it publishes.

( Companies Mentioned: DLS:ASX,
(01555:SEHK),
SEH:ASX,

)

Ralph Aldis: How the Five Principles of Capital Allocation Can Mean Gold Mining Success

S&P 500 chart

The Gold Report: The price of gold is flirting with a five-year low. Do you attribute this solely to the strength of the U.S. dollar, or are there other factors at work?

Ralph Aldis: There are other factors. Most important is the strength of the equity markets. Looking at a six-year window, we have seen, for the third time in the last hundred years, the highest returns for such a period. This happened before in 1929 and 1999. These phenomenal returns have been fueled not by fundamentals but rather by the U.S. Federal Reserve, which is trying to jumpstart the economy.

All this has taken people’s eyes off gold, but it won’t go on forever.

TGR: The bear market in gold equities is now four years old. This means lower gold production and less exploration. Gold production from South Africa has collapsed. Shouldn’t lower gold production result in a higher gold price?

RA: Yes, but it’s not always linear. The amount of gold mined annually is relatively small compared to total gold supply. That is one of the reasons some people argue that the mines don’t matter that much. But I think on the margin they do.

“One company doing the right things is Klondex Mines Ltd.

South African gold production has fallen. And not that long ago, the central banks were selling 400–500 tons per year of gold to the market. Now, they’re buying 400–500 tons. China is the world’s largest gold producer, but it’s not exporting. We can see what’s happening and be invested for it, but we don’t know when lower supply will lead to higher prices.

TGR: How do you see the mining industry adjusting to lower gold prices?

RA: I look at the income statements from all the mining companies and calculate their break-even point. Right now, it is about $1,149 per ounce ($1,149/oz). The forecasted average 2015 gold price remains about $1,200/oz. If the gold price continues to fall, companies will adjust. Some projects won’t be built, but that is good because those are marginal projects.

About 40 CEOs in the mining industry have lost their jobs in the past couple of years. The new generation of mining CEOs is focused more on profit than growth. They know that even if the gold price falls more, the suppliers to them must drop their prices. If the gold price goes $100/oz lower, the smart companies will survive. Meanwhile, gold miners now benefit from lower energy prices, while the stronger U.S. dollar has been very positive for Canadian and Australian miners.

TGR: Why do you believe gold stocks can still deliver favorable returns?

RA: Because of the mindset of some of these new CEOs. One company doing the right things is Klondex Mines Ltd. (KDX:TSX; KLNDF:OTCBB). It was up 29% in 2013, while the Market Vectors Junior Gold Miners ETF (GDXJ:NYSE.Arca) was down 61%. In 2014, Klondex was up 21%, while the Market Vectors Junior Gold Miners ETF was down 23%.

Mandalay Resources Corp. is one of our top five holdings.

Investors will need to buy very selectively, and they will need to buy those companies that are not growing ounces at thinner margins. Companies that know how to, if necessary, shrink production in order to get acceptable margins.

TGR: Could you explain the “Five Principles of Capital Allocation” and how they pertain to mining, given that mining companies typically have no revenues for years after their founding?

RA: These five principles are the work of a Credit Suisse writer, Michael Mauboussin. They apply to some companies in the exploration and development phase but obviously more so to producers.

The first principle is “Zero-Based Capital Allocation.” This means, for instance, that you don’t give your exploration department $20 million ($20M) this year solely because they got $20M last year. Companies need a strategy to determine the proper amount of capital spending.

Pretium Resources Inc. probably leads the pack in the near-term production category right now.

The second principle is “Fund Strategies, Not Projects.” In other words, capital allocation is not about assessing and approving projects; it is about assessing and approving strategies and then determining the projects that support those strategies. It is a common mistake for explorers to continue to push a project forward—particularly if it is its only project—even though it lacks the potential for great returns.

Randgold Resources Ltd. (GOLD:NASDAQ; RRS:LSE) is a good example of the proper approach. When it evaluates a project, it’s looking for grade sufficiently high that it can produce a good margin at a $1,000 pit shell or even an $800 pit shell. Restricting your return calculation to the pit shell is more conservative, as you are only including those ounces contained within the mine’s engineering plan.

TGR: Don’t companies with only one project face a particular problem? Given that the market demands constant news, if a company does an internal evaluation that suggests that its sole project is marginal and then reorganizes to seek new projects, won’t the disappearance of news about the original project lead to the market concluding that the company has essentially closed up shop and then valuing it to zero?

RA: I agree. Look at Allied Nevada Gold Corp.’s (ANV:TSX; ANV:NYSE.MKT) Hycroft mine. It was premised on a higher gold price, but there were probably things Allied Nevada could have done to maximize wealth as opposed to merely moving forward. It might have closed down Hycroft sooner and perhaps salvaged some value as opposed to being forced into bankruptcy.

TGR: What is the third principle?

RA: “No Capital Rationing.” Typically, miners believe that capital is scarce but free. They believe that profits are free money, or if they’re raising equity, they sometimes don’t seem to care enough about dilution. Properly speaking, capital is plentiful but expensive. Profits need to be spent in a manner that results in future profitability. And equity financing is only plentiful if you have a good project.

Rye Patch Gold Corp. being taken out by Coeur should be a slam dunk.

No. 4 is “Zero Tolerance for Bad Growth.” In other words, don’t throw good money after bad. Barrick Gold Corp. (ABX:TSX; ABX:NYSE) fell into that trap with its Pascua-Lama project in Argentina. Long before its price tag reached $8.5 billion ($8.5B), the company should have thought hard about whether it would ever generate good returns. Mining companies should always seek to upgrade their portfolios.

TGR: And what’s the final principle?

RA: No. 5 is “Know the Value of Assets and Be Ready to Take Action to Create Value.” So many people in the mining industry don’t know the value of their assets. We value companies based on their resource statements, and we get a very high correlation to where these stocks trade. But we constantly see companies decide to spend, for example, $1.8B on a project that the market values at only $800M. It makes no sense to spend that much because similar projects could be acquired for less capital.

To sum up, the proper use of capital allocation is to maximize long-term value per share.

TGR: Besides understanding capital allocation, what else do you look for in management?

“One of our favorite silver producers is Tahoe Resources Inc.

RA: A significant ownership stake. You get a much higher standard of care when you’re an owner instead of a mere manager. Investors need to look at a company’s general and administrative expenses, whether it is in production or not. If those expenses are too high, this tells you that the managers’ interests are not aligned with the shareholders’ interests.

TGR: Let’s talk about specifics. Which are your favorite Canadian gold producers?

RA: Those that are focusing on profit. If they have debt, they pay it down; they maximize their returns. Kirkland Lake Gold Inc. (KGI:TSX) is one example. CEO George Ogilvie has really done a great job in turning that company around.

Another example is Claude Resources Inc. (CRJ:TSX). Its CEO is Brian Skanderbeg. Claude has been around for a long time, but its new management understood that it had to change its mining method, which has made a big difference.

Another company with new management doing the right things is Richmont Mines Inc. (RIC:NYSE.MKT; RIC:TSX). Recently, Renaud Adams joined Richmont as president and CEO, and he is highly respected on the street. In addition, Renaud is a board member of Klondex Mines where he has helped oversee its success. With the higher grades Richmont is encountering at Island Gold Deep, I believe the company has a much more robust asset to work with now.

TGR: Kirkland Lake announced March 11 year-to-date free cash flow generation of $22M. Were you impressed by that?

RA: Yes, I was. Lake Shore Gold Corp. (LSG:TSX) is another company that really seems to have figured it out. It repaid $45M in debt in 2014 and now has $60M in cash and bullion.

TGR: Can you comment on any major Canadian gold producers?

RA: Goldcorp Inc.’s (G:TSX; GG:NYSE) bid for Osisko Mining Corp. ran the risk of buying a great company at the wrong price, so I’m glad that CEO Chuck Jeannes walked away. Since it announced its takeover attempt of Osisko, Goldcorp has sold its Wharf mine in South Dakota to Coeur Mining Inc. (CDM:TSX; CDE:NYSE) and its Marigold mine in Nevada to Silver Standard Resources Inc. (SSO:TSX; SSRI:NASDAQ).

