Moly markets: China uncertainty dominates (part 2)

 

The following is a continuation of a story posted on Oct. 30.

There’s been quite a bit of molybdenum project news over the past year:

Climax & Henderson mines — In November 2008, Freeport McMoRan Copper & Gold (FCX-N)announced it would delay construction at Climax and reduce production at its Henderson by 10 million lbs. per year, after having earlier committed US$500 million to reopen Climax.

Mill testing had been scheduled for the fourth quarter of 2009, and 2010 production from Climax had been pegged at 28 million lbs., or just shy of the full capacity is 30 million lbs. per year, or about 6% of world production.

Many industry observers believe Freeport will use Climax and Henderson to meter production to levels that maintain good moly prices in the market. Together, Freeport’s Climax and Henderson mines could produce about 70 million lbs. per year, or about 15% of world production.

Freeport’s choice is to either produce at high levels and get depressed prices, or cut back production to preserve its assets and get higher prices in the long term. Obviously, Freeport has made the decision to reduce moly output in the short term.

Metering production at these mines is relatively easy as they are primary moly producers. Freeport says that Climax production could be doubled to 60 million lbs. moly per year if market conditions warrant, though many market observers believe the odds of this expansion going forward are low. Their view is that Freeport is sabre-rattling to discourage others from opening large primary moly mines.

Even though prices have rebounded in 2009, as of this writing, there has been no announcement by Freeport that the Climax mine will be reopened in the near future. It should take about 18 months to reopen it once Freeport restarts construction.

Spinifex Ridge — Moly Mines (MOL-T, MOL-A) of Australia announced recently that Hanlong Mining Investment of China had committed to US$700 million in debt and equity financing to develop the Spinifex Ridge moly-copper project in Western Australia’s Pilbara region.

Although the Spinifex Ridge resource might technically be called a byproduct producer, the copper grade is low at only 0.08% and the copper represents only a small percentage of the ore’s value. So the project should be viewed as a primary moly producer with minor copper credits.

Originally planned as a 20-million-tonne-per-year open-pit operation with an estimated capital expenditure of US$1.1 billion, a revised plan developed in mid-2009 calls for a 10-million-tonne-per-year mine with an estimated US$553-million capex.

This announcement is significant on many levels:

1) It indicates Chinese moly consumers may be concerned about the ability of Chinese producers to meet expected Chinese demand.

2) The investment by Hanlong may also be a result of China’s need to purchase hard assets with its large reserves of U.S. currency, which may see significant depreciation in the years ahead.

3) In its August 2009 updated National Instrument 43-101 report on Spinifex, Moly Mines expressed the view that the high-cost, smaller moly mines in China that had closed in late 2008 and early 2009, would *not* reopen even if moly prices increased. While no verification of this is available, it’s notable that this was expressed in a document that was presumably written when the company was in deep negotiations with a Chinese partner.

4) With a moly equivalent grade of 0.063%, the Spinifex Ridge resource is only 60% of the average grade of existing surface moly producers. And of the 46 relatively advanced potential new primary and byproduct moly mines, it has the sixth-lowest grade. While ore grade is only one factor in determining whether a resource will be economic, it is certainly one of the most important.

5) In its revised planning, Moly Mines uses long-term moly and copper price forecasts of US$20 and US$2.60 per lb. respectively. Presumably Hanlong would not have invested US$700 million with Moly Mines if Hanlong believed these price forecasts to be too optimistic.

Mt. Hope — General Moly (GMO-T, GMO-X) has been working to bring its Mt. Hope project in central Nevada into production by late 2010 or early 2011. The company says the project will produce 40 million lbs. moly per year for its first five years, and capital costs are estimated at more than US$1 billion.

As is the case with Climax, this production may create an oversupply situation. However, unlike Climax, where Freeport has the financial strength and the market presence to meter production, it is likely Mt. Hope will be highly leveraged, thus making it difficult for General Moly to reduce production in the face of market surpluses.

Because of the recent price volatility, General Moly has placed the project on hold.

Codelco — In Chