A fundamental roadblock to globalization that we are far
from overcoming is simply that different cultures and economic systems have
different ways of conducting themselves and doing business.
Human nature is such that we tend to believe everyone
thinks and acts broadly as we do.
"Western" companies all too often make
assumptions regarding things we take for granted, such as the profit motive
or the sanctity of contractual law and property rights, that can be easily
exploited by their counterparts in developing countries where such notions
are often lax and sometimes wholly lacking.
In short, developed and developing countries often play
by different rulebooks.
While my comments today are focused on rare earth
elements (REE), they are broadly consistent for all specialty metals and
certainly for those under the control of cartels, such as niobium, beryllium
and indium.
China, through its centrally planned economy, operates a
state-controlled cartel over the production and processing of REE and at
least a dozen other specialty metals.
Despite the West's experience with OPEC in the 1970s and
1980s, it chose to disregard the threat implicit in Deng Xiaoping's 1992
comment that "The Middle East has oil. China has rare earths."
Unburdened by labor, energy or material costs, not to
mention competition or environmental concerns, China made a policy decision
to seize control of a number of specialty metal markets by undermining
project economics wherever it could; the West with its "New
Economy" focus on short-term profits rather than long-term security of
supply simply went along with the program from which it clearly benefited.
Over the ensuing two decades, while incurring untold
losses and massive environmental degradation, China gradually assumed control
of a number of specialty metal markets.
But it was not until mid-2010, when China abruptly cut
off REE supply to Japan over a minor fishing incident, that the West finally
caught a glimpse of the predicament its dogmatic belief that "free
market economics will prevail" had landed it in with regard to specialty
metals.
Some maintain the incident was a red herring used to
drive up the price not only of REE but also of all of the specialty metals
China controlled, which it certainly did, but the larger effect was to spark
a panic-driven frenzy of speculation and capital misallocation as the West
scrambled to secure non-Sino sources of these metals.
The West, as it is wont to do when caught flat-footed due
to poor policy decisions, responded by "throwing money at the
problem" and filing complaints against China with the World Trade
Organization (WTO), premature membership to which the West had ardently
pushed after the collapse of the Internet Bubble.
Fueled by panicked bureaucrats, unscrupulous resource
project promoters, and at best superficial analysis on the part of both
retail and institutional investors, a speculative bubble in REE and to a
lesser extent specialty metals resulted.
China stoked the speculative fervor with a series of
well-timed announcements regarding the curtailment REE and specialty metal
exports, increased tariffs on same, and by pricing REE as much as 50% lower
for domestic end-users in order both to improve Chinese companies'
competitive position as well as to entice foreign companies to relocate their
high tech operations to China in order to secure continued access to REE.
This enabled a number of Chinese companies to appropriate
Western proprietary technologies and/or manufacturing techniques.
Meanwhile, it was not the best REE projects, i.e., those
supplying the heavy REE the West needs for permanent magnets and myriad high
tech applications, but the REE projects most hyped by Wall Street, that
received funding and were rushed into production with tremendous fanfare.
Ironically, not one produced the heavy REE needed to alleviate the Chinese
cartel threat.
China then administered the coup de grace by cutting REE prices
sufficiently to undermine the economics of these over-hyped projects: two
failed outright, and a third remains effectively on life support.
The resulting billions of dollars of investment losses have made Western
investors gun shy, and since China could cut REE prices again at any time to
protect its monopoly, project funding for REE and specialty metal projects
has slowed to a trickle.
But the problem has not gone away. Six years on the problem of Chinese
control of REE and numerous specialty metals has not been addressed, and the
West remains vulnerable to supply disruptions.
China has effectively disregarded the WTO ruling that condemned its
practices and is pretty much doing as it damn well pleases while the West
sputters impotently.
And in the interim, the world seems to be edging ever closer to chaos.
Why Alkane, Why Now
With Mountain Pass (Molycorp Inc. [MCP:NYSE]) and Steenkampskraal (Great
Western Minerals Group Ltd. [GWG:TSX.V; GWMGF:OTCQX]) failing and Mt. Weld
(Lynas Corp. [LYC:ASX]) producing too few, if any, heavy REE and not living
up to the hype, the short list of potential non-Sino REE producers has
thinned dramatically.
Realistically, we only see three projects globally today that have a
decent chance of loosening the Chinese stranglehold on the REE market.
These are Peak
Resources Ltd.'s (PEK:ASX; PKRLY:OTCQX) Ngualla project in Tanzania,
which contains primarily light REEs in bastnasite; Northern
Minerals Ltd.'s (NTU:ASX) xenotime heavy REE project in the Browns Range
of Western Australia; and Alkane Resources Ltd.'s (ALK:ASX; ANLKY:OTCQX) Dubbo
Zirconia Project (DZP), which has both zirconosilicates hosting zirconium,
hafnium, yttrium and heavy REE as well as natroniobite and calcian bastnsite
hosting niobium, tantalum and light REE respectively in rural New South
Wales, Australia.
By our estimation, the first two projects require higher sustained REE
prices to be economic and will therefore remain subject to the threat of
Chinese price manipulation.
Further, because both projects will only produce an REE concentrate
initially, questions remain regarding who will process their concentrates
into marketable products because, in addition to REE supply, China also
controls most of the world's REE processing capacity.
This is an important consideration because with a range of specialty metal
concentrates, notably antimony and tungsten (APT), once the concentrate
reaches China for processing, it usually doesn't come out again and is lost
to world markets.
Both projects lack existing infrastructure (power, gas, water, roads,
rail), and the Northern Minerals project is likely to be a costly fly-in,
fly-out operation.
In contrast, Alkane's polymetallic Dubbo Zirconia Project (DZP) has all of
the infrastructure the others lack as well as a revenue stream spread between
both light REE (22% neodymium & praseodymium) and heavy REE (15% terbium,
dysprosium & yttrium), which are quite profitable at current REE prices,
and in-demand specialty metals, zirconium (31%), ferroniobium (16%), and
hafnium (9%), which should render market shocks and price manipulation less
of an existential threat.
Alkane has a marketing agreement with the Austrian company Treibacher
Industrie AG for all of the ferroniobium output and recently signed a letter
of intent with Vietnam Rare Earth JSC (VTRE), an established mineral
processing business that competes directly with China, to toll treat DZP
concentrates to produce the entire suite of certified REE products. This may
also include the production of metals and permanent magnets.
Over the last six years, while the wrong projects were getting funded and
investors were getting burned, Alkane has "stuck to its knitting"
and progressed its flagship project, the DZP, toward production.
With project funding unavailable and dilution and debt
unattractive options, Alkane elected to sell some assets in order to self-fund
the $115 million ($115M) Tomingley gold project, which like all of Alkane's
projects is also in the vicinity of Dubbo, NSW, a regional hub with a
population of roughly 40,000.
In early 2014, the 60,000-ounce-per-year project went into production,
ahead of schedule and under budget, and Alkane has used the roughly $25M of
free cash flow Tomingley generates annually ever since to advance the DZP.
Today, the DZP is fully permitted, the plant's Front-End Engineering
Design is completed, and the project is construction-ready, pending ~$910M in
project funding.
Now that the DZP has reached the construction-ready phase, the majority of
that $25M per year of free cash flow will drop straight to Alkane's bottom
line.
While senior management continues to negotiate marketing and off-take
agreements across the DZP's product line and to advance project funding
through what is anticipated to be the combination of the sale of a partial
interest in the DZP, a low interest Export Credit Agency debt facility and
equity, Alkane is also extending Tomingley's open pit gold mining operations
underground to access higher grade ore, as well as stepping up exploration
drilling along trend.
Paradoxically, rather than being rewarded for these accomplishments, which
has been no mean feat in the current funding environment, Alkane has been
punished by investors apparently still smarting from REE fiascos and trades
today for roughly one-third less than the value of just its gold operations.
That's right. The most advanced and arguably best REE and specialty metal
project in the world, not least because of its 40-year mine life, has a
negative valuation in the eyes of the market.
If Alkane were another company, say one that had hyped the dickens out of
its REE project and then failed to deliver anything of value, we could
understand this position, but that is simply not the case with Alkane.
Alkane is a "good operator" with a proven track record of
profitable mine operations.
The nuts and bolts of Alkane's operations are easily grasped and valued,
and to see what we mean just glance through the most recent Quarterly and Annual Reports.
Tomingley has all-in-sustaining-costs (AISC) of $1,125/oz, and if valued
with its peers in the Australian gold sector would be worth $150M all by
itself. Alkane also has roughly $30M in cash and gold bullion.
Harder to quantify are a number of intangibles we attribute to outstanding
management.