TGR: What’s your opinion of Goldcorp after these deals?

RA: Goldcorp has done a really good job of capital allocation. It looks at the cash that it’s generating, and it looks at how to maximize the assets on its balance sheet. It created Silver Wheaton Corp. (SLW:TSX; SLW:NYSE) and Tahoe Resources Inc. (TAHO:NYSE; THO:TSX) out of existing assets. It helped create Primero Mining Corp. (P:TSX; PPP:NYSE). So I give it kudos. It is a little bit undervalued on our models but not terribly.

TGR: Can Barrick rescue itself?

RA: The company is talking about returning to the old Barrick model, but I don’t know if it can do that. It certainly faces a lot of challenges.

TGR: What’s your favorite junior gold producer in the U.S.?

RA: I’ve already mentioned Klondex in Nevada. It is my favorite junior producer anywhere. Considering what it has achieved and what it is likely to achieve, I think it probably offers at least a double of its present share price. Some people might say it has a short-life resource statement, but the recent discoveries at Fire Creek are not yet in the resource statement. And the free cash flow it generates will pay for its exploration program at Midas. I expect more discoveries from Klondex and a bigger resource statement. Its very robust ore body will allow it to produce gold at even lower prices, should the market demand that. I talk to its management team, and they understand capital allocation.

TGR: What’s your favorite gold producer elsewhere in the world?

RA: I like Mandalay Resources Corp. (MND:TSX). Its management is very experienced in rescuing assets that have been mismanaged. Mandalay has turned around the Cerro Bayo silver-gold mine in Chile and the Costerfield gold-antimony mine in Australia. Last year, it bought the Björkdal gold mine in Sweden from Elgin Mining, and I think Mandalay will turn that around too.

Management owns a lot of stock. Mandalay pays a healthy dividend: 5.4%. The market has not yet completely woken up yet to this stock. We still think it’s easily a 100% gain. It’s one of our top five holdings.

TGR: You mentioned earlier that you admire Randgold.

RA: CEO Mark Bristow, as ornery as he can be, deserves all the respect in the world. We download all the data, taking the quarterly net income or net operating profit after tax provisions (NOPAT), multiply that by four and divide it by the investment capital base to get a quarterly return on invested capital. We did that with the Market Vectors Gold Miners ETF stocks, and Randgold came in with a 10.32% median return on invested capital. That’s for 8+ years. We also measured the volatility of these returns over time, and Randgold’s was only 6.4%.

Over the same time period, Barrick had a median return on investment capital of 7.09% with a quarterly volatility of 24.4%. So Randgold gets about twice the returns with half the volatility. That’s management skill for you.

TGR: What are your favorite silver producers?

RA: There are two that really stand out to us based largely on management skill and management ownership of stock. The first is Tahoe Resources. Kevin McArthur is the CEO. It recently bought Rio Alto Mining Ltd. (RIO:TSX; RIOM:NYSE; RIO:BVL), which has two run-of-mine heap-leach mines in Peru. One is in production. Alex Black will be the new CEO of the new company. He put Rio Alto in production for very little capital and achieved tremendous returns for shareholders.

The combination of McArthur and Black results in a team that really understands the value of assets and has the ability to deliver. We like high grade, but adding those heap-leach mines gives Tahoe more flexibility. That’s one of the things we look for in companies.

TGR: And what’s the second?

RA: Fortuna Silver Mines Inc. (FSM:NYSE; FVI:TSX; FVI:BVL; F4S:FSE). The Ganoza brothers have done a great job, especially with the San Jose mine in Mexico and the discovery Fortuna has made there. This is a management team that understands capital markets.

TGR: What are your favorite near-term production stories?

RA: The one with the biggest potential is Pretium Resources Inc.’s (PVG:TSX; PVG:NYSE) Brucejack project in British Columbia. If its resource matches its published results, this is one of the best discoveries we’ve seen in the last decade. Its initial bulk sampling delivered 10% more ounces than expected. It is now drilling to confirm that the ore body is pretty well mathematically modeled. We anticipate substantial value correction based on our models. Pretium probably leads the pack in that category right now.

In Northern Ireland, Dalradian Resources Inc. (DNA:TSX) and CEO Patrick Anderson have a very good, well understood, high-grade gold project at Curraghinalt. Patrick also has a successful track record in selling Aurelian Resources, which was one of the best gold discoveries in the prior decade, to Kinross Gold Corp. (K:TSX; KGC:NYSE) in 2008. It is important to us that management understands capital markets.

We also like Rye Patch Gold Corp. (RPM:TSX.V; RPMGF:OTCQX) in Nevada. CEO Bill Howald staked the unpaid mineral rights at Coeur Mining’s Rochester mine. As a result, Rye Patch got about a $21M settlement in the form of a royalty on Rochester. Rye Patch’s Lincoln Hill deposit is within kilometers of Rochester. Howald has about a $26M budget to bring that into production, but I expect that after he does all the technical work and gets his permitting, Coeur will take it out and thereby extend Rochester’s mine life. Because Howald has funded Rye Patch with that royalty, and Lincoln Hill is such a simple, cheap operation, he doesn’t need to come to the market and dilute shareholders, so Coeur taking it out should be a slam dunk. In addition, Rye Patch has two other targets quite close to Lincoln Hill.

TGR: What about a gold project in South Carolina?

RA: Romarco Minerals Inc.’s (R:TSX) Haile project is fully funded. What was interesting about that company’s last financing is that I think that a major gold mining company may have participated in the placement, which speaks to the company as a potential takeout target in the near term. Haile is completely derisked, and so for a bigger producer with production drop-offs or operations in less-safe jurisdictions, Romarco makes a lot of sense.

Haile has great potential to grow over time. And management was smart not to supersize the project. This goes against the history of the 20 years, where investment bankers see a net asset value (NAV) model with cash flows extending into years 10–20. They believe these cash flows aren’t worth anything, and so the project size is doubled to move the cash flows forward and maximize NAV. That’s the worst thing you can do, and Romarco hasn’t done it.

TGR: What’s your favorite royalty company?

RA: Osisko Gold Royalties Ltd. (OR:TSX) probably has the safest royalties. It has a lot of room to grow but not so much as to draw the attention of Franco-Nevada Corp. (FNV:TSX; FNV:NYSE), Royal Gold Inc. (RGL:TSX; RGLD:NASDAQ) or Silver Wheaton. Osisko’s royalties might be too small for the big players, but royalties such as the 5% on Malartic and the 2.2–3.5% on Éléonore are tremendously valuable to Osisko. These Canadian mines will continue to produce for a long time.

TGR: Do you approve of its takeover of Virginia Mines Inc.?

RA: Yes. CEO Sean Roosen is a marketing genius, and this takeover complements the Canada-centric powerhouse he has put together. The company owns a significant stake in Falco Resources Ltd. (FPC:TSX.V). It has royalties on a portfolio of projects Agnico Eagle Mines Ltd. (AEM:TSX; AEM:NYSE) and Yamana Gold Inc. (YRI:TSX; AUY:NYSE; YAU:LSE) control after their takeover of Osisko Mining.

Plus there is a whole suite of Canadian assets it would make a lot of sense for it to get involved with. Maybe it does something with Integra Gold Corp. (ICG:TSX.V; ICGQF:OTCQX). One of the advantages Osisko Gold Royalties has is that its assets are not dependent on other commodities. Franco-Nevada has oil exposure, and maybe oil prices don’t go up very soon. Royal Gold has base metal exposure in some of its assets, and if prices of those were to drop tremendously, some of its assets could be shuttered. Osisko doesn’t have those worries.

TGR: What’s your favorite junior gold explorer?

RA: The one that really stands out to us is Orex Minerals Inc. (REX:TSX.V). It’s not well known now, but everybody would know the deal that its management was last involved in, the sale of Orko Silver Corp. First Majestic Silver Corp. (FR:TSX; AG:NYSE; FMV:FSE) tried to buy Orko but was outbid by Coeur. Now management has returned with a new company with four assets.

Orex has just signed a joint venture (JV) on its Barsele project in Sweden with Agnico Eagle. It took a year to negotiate. At the time the deal was announced, Orex had a $30M market cap. Agnico gave it $10M and will spend a further $7M into exploration. As you know, Agnico already has assets in that area, and if Barsele meets the test, Agnico will probably do something serious with it.

Orex also has a JV with Fresnillo Plc (FRES:LSE) on one of its two Mexican properties. Fresnillo late last year was moving more rigs on that, so I think it liked what it saw. Orex has an asset in Canada that it will probably be able to JV. This company has great geologists, and its management knows how to make deals.

TGR: Realistically, how many gold producers are prudent investments?

RA: Of the 80 or so producers that Western investors can buy into, there are about 20 that get it and have the flexibility to be able to adjust. Not so much the seniors. It’s the smaller, midsized companies that have a better handle on their operations.

TGR: Ralph, thank you for your time and your insights.

Ralph Aldis, CFA, rejoined U.S. Global Investors as senior mining analyst in November 2001. He is responsible for analyzing gold and precious metals stocks for the World Precious Minerals Fund (UNWPX) and the Gold and Precious Metals Fund (USERX). Aldis also works with the portfolio management team of the Global Resources Fund (PSPFX) to provide tactical analyses of base metal, paper, chemical, steel and non-ferrous industries. Previously, Aldis worked for Eisner Securities, where he was an investment analyst for its high net worth group and oversaw its mutual fund operations. Before joining Eisner Securities, Aldis worked for 10 years as director of research for U.S. Global Investors, where he applied quantitative skills toward stocks, portfolio tilting, cash optimization and performance attribution analysis. Aldis received a master’s degree in energy and mineral resources from the University of Texas at Austin in 1988 and a Bachelor of Science in Geology, cum laude, in 1981, from Stephen F. Austin University. Aldis is a member of the CFA Society of San Antonio.

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DISCLOSURE:
1) Kevin Michael Grace conducted this interview for Streetwise Reports LLC, publisher of The Gold Report, The Energy Report, The Life Sciences Report and The Mining Report, and provides services to Streetwise Reports as an independent contractor. He owns, or his family owns, shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of Streetwise Reports: Klondex Mines Ltd., Richmont Mines Inc., Tahoe Resources Inc., Silver Wheaton Corp., Primero Mining Corp., Mandalay Resources Corp., Pretium Resources Inc., Rye Patch Gold Corp. and Integra Gold Corp. Goldcorp Inc. and Franco-Nevada Corp. are not affiliated with Streetwise Reports. The companies mentioned in this interview were not involved in any aspect of the interview preparation or post-interview editing so the expert could speak independently about the sector. Streetwise Reports does not accept stock in exchange for its services.
3) Ralph Aldis: I own, or my family owns, shares of the following companies mentioned in this interview: None. I personally am, or my family is, paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: None. Funds operated by U.S. Global Investors hold the following companies mentioned: Agnico Eagle Mines Ltd., Claude Resources Inc., Dalradian Resources Inc., Falco Resources Ltd., First Majestic Silver Corp., Fortuna Silver Mines Inc., Franco-Nevada Corp., Goldcorp Inc., Integra Gold Corp., Kirkland Lake Gold Inc., Klondex Mines Ltd., Mandalay Resources Corp., Orex Minerals Inc., Osisko Gold Royalties Ltd., Pretium Resources Inc., Randgold Resources Ltd., Richmont Mines Inc., Romarco Minerals Inc., Royal Gold Inc., Rye Patch Gold Corp., Silver Wheaton Corp., Tahoe Resources Inc. and Yamana Gold Inc. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I determined and had final say over which companies would be included in the interview based on my research, understanding of the sector and interview theme. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
4) Interviews are edited for clarity. Streetwise Reports does not make editorial comments or change experts’ statements without their consent.
5) The interview does not constitute investment advice. Each reader is encouraged to consult with his or her individual financial professional and any action a reader takes as a result of information presented here is his or her own responsibility. By opening this page, each reader accepts and agrees to Streetwise Reports’ terms of use and full legal disclaimer.
6) From time to time, Streetwise Reports LLC and its directors, officers, employees or members of their families, as well as persons interviewed for articles and interviews on the site, may have a long or short position in securities mentioned. Directors, officers, employees or members of their families are prohibited from making purchases and/or sales of those securities in the open market or otherwise during the up-to-four-week interval from the time of the interview until after it publishes.

( Companies Mentioned: ABX:TSX; ABX:NYSE,
CRJ:TSX,
DNA:TSX,
FSM:NYSE; FVI:TSX; FVI:BVL; F4S:FSE,
G:TSX; GG:NYSE,
KGI:TSX,
KDX:TSX; KLNDF:OTCBB,
LSG:TSX,
MND:TSX,
REX:TSX.V,
OR:TSX,
PVG:TSX; PVG:NYSE,
GOLD:NASDAQ; RRS:LSE,
RIC:NYSE.MKT; RIC:TSX,
RIO:TSX; RIOM:NYSE; RIO:BVL,
R:TSX,
RPM:TSX.V; RPMGF:OTCQX,
TAHO:NYSE; THO:TSX,
)

A wonderful profile of Joe Bageant

joe

MARCH 23, 2015 By: Ken Smith http://JoeBageant.com Editors Note: Joe Bageant -1946-2011. AUTHOR OF RAINBOW PIE: A REDNECK MEMOIR AND DEER HUNTING WITH JESUS Joe’s Website is maintained by Ken Smith a friend of ours as well as a good friend of Joe’s. The most thoroughly researched profile of Joe Bageant is in the current issue ofThe Baffler, a high quality print and online magazine. It is titled “Toxically Pure: Joe Bageant drops out”, written by John Lingan, and is several thousands words over 14 pages, including photographs not previously published. The article is now available to the magazine’s subscribers only, but The Baffler’s editors have said it will be available online to the public in about a month. Or, you could subscribe. Here’s the link: http://www.thebaffler.com/issues/no-27 Hard copies of The Baffler magazine should also be available in better bookstores. John Lingan says in an email: “I’m happy to report … Continue reading

Where Will the Graphite, Lithium and Cobalt for the Battery Revolution Come From?: Simon Moores

The Mining Report: You have said, “Electrification of transport will not succeed unless the world has cheap, abundant, longer-lasting batteries.” What are the obstacles to obtaining such batteries?

Simon Moores: There are a number. The first is the scaling of battery supply. The megafactories will be needed to drive down costs significantly. Tesla Motors Inc. (TSLA:NASDAQ), LG Chem Ltd. (051910:KSE; LGCLF:OTCPK), Boston-Power Inc., Foxconn Technology Group and, most recently, Chinese electric vehicle producer BYD (1211:HKSE) have all announced plans to build them. Meanwhile majors like Samsung SDI have announced significant expansions of existing operations. The battery industry is preparing for a surge in demand and its next phase of growth.

Focus Graphite Inc. is looking at serving a market from the user perspective.

But these megafactories will need assured quality raw materials, which is the second obstacle. The third is the security of supply for raw materials. This last obstacle is overlooked at the moment, as the battery industry is taking it as a given they will have supply as needed. But when megafactories come on line, demand will soar. Therefore, supply visibility all the way upstream to the mine is crucial to their success. This is what Benchmark specializes in.

TMR: How does the oil price collapse affect current and future demand for battery power?

SM: This is the question everyone’s asking. Without a doubt, a halved oil price has a negative impact on those consumers who want electric vehicles (EVs) in order to save money on gasoline. To be honest, though, the success of Tesla raises the question of how many people are buying EVs for economic reasons today.

Regardless of the short-term effect, I don’t think the oil price collapse will have a long-term impact. I see internal combustion engines and EVs as fundamentally different technologies. Once EVs mature, they will be far more efficient and software-driven than cars powered by internal combustion engines. I actually believe that you will get to a stage where a remote software upgrade will improve the cars’ performance. You are already seeing this with Tesla. Once you reach this stage, the vehicles will actually improve over time—in essence, cars will no longer be a depreciating asset.