Alkane's first project in the Dubbo region was the Peak Hill gold mine,
which it operated from 1996 to 2006, and which won environmental awards for
its remediation efforts and includes a self-guided educational tour of the
project.
About a decade ago, Alkane made the strategic decision to focus all of its
activities in the mineral rich Dubbo, NSW, region and subsequently gradually
sold off all of its other assets, streamlining operations.
Most investors do not appreciate the time, energy and expense required to
put a mine into production today, especially in left-leaning, overly
litigious New South Wales, so by focusing exclusively on the Dubbo region
Alkane has been able to avoid "reinventing the wheel" each time it
commits to putting a project into production.
This has enabled Alkane to establish and maintain a positive relationship
with the pertinent bureaucracies and environmental groups.
Twenty years of operations in the region have made Alkane a significant
regional employer with strong community support: yesterday, Peak Hill
employed 35 Dubbo region residents; today, Tomingley employs about 170;
tomorrow, the DZP will mark Alkane's evolution into a globally significant
mining company that will employ approximately 270.
This focus on the Dubbo region adds considerable value by improving the
efficiency and ease with which Alkane can conduct business in the region-but
how do you value such a metric?
Also not fully appreciated by investors is that developing a flow sheet
proven to separate and recover both REE and such a range of specialty metals
is in itself a remarkable feat of chemical engineering, which at some point
will be of tremendous value because each REE deposit is unique and requires a
custom flow sheet.
Most REE projects fail because of shortcomings attendant to their flow
sheets.
Most REE projects during the REE bubble of 2010-12 didn't even have a flow
sheet.
Alkane has been developing the DZP's flow sheet for 15 years and has been
running a demonstration plant at the secure Australian Nuclear Science and
Technology Organization (ANSTO) facility in Lucas Heights for the last eight
years.
In addition to providing product samples for end-user evaluation and
certification, the constant optimization of the flow sheet has paid
significant dividends, perhaps the most fascinating of which is Alkane's
ability to now separate hafnium from the zirconium circuit.
Zirconium and hafnium are so chemically similar that they are widely
regarded as being the most difficult metals to separate-harder even than REE,
which is saying something.
By removing the hafnium from the zirconium stream, which serves to refine
it, Alkane will now be able to produce a high value 99.9% pure zirconium
compound. This has raised the average price across its range of zirconium
compounds from $4-5/kg to $8-9/kg.
This also means Alkane's DZP will constitute the world's first and only
primary mine supply of hafnium oxide, a specialty metal with critical
applications in the aerospace and nuclear industries.
This is an achievement markets fail to comprehend-or to value properly.
This constant optimization has both increased the value of one of Alkane's
principal revenue streams and created a whole new one; what was a flow sheet
complication has become a new source of revenue with striking potential.
Alkane is investigating the development of a tantalum circuit to add to
the niobium stream once the main project is operating.
We do not know what value should be placed on such foresight, perseverance
and innovation, but we're certain it shouldn't be assigned a negative
valuation.
Demand for REE and specialty metals is not going away-if
anything demand is increasing as advances in metallurgy and material science
continue to develop new products and uses that have profound effects on our
world.
Machiavelli noted, "history repeats because human
nature does not change."
Cartels always and everywhere use their position to their
advantage: that is the primary motivation for seeking monopolistic powers, so
we believe it is only a matter of time until China misbehaves again.
Strategically, Alkane represents the West's best answer
to cartel control of both REE and niobium supply, as well as to cartel
control of REE, niobium and zirconium processing capacity.
China has disregarded the WTO rulings regarding REE and other specialty
metal markets.
It has recently declared it will disregard the findings of The Hague
regarding its territorial claims of control of the majority of the South China Sea and continues to militarize the region.
Now it has declared it will prosecute those caught illegally fishing in "Chinese
waters."
It is not a question of whether the West needs Alkane's specialty metals,
for that is clearly established, but of when the West will come to its senses
and fund the DZP's construction.
In the meantime Alkane will continue producing gold, optimizing the DZP's
flow sheet and developing mining projects in the Dubbo region-a profitable
but undervalued company that stands to benefit directly from the specialty
metal price recovery as well as more Chinese shenanigans.
As managing editor of The Emerging Trends Report, Richard Karn has a broad, multidisciplinary background
and a working knowledge of precious and specialty metals, as well as
considerable research, analytical and writing experience. He has written for
publications ranging from Barron's, Kitco and Fullermoney to Financial
Sense Online.