TMR: Would you say that Tesla has a fundamentally different target audience than Toyota Motor Corp.’s (TM:NYSE) Prius?

SM: Definitely. The Prius was created and priced for the mass market from day one. At the time “green” and “cool” did not go hand in hand, so many early Prius owners had to live with an eco-label. The car has since proven to be one of the most economical and best overall models on the road. People now have forgotten about the fact that it is a hybrid and it has been accepted in today’s world.

Whereas the Prius took years to shake off the green label, Tesla has made its cars desirable from day one on the basis of performance and design. Tesla has made EVs desirable. The fact its electric is now secondary.

Mason Graphite Inc.’s ability to raise money for a niche mineral in this environment is an achievement.

Tesla’s Model S is a quality super car, rather than just a functional vehicle. It has achieved something in EVs similar to the “Apple effect” on consumer electronics. The biggest challenge is yet to come, however, as Tesla now wants to shift this success to the mass market with its Model III launch in 2017—a car that will be powered by Gigafactory batteries.

TMR: We’ve heard that Apple Inc. (AAPL:NASDAQ) is about to enter the EV market. How important would that be?

SM: It hasn’t actually announced anything yet. But the rumor that Apple is getting into the self-driving EV space is supported by a lawsuit filed by A123 Systems Inc. (AONE:NASDAQ), a U.S.-based lithium-ion battery producer, which claims Apple is poaching its staff. As for the possible importance, well, if you thought Tesla was a game-changer, then Apple is another thing entirely.

I was at first surprised by the rumor, but it really makes sense. Apple has $178 billion ($178B) in cash and nowhere to spend it. It has already disrupted the consumer goods market, and now it needs another huge global market ripe for disruption.

TMR: China intends to become the world’s biggest EV market by 2016. What are the long-term implications of this for battery-production growth?

SM: In short, we need more batteries. China’s EV market has already shown exponential growth. In January 2014, about 600 EVs were sold. In December 2014, that number had risen to about 27,000, almost 30 times as many.

It’s too soon to say whether this is a trend, but it does show how hard it is to forecast new markets and how they can creep up on you.

TMR: Is China’s massive expansion of the EV market a top-down directive, or is it market driven?

SM: A bit of both. It does come from the top, as China’s urban pollution is so bad that clean vehicles are essential. But the Chinese are business savvy, and they’re not going to waste a lot of money producing vehicles without a return.

The electric bike market in China shows that it’s a fundamentally different market than anywhere in the world. The Chinese don’t have to be persuaded on switching gasoline for electric—they are far less in love with cars than the West. It’s more of a cost proposition.

TMR: What’s the optimum price point for the widespread adoption of electric vehicles? Is it $50,000, $40,000, $30,000? Lower?

SM: Mass-market EVs need a price that can more than compete against gas powered vehicles. Tesla and General Motors Inc. (GM:NYSE) have both said that they’re aiming for a sub-$35,000 car in 2017 (in 2017 dollars). If they can make EVs profitable at under $30,000, we could see a market shift, with EVs becoming genuinely popular with consumers in all income levels.

The only way you can achieve this is by producing cars, batteries and raw materials through economies of scale.

TMR: Since 2008, economic growth worldwide has hardly been robust. Has this slowed the shift to EVs?

SM: It has because consumers haven’t had the money to spend on them, and they are at present deemed niche or luxury vehicles. For manufacturers, they are more of a PR concept than an actual business proposition.

Syrah Resources Ltd. intends to position itself to supply a surge in battery production.

A weak global economy has also meant that these auto manufacturers haven’t been willing to invest the money in R&D to really innovate their cars or improve their batteries. Nissan Motor Co. Ltd.’s (NSANY:OTCPK;7201:TYO) Leaf came out in 2010, and we haven’t seen much from the traditional manufacturers since.

This gave a window of opportunity for someone to steal the limelight. Progress in EVs is now being led by a disruptor, Tesla, which designs and sells EVs in a completely new way. That’s the upside to a poor economic situation.

TMR: The shift in the U.S. to more efficient, less-polluting cars was driven by government mandates from Washington and from individual states, California in particular. Could we see similar mandates with regards to EVs, with U.S. governments requiring X percent of manufacturers’ fleets to be electric?

SM: Such mandates would obviously have a very positive medium-term impact on the EV space because they would guarantee sales. Ultimately, however, EV producers can’t rely on governments. They need to build vehicles that can compete in quality and price with the vehicles that the average person buys.

TMR: The three metals key to increased battery production are graphite, cobalt and lithium. How is each placed to meet increasing demand?

SM: I’ll consider them individually and start with graphite. The problem here is the ability to produce spherical graphite, which is used to make the anode in the EV battery. Currently, 95+% of the world’s spherical graphite uncoated comes from China. There is no diversification in supply. You can also use synthetic graphite in batteries, so you have a substitution option here. At Benchmark we estimate that there is about a 50/50 split for natural versus synthetic used in batteries.

Lithium is better placed as the battery market has been the number one consumer for the last five years. But the volume of battery-grade lithium isn’t sufficient to supply the megafactories that are planned for the near future. For example, lithium hydroxide, which is also used in batteries along with the more familiar lithium carbonate, has been neglected and is likely to see a squeeze in demand this year. In the long run, however, I expect, that this capacity issue will be corrected.

Cobalt has an even bigger upstream problem than the first two, because 55% of the world’s cobalt now comes from the Democratic Republic of the Congo. In the rest of the world, there’s a selection of very small producers, and their output is overwhelmingly a byproduct.

All three of these industries are structurally inflexible to any major demand shocks. That is something buyers must be aware of.

TMR: We began by talking about cheap, abundant, longer-lasting batteries. Now, even with megafactory economies of scale, wouldn’t the huge quantities of graphite, lithium and cobalt needed for them drive up prices of both the metals and the batteries?

SM: Yes. If the megafactories come on stream in the next two years with little change in the raw material supply, prices will rise and impact the cost of the battery. Currently, the battery industry and the people who supply the raw materials are not working together. There is a disconnect in the supply chain.

Those who are planning these megafactories need to get visibility all the way upstream to the mine. At the moment, they look only for the cathode and anode materials, which they regard as raw materials but are really semi-processed products.

TMR: You’ve argued that we have likely seen “peak graphite supply” in China. Will this result in a race to new production outside China?

SM: I think we’re already seeing that from the juniors and from some private companies. The world is too dependent on China for battery-grade graphite and needs supply diversification if batteries are going to fulfill the potential of being a new, major global industry.

TMR: How will this new boom in graphite compare to the boom of five years ago?

SM: Back in 2010, the boom was all about the resource: the location, its size and the size of the flakes. Now the industry has matured. The juniors now know that success, in the main, requires three things. First, they need a good-quality resource. Second, they need clear goals in sales, marketing and processing. Third, they need a profitable selling price on a par with the Chinese export price for graphite. Medium-flake graphite exported from China sells now for about $1,000 per ton. Large-flake graphite of 94–95% carbon sells for about $1,250 per ton. If the juniors can compete with those prices or the prices of semi-processed products, such as spherical graphite, they’ll have a great chance of success.

TMR: Would you comment on the prospects of specific juniors with regard to meeting the increasing demand for graphite?

SM: At Benchmark we don’t endorse or invest in any junior stocks. We view the industry from our independent perspective in relation to predicting when new supply will be coming into the market. There have been a number of recent news developments in this sector.

Many people have been talking about Syrah Resources Ltd. (SYR:ASX) and its Balama project in Mozambique. The company signed an 80,000 ton offtake deal with Chalieco, a subsidiary of Chinalco (ACH:NYSE), to sell into the aluminum industry. This is a new market for flake graphite that shows that China is looking to lock up foreign raw material. The company also announced preliminary plans to establish two spherical graphite plants in Africa and the U.S., which shows its intention to position itself for supplying a surge in battery production.

In February 2015, Energizer Resources Inc. (EGZ:TSX.V; ENZR:OTCQX) released its Bankable Feasibility Study (BFS) for its Molo flake graphite deposit in Mozambique that it has been progressing for some time. The BFS outlines the costs for the project and shows that the new generation of projects can compete on cost with China.

Focus Graphite Inc. (FMS:TSX.V; FCSMF:OTCQX; FKC:FSE), which has the Lac Knife project in Quebec, has done much testing on coated spherical graphite. This is an example of having a strategy beyond the resource and looking at serving a market from the user perspective. It is also another company that is looking to capitalize a battery sector that is evolving.

Northern Graphite Corporation (NGC:TSX.V; NGPHF:OTCQX) is another one of only a handful of companies that have created battery-grade spherical graphite sourced from its Bissett Creek project in Canada. It is positioning itself to serve this market, but also in its March 2 press release reminded the industry of its intention to serve existing industrial sectors of refractories and expandable graphite.

Canada Carbon Inc. (CCB:TSX.V) has three graphite projects in Quebec, including two past-producing mines. The company has been doing work on the Miller project and is going down the high-purity graphite route. Canada Carbon is finding a niche in the graphite space and this gives it several options, such as nuclear-grade graphite or other specialist markets.

From a fundraising perspective, Mason Graphite Inc. (LLG:TSX.V; MGPHF:OTCQX), with its Lac Gueret project in Quebec, has been active in a very tough market. I was in Vancouver in February, and the consensus was that we could be in the worst slump of all time, certainly if it continues for another 18 months. To raise money for a niche mineral in this environment is an achievement.

Great Lakes Graphite Inc. (GLK:TSX.V; GLKIF:OTCPK; 8GL:FSE) has been focusing recently on launching Great Lakes Innovations, the company that is investing in the restart of a micronization facility. The plant has a capacity to produce 10,000 tonnes of product and gives the company value added capabilities to go with its Lochaber project 30 kilometers from Ottawa.

Finally, from Graphite One Resources Inc. (GPH:TSX.V) the industry is awaiting the release of its first preliminary economic assessment (PEA), which is expected mid-2015 and will give a clear picture of how the company can position itself in the growth markets. The company has also just updated its resource estimate on the Graphite Creek project in Alaska in a build up to the PEA announcement.

From the active producers’ side, there is GK, Graphit Kropfmühl, which is owned by AMG Mining AG, one of the world’s major processors of graphite and producers of specialist graphite products. The company recently sold a 30% stake to private investors, and the impetus from this deal will push GK into the new graphite markets.

At the end of 2014, U.S.-based Asbury Carbons Inc. (privately held) officially opened its graphite and carbon plant in Europe. The plant in the Netherlands is a major investment for the company as it extends its presence for the first time outside of North America. This foothold in Europe will mature in the next 18 months and will be one to watch.

Flinders Resources Ltd. (FDR:TSX.V) is actually producing now from its Woxna graphite mine in Sweden. It has a very different challenge to those not in production and that is to actually sell product into the market, negotiate contracts and find new customers. Flinders is Europe’s first flake graphite mine since the late 1990s and in essence doubles the continent’s capacity to around 20,000 tons per annum.

StratMin Global Resources Plc (STGR:AIM) was the only other junior company that graduated into production last year. The company is now selling flake graphite to customers and in February sold +80 (large flake) and +50 (extra large flake) to the global market.

Australia’s Valence Industries Ltd. (VXL:ASX) has restarted the Uley flake graphite plant and is now producing from stockpiles. The company announced recently it has signed a number of contacts for a total of 8,000 tonnes. The product ranges from extra-large +35 mesh to fine powder of -300 mesh.

TMR: If you compare the graphite industry with the gold industry, gold is pretty simple. Does the market understand the complexity of the problems involved with graphite, the questions of flake type, flake size, purity, type of product and the necessity of offtakes?

SM: Much of the market probably doesn’t understand it yet. But the more advanced and more experienced juniors do. Many of these companies have spent the last three years working closely with end users to develop their projects, and this close connection to the end market, especially with regard to specialist graphite products, is critical. This is a make-or-break issue.

TMR: Tesla is committed to ethical cobalt sourcing, which would rule out supply from the Congo. But the Congo, which currently supplies 55% of world cobalt, is not included in the Dodd-Frank restrictions on critical metals. So we can expect that country to continue to supply the battery industry, yes?

SM: Correct. The Dodd-Frank legislation only applies to the U.S., and it only says that public companies have to report where they source conflict minerals from, i.e., tin, tantalum, tungsten and gold. It is not a trade ban. We really think cobalt wasn’t listed because it would have caused significant disruption to what is a niche but important market.

But with such a large proportion of supply coming from one country, and no major secondary options on the same scale, the majority of the battery industry has little choice but to use material sourced here, usually via the refineries based in China.

TMR: What are the alternatives to Congo for cobalt?

SM: It’s important to understand that 60% of the world’s cobalt-refining capacity is in China. There are environmental and supply restrictions and problems all the way along the supply chain for cobalt because it has been neglected for a generation, as have so many other critical minerals. Now the upsurge in the battery market has forced the world to confront these problems.

There aren’t many cobalt companies out there. It’s easier to find graphite and lithium as they are not rare minerals, so there’s more of these companies listed. Cobalt, and certainly primary cobalt deposits, are much more difficult to find.

TMR: Which juniors are poised to benefit from the rush to find non-African supply?

SM: There are currently three companies based in North America: Global Cobalt Corp. (GCO:TSX.V), Fortune Minerals Ltd. (FT:TSX) and Formation Metals Inc. (FCO:TSX). All three are focusing on developing cobalt assets but out of all three major battery raw materials to date, cobalt has been the most overlooked.

But investors have an information problem. You can’t get very reliable data out of the Congo, and this makes it difficult to evaluate these projects on an economic basis. That said, the fact that there are few options for new sources plays strongly into the hands of those juniors developing projects on a supply security basis for North America.

TMR: With regard to lithium, Tesla is in Nevada, and there’s been an assumption that it will look for suppliers as close as possible to its Gigafactory. Is this a given?

SM: It’s not, because the team at Tesla that’s developing the Gigafactory, especially on the raw-materials side, is savvy and very aware of the fact that it’s a game of economics. They will insist on getting from suppliers the right quality of minerals, at the right volume, and at the right price.

However, to get lithium sourced in Nevada for batteries made in Nevada that then go into cars manufactured in California would be a mine-to-market, made in the U.S.A. story that’s very attractive to Tesla on a political and public relations level.

TMR: Should Tesla decide to source lithium in Nevada, which companies would benefit?

SM: Western Lithium USA Corp. (WLC:TSX; WLCDF:OTCQX) is the closest source to the Gigafactory and is actually up and running, not yet with lithium production but in hectorite clay, which is used in oil and gas drilling. Western is seeking to develop its lithium production line and will look at both the carbonate and hydroxide options as most exploration-stage companies are now.

Currently, the only place in North America where lithium is produced is Rockwood Lithium GmbH’s Silver Peak site in Nevada. Next door to this is Pure Energy Minerals Ltd. (PE:TSX.V), which is undertaking a detailed drilling program of Clayton Valley.

Also located close to the Silver Peak facility is Ultra Lithium Inc. (ULI:TSX.V), which is developing its South Big Smokey Valley project 16 miles from Clayton Valley.

The battery megafactory trend and Tesla’s Gigafactory will most definitely be on all of these companies’ radars and vice versa. But this is not necessarily a question of proximity; more important is stable supply, at the right specification, at the right price.

TMR: Which other lithium companies elsewhere in the world are poised to benefit from the megafactories?

SM: Orocobre Ltd. (ORL:TSX; ORE:ASX) is the newest producer in the space. The company commissioned its Olaroz facility in Argentina in February and is the first brine junior to enter lithium production from the boom that started in 2009.

It’s now 2015, and only now are we seeing the first new tonnages coming onto the market to challenge the established producers: Sociedad Química y Minera de Chile S.A. (SQM:NYSE; SQM-B:SSX; SQM-A:SSX), FMC Lithium Corp. (FMC:NYSE), Rockwood Lithium and Talison Lithium.

It has taken the company seven years to get from registration to production. That itself should come as a warning to any new, major buyers of these raw materials.

TMR: There is an enormous amount of lithium where Chile meets Argentina, and there are quite a few juniors with brine projects there. Given the estimates of how much lithium will be needed to supply the burgeoning battery market, is this a rising tide that will lift all Andean boats?

SM: It should because this is the lowest-cost production area in the world. But I think this is a bullish story for all lithium juniors anywhere. Tesla’s Gigafactory will be buying lithium hydroxide, but if it came on stream today at capacity, there just wouldn’t be enough.

And it’s not just about getting the lithium onto the market, but developing the technology and know-how to produce the battery-grade materials at the right volumes. That’s the challenge Orocobre faces and one for any new producer looking to enter this ever changing market. This will challenge the established producers as well, as they must increase capacity in line with demand, and not overshoot, in order to keep the price healthy. They can’t invest too much too soon. It’s all a question of timing and getting the balance right.

TMR: What is your general advice for investors seeking to benefit from the battery revolution?

SM: I can’t give investment advice because I’m not qualified, and I don’t invest in any of these companies because it’s against the policy for any Benchmark employees to do so as an independent source of analysis in the sector.

But I will say that investors in raw materials always tend to look upstream at the minerals. They always speak of a gold story or a graphite story, for example, with very little focus downstream at the sectors that are buying these raw materials.

If investors looked more downstream and mapped out these growth sectors and actual plant by plant expansions, that will give a very good indication of whether a certain mineral or metal is the right one to invest in.

This industry is a medium- to long-term prospect. Any investor looking for short-term returns from critical minerals and metals is playing a high-risk strategy.

TMR: Simon, thank you for your time and your insights.

Simon Moores is managing director of Benchmark Mineral Intelligence, an online publishing and consultancy business specializing in critical minerals and metals, disruptive technology and emerging markets. Moores has also worked as a business journalist focusing on non-metallic minerals such as lithium, graphite, rare earths, potash, TiO2 pigment and feedstocks (rutile, ilmenite).

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DISCLOSURE:
1) Kevin Michael Grace conducted this interview for Streetwise Reports LLC, publisher of The Gold Report, The Energy Report, The Life Sciences Report and The Mining Report, and provides services to Streetwise Reports as an independent contractor. He owns, or his family owns, shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of Streetwise Reports: Syrah Resources Ltd., Focus Graphite Inc. and Mason Graphite Inc. The companies mentioned in this interview were not involved in any aspect of the interview preparation or post-interview editing so the expert could speak independently about the sector. Streetwise Reports does not accept stock in exchange for its services.
3) Simon Moores: I own, or my family owns, shares of the following companies mentioned in this interview: None. I personally am, or my family is, paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I determined and had final say over which companies would be included in the interview based on my research, understanding of the sector and interview theme. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
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( Companies Mentioned: CCB:TSX.V,
EGZ:TSX.V; ENZR:OTCQX,
FDR:TSX.V,
FMS:TSX.V; FCSMF:OTCQX; FKC:FSE,
FCO:TSX,
FT:TSX,
GCO:TSX.V,
GPH:TSX.V,
GLK:TSX.V; GLKIF:OTCPK; 8GL:FSE,
LLG:TSX.V; MGPHF:OTCQX,
NGC:TSX.V; NGPHF:OTCQX,
ORL:TSX; ORE:ASX,
PE:TSX.V,
STGR:AIM,
SYR:ASX,
ULI:TSX.V,
VXL:ASX,
WLC:TSX; WLCDF:OTCQX,
)

Where Will the Graphite, Lithium and Cobalt for the Battery Revolution Come From?: Simon Moores

The Mining Report: You have said, “Electrification of transport will not succeed unless the world has cheap, abundant, longer-lasting batteries.” What are the obstacles to obtaining such batteries?

Simon Moores: There are a number. The first is the scaling of battery supply. The megafactories will be needed to drive down costs significantly. Tesla Motors Inc. (TSLA:NASDAQ), LG Chem Ltd. (051910:KSE; LGCLF:OTCPK), Boston-Power Inc., Foxconn Technology Group and, most recently, Chinese electric vehicle producer BYD (1211:HKSE) have all announced plans to build them. Meanwhile majors like Samsung SDI have announced significant expansions of existing operations. The battery industry is preparing for a surge in demand and its next phase of growth.

Focus Graphite Inc. is looking at serving a market from the user perspective.

But these megafactories will need assured quality raw materials, which is the second obstacle. The third is the security of supply for raw materials. This last obstacle is overlooked at the moment, as the battery industry is taking it as a given they will have supply as needed. But when megafactories come on line, demand will soar. Therefore, supply visibility all the way upstream to the mine is crucial to their success. This is what Benchmark specializes in.

TMR: How does the oil price collapse affect current and future demand for battery power?

SM: This is the question everyone’s asking. Without a doubt, a halved oil price has a negative impact on those consumers who want electric vehicles (EVs) in order to save money on gasoline. To be honest, though, the success of Tesla raises the question of how many people are buying EVs for economic reasons today.

Regardless of the short-term effect, I don’t think the oil price collapse will have a long-term impact. I see internal combustion engines and EVs as fundamentally different technologies. Once EVs mature, they will be far more efficient and software-driven than cars powered by internal combustion engines. I actually believe that you will get to a stage where a remote software upgrade will improve the cars’ performance. You are already seeing this with Tesla. Once you reach this stage, the vehicles will actually improve over time—in essence, cars will no longer be a depreciating asset.

TMR: Would you say that Tesla has a fundamentally different target audience than Toyota Motor Corp.’s (TM:NYSE) Prius?

SM: Definitely. The Prius was created and priced for the mass market from day one. At the time “green” and “cool” did not go hand in hand, so many early Prius owners had to live with an eco-label. The car has since proven to be one of the most economical and best overall models on the road. People now have forgotten about the fact that it is a hybrid and it has been accepted in today’s world.

Whereas the Prius took years to shake off the green label, Tesla has made its cars desirable from day one on the basis of performance and design. Tesla has made EVs desirable. The fact its electric is now secondary.

Mason Graphite Inc.’s ability to raise money for a niche mineral in this environment is an achievement.

Tesla’s Model S is a quality super car, rather than just a functional vehicle. It has achieved something in EVs similar to the “Apple effect” on consumer electronics. The biggest challenge is yet to come, however, as Tesla now wants to shift this success to the mass market with its Model III launch in 2017—a car that will be powered by Gigafactory batteries.

TMR: We’ve heard that Apple Inc. (AAPL:NASDAQ) is about to enter the EV market. How important would that be?

SM: It hasn’t actually announced anything yet. But the rumor that Apple is getting into the self-driving EV space is supported by a lawsuit filed by A123 Systems Inc. (AONE:NASDAQ), a U.S.-based lithium-ion battery producer, which claims Apple is poaching its staff. As for the possible importance, well, if you thought Tesla was a game-changer, then Apple is another thing entirely.

I was at first surprised by the rumor, but it really makes sense. Apple has $178 billion ($178B) in cash and nowhere to spend it. It has already disrupted the consumer goods market, and now it needs another huge global market ripe for disruption.

TMR: China intends to become the world’s biggest EV market by 2016. What are the long-term implications of this for battery-production growth?

SM: In short, we need more batteries. China’s EV market has already shown exponential growth. In January 2014, about 600 EVs were sold. In December 2014, that number had risen to about 27,000, almost 30 times as many.

It’s too soon to say whether this is a trend, but it does show how hard it is to forecast new markets and how they can creep up on you.

TMR: Is China’s massive expansion of the EV market a top-down directive, or is it market driven?

SM: A bit of both. It does come from the top, as China’s urban pollution is so bad that clean vehicles are essential. But the Chinese are business savvy, and they’re not going to waste a lot of money producing vehicles without a return.

The electric bike market in China shows that it’s a fundamentally different market than anywhere in the world. The Chinese don’t have to be persuaded on switching gasoline for electric—they are far less in love with cars than the West. It’s more of a cost proposition.

TMR: What’s the optimum price point for the widespread adoption of electric vehicles? Is it $50,000, $40,000, $30,000? Lower?

SM: Mass-market EVs need a price that can more than compete against gas powered vehicles. Tesla and General Motors Inc. (GM:NYSE) have both said that they’re aiming for a sub-$35,000 car in 2017 (in 2017 dollars). If they can make EVs profitable at under $30,000, we could see a market shift, with EVs becoming genuinely popular with consumers in all income levels.

The only way you can achieve this is by producing cars, batteries and raw materials through economies of scale.

TMR: Since 2008, economic growth worldwide has hardly been robust. Has this slowed the shift to EVs?

SM: It has because consumers haven’t had the money to spend on them, and they are at present deemed niche or luxury vehicles. For manufacturers, they are more of a PR concept than an actual business proposition.

Syrah Resources Ltd. intends to position itself to supply a surge in battery production.

A weak global economy has also meant that these auto manufacturers haven’t been willing to invest the money in R&D to really innovate their cars or improve their batteries. Nissan Motor Co. Ltd.’s (NSANY:OTCPK;7201:TYO) Leaf came out in 2010, and we haven’t seen much from the traditional manufacturers since.

This gave a window of opportunity for someone to steal the limelight. Progress in EVs is now being led by a disruptor, Tesla, which designs and sells EVs in a completely new way. That’s the upside to a poor economic situation.

TMR: The shift in the U.S. to more efficient, less-polluting cars was driven by government mandates from Washington and from individual states, California in particular. Could we see similar mandates with regards to EVs, with U.S. governments requiring X percent of manufacturers’ fleets to be electric?

SM: Such mandates would obviously have a very positive medium-term impact on the EV space because they would guarantee sales. Ultimately, however, EV producers can’t rely on governments. They need to build vehicles that can compete in quality and price with the vehicles that the average person buys.

TMR: The three metals key to increased battery production are graphite, cobalt and lithium. How is each placed to meet increasing demand?

SM: I’ll consider them individually and start with graphite. The problem here is the ability to produce spherical graphite, which is used to make the anode in the EV battery. Currently, 95+% of the world’s spherical graphite uncoated comes from China. There is no diversification in supply. You can also use synthetic graphite in batteries, so you have a substitution option here. At Benchmark we estimate that there is about a 50/50 split for natural versus synthetic used in batteries.

Lithium is better placed as the battery market has been the number one consumer for the last five years. But the volume of battery-grade lithium isn’t sufficient to supply the megafactories that are planned for the near future. For example, lithium hydroxide, which is also used in batteries along with the more familiar lithium carbonate, has been neglected and is likely to see a squeeze in demand this year. In the long run, however, I expect, that this capacity issue will be corrected.

Cobalt has an even bigger upstream problem than the first two, because 55% of the world’s cobalt now comes from the Democratic Republic of the Congo. In the rest of the world, there’s a selection of very small producers, and their output is overwhelmingly a byproduct.

All three of these industries are structurally inflexible to any major demand shocks. That is something buyers must be aware of.

TMR: We began by talking about cheap, abundant, longer-lasting batteries. Now, even with megafactory economies of scale, wouldn’t the huge quantities of graphite, lithium and cobalt needed for them drive up prices of both the metals and the batteries?

SM: Yes. If the megafactories come on stream in the next two years with little change in the raw material supply, prices will rise and impact the cost of the battery. Currently, the battery industry and the people who supply the raw materials are not working together. There is a disconnect in the supply chain.

Those who are planning these megafactories need to get visibility all the way upstream to the mine. At the moment, they look only for the cathode and anode materials, which they regard as raw materials but are really semi-processed products.

TMR: You’ve argued that we have likely seen “peak graphite supply” in China. Will this result in a race to new production outside China?

SM: I think we’re already seeing that from the juniors and from some private companies. The world is too dependent on China for battery-grade graphite and needs supply diversification if batteries are going to fulfill the potential of being a new, major global industry.

TMR: How will this new boom in graphite compare to the boom of five years ago?

SM: Back in 2010, the boom was all about the resource: the location, its size and the size of the flakes. Now the industry has matured. The juniors now know that success, in the main, requires three things. First, they need a good-quality resource. Second, they need clear goals in sales, marketing and processing. Third, they need a profitable selling price on a par with the Chinese export price for graphite. Medium-flake graphite exported from China sells now for about $1,000 per ton. Large-flake graphite of 94–95% carbon sells for about $1,250 per ton. If the juniors can compete with those prices or the prices of semi-processed products, such as spherical graphite, they’ll have a great chance of success.

TMR: Would you comment on the prospects of specific juniors with regard to meeting the increasing demand for graphite?

SM: At Benchmark we don’t endorse or invest in any junior stocks. We view the industry from our independent perspective in relation to predicting when new supply will be coming into the market. There have been a number of recent news developments in this sector.

Many people have been talking about Syrah Resources Ltd. (SYR:ASX) and its Balama project in Mozambique. The company signed an 80,000 ton offtake deal with Chalieco, a subsidiary of Chinalco (ACH:NYSE), to sell into the aluminum industry. This is a new market for flake graphite that shows that China is looking to lock up foreign raw material. The company also announced preliminary plans to establish two spherical graphite plants in Africa and the U.S., which shows its intention to position itself for supplying a surge in battery production.

In February 2015, Energizer Resources Inc. (EGZ:TSX.V; ENZR:OTCQX) released its Bankable Feasibility Study (BFS) for its Molo flake graphite deposit in Mozambique that it has been progressing for some time. The BFS outlines the costs for the project and shows that the new generation of projects can compete on cost with China.

Focus Graphite Inc. (FMS:TSX.V; FCSMF:OTCQX; FKC:FSE), which has the Lac Knife project in Quebec, has done much testing on coated spherical graphite. This is an example of having a strategy beyond the resource and looking at serving a market from the user perspective. It is also another company that is looking to capitalize a battery sector that is evolving.

Northern Graphite Corporation (NGC:TSX.V; NGPHF:OTCQX) is another one of only a handful of companies that have created battery-grade spherical graphite sourced from its Bissett Creek project in Canada. It is positioning itself to serve this market, but also in its March 2 press release reminded the industry of its intention to serve existing industrial sectors of refractories and expandable graphite.

Canada Carbon Inc. (CCB:TSX.V) has three graphite projects in Quebec, including two past-producing mines. The company has been doing work on the Miller project and is going down the high-purity graphite route. Canada Carbon is finding a niche in the graphite space and this gives it several options, such as nuclear-grade graphite or other specialist markets.

From a fundraising perspective, Mason Graphite Inc. (LLG:TSX.V; MGPHF:OTCQX), with its Lac Gueret project in Quebec, has been active in a very tough market. I was in Vancouver in February, and the consensus was that we could be in the worst slump of all time, certainly if it continues for another 18 months. To raise money for a niche mineral in this environment is an achievement.

Great Lakes Graphite Inc. (GLK:TSX.V; GLKIF:OTCPK; 8GL:FSE) has been focusing recently on launching Great Lakes Innovations, the company that is investing in the restart of a micronization facility. The plant has a capacity to produce 10,000 tonnes of product and gives the company value added capabilities to go with its Lochaber project 30 kilometers from Ottawa.

Finally, from Graphite One Resources Inc. (GPH:TSX.V) the industry is awaiting the release of its first preliminary economic assessment (PEA), which is expected mid-2015 and will give a clear picture of how the company can position itself in the growth markets. The company has also just updated its resource estimate on the Graphite Creek project in Alaska in a build up to the PEA announcement.

From the active producers’ side, there is GK, Graphit Kropfmühl, which is owned by AMG Mining AG, one of the world’s major processors of graphite and producers of specialist graphite products. The company recently sold a 30% stake to private investors, and the impetus from this deal will push GK into the new graphite markets.

At the end of 2014, U.S.-based Asbury Carbons Inc. (privately held) officially opened its graphite and carbon plant in Europe. The plant in the Netherlands is a major investment for the company as it extends its presence for the first time outside of North America. This foothold in Europe will mature in the next 18 months and will be one to watch.

Flinders Resources Ltd. (FDR:TSX.V) is actually producing now from its Woxna graphite mine in Sweden. It has a very different challenge to those not in production and that is to actually sell product into the market, negotiate contracts and find new customers. Flinders is Europe’s first flake graphite mine since the late 1990s and in essence doubles the continent’s capacity to around 20,000 tons per annum.

StratMin Global Resources Plc (STGR:AIM) was the only other junior company that graduated into production last year. The company is now selling flake graphite to customers and in February sold +80 (large flake) and +50 (extra large flake) to the global market.

Australia’s Valence Industries Ltd. (VXL:ASX) has restarted the Uley flake graphite plant and is now producing from stockpiles. The company announced recently it has signed a number of contacts for a total of 8,000 tonnes. The product ranges from extra-large +35 mesh to fine powder of -300 mesh.

TMR: If you compare the graphite industry with the gold industry, gold is pretty simple. Does the market understand the complexity of the problems involved with graphite, the questions of flake type, flake size, purity, type of product and the necessity of offtakes?

SM: Much of the market probably doesn’t understand it yet. But the more advanced and more experienced juniors do. Many of these companies have spent the last three years working closely with end users to develop their projects, and this close connection to the end market, especially with regard to specialist graphite products, is critical. This is a make-or-break issue.

TMR: Tesla is committed to ethical cobalt sourcing, which would rule out supply from the Congo. But the Congo, which currently supplies 55% of world cobalt, is not included in the Dodd-Frank restrictions on critical metals. So we can expect that country to continue to supply the battery industry, yes?

SM: Correct. The Dodd-Frank legislation only applies to the U.S., and it only says that public companies have to report where they source conflict minerals from, i.e., tin, tantalum, tungsten and gold. It is not a trade ban. We really think cobalt wasn’t listed because it would have caused significant disruption to what is a niche but important market.

But with such a large proportion of supply coming from one country, and no major secondary options on the same scale, the majority of the battery industry has little choice but to use material sourced here, usually via the refineries based in China.

TMR: What are the alternatives to Congo for cobalt?

SM: It’s important to understand that 60% of the world’s cobalt-refining capacity is in China. There are environmental and supply restrictions and problems all the way along the supply chain for cobalt because it has been neglected for a generation, as have so many other critical minerals. Now the upsurge in the battery market has forced the world to confront these problems.

There aren’t many cobalt companies out there. It’s easier to find graphite and lithium as they are not rare minerals, so there’s more of these companies listed. Cobalt, and certainly primary cobalt deposits, are much more difficult to find.

TMR: Which juniors are poised to benefit from the rush to find non-African supply?

SM: There are currently three companies based in North America: Global Cobalt Corp. (GCO:TSX.V), Fortune Minerals Ltd. (FT:TSX) and Formation Metals Inc. (FCO:TSX). All three are focusing on developing cobalt assets but out of all three major battery raw materials to date, cobalt has been the most overlooked.

But investors have an information problem. You can’t get very reliable data out of the Congo, and this makes it difficult to evaluate these projects on an economic basis. That said, the fact that there are few options for new sources plays strongly into the hands of those juniors developing projects on a supply security basis for North America.

TMR: With regard to lithium, Tesla is in Nevada, and there’s been an assumption that it will look for suppliers as close as possible to its Gigafactory. Is this a given?

SM: It’s not, because the team at Tesla that’s developing the Gigafactory, especially on the raw-materials side, is savvy and very aware of the fact that it’s a game of economics. They will insist on getting from suppliers the right quality of minerals, at the right volume, and at the right price.

However, to get lithium sourced in Nevada for batteries made in Nevada that then go into cars manufactured in California would be a mine-to-market, made in the U.S.A. story that’s very attractive to Tesla on a political and public relations level.

TMR: Should Tesla decide to source lithium in Nevada, which companies would benefit?

SM: Western Lithium USA Corp. (WLC:TSX; WLCDF:OTCQX) is the closest source to the Gigafactory and is actually up and running, not yet with lithium production but in hectorite clay, which is used in oil and gas drilling. Western is seeking to develop its lithium production line and will look at both the carbonate and hydroxide options as most exploration-stage companies are now.

Currently, the only place in North America where lithium is produced is Rockwood Lithium GmbH’s Silver Peak site in Nevada. Next door to this is Pure Energy Minerals Ltd. (PE:TSX.V), which is undertaking a detailed drilling program of Clayton Valley.

Also located close to the Silver Peak facility is Ultra Lithium Inc. (ULI:TSX.V), which is developing its South Big Smokey Valley project 16 miles from Clayton Valley.

The battery megafactory trend and Tesla’s Gigafactory will most definitely be on all of these companies’ radars and vice versa. But this is not necessarily a question of proximity; more important is stable supply, at the right specification, at the right price.

TMR: Which other lithium companies elsewhere in the world are poised to benefit from the megafactories?

SM: Orocobre Ltd. (ORL:TSX; ORE:ASX) is the newest producer in the space. The company commissioned its Olaroz facility in Argentina in February and is the first brine junior to enter lithium production from the boom that started in 2009.

It’s now 2015, and only now are we seeing the first new tonnages coming onto the market to challenge the established producers: Sociedad Química y Minera de Chile S.A. (SQM:NYSE; SQM-B:SSX; SQM-A:SSX), FMC Lithium Corp. (FMC:NYSE), Rockwood Lithium and Talison Lithium.

It has taken the company seven years to get from registration to production. That itself should come as a warning to any new, major buyers of these raw materials.

TMR: There is an enormous amount of lithium where Chile meets Argentina, and there are quite a few juniors with brine projects there. Given the estimates of how much lithium will be needed to supply the burgeoning battery market, is this a rising tide that will lift all Andean boats?

SM: It should because this is the lowest-cost production area in the world. But I think this is a bullish story for all lithium juniors anywhere. Tesla’s Gigafactory will be buying lithium hydroxide, but if it came on stream today at capacity, there just wouldn’t be enough.

And it’s not just about getting the lithium onto the market, but developing the technology and know-how to produce the battery-grade materials at the right volumes. That’s the challenge Orocobre faces and one for any new producer looking to enter this ever changing market. This will challenge the established producers as well, as they must increase capacity in line with demand, and not overshoot, in order to keep the price healthy. They can’t invest too much too soon. It’s all a question of timing and getting the balance right.

TMR: What is your general advice for investors seeking to benefit from the battery revolution?

SM: I can’t give investment advice because I’m not qualified, and I don’t invest in any of these companies because it’s against the policy for any Benchmark employees to do so as an independent source of analysis in the sector.

But I will say that investors in raw materials always tend to look upstream at the minerals. They always speak of a gold story or a graphite story, for example, with very little focus downstream at the sectors that are buying these raw materials.

If investors looked more downstream and mapped out these growth sectors and actual plant by plant expansions, that will give a very good indication of whether a certain mineral or metal is the right one to invest in.

This industry is a medium- to long-term prospect. Any investor looking for short-term returns from critical minerals and metals is playing a high-risk strategy.

TMR: Simon, thank you for your time and your insights.

Simon Moores is managing director of Benchmark Mineral Intelligence, an online publishing and consultancy business specializing in critical minerals and metals, disruptive technology and emerging markets. Moores has also worked as a business journalist focusing on non-metallic minerals such as lithium, graphite, rare earths, potash, TiO2 pigment and feedstocks (rutile, ilmenite).

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( Companies Mentioned: CCB:TSX.V,
EGZ:TSX.V; ENZR:OTCQX,
FDR:TSX.V,
FMS:TSX.V; FCSMF:OTCQX; FKC:FSE,
FCO:TSX,
FT:TSX,
GCO:TSX.V,
GPH:TSX.V,
GLK:TSX.V; GLKIF:OTCPK; 8GL:FSE,
LLG:TSX.V; MGPHF:OTCQX,
NGC:TSX.V; NGPHF:OTCQX,
ORL:TSX; ORE:ASX,
PE:TSX.V,
STGR:AIM,
SYR:ASX,
ULI:TSX.V,
VXL:ASX,
WLC:TSX; WLCDF:OTCQX,
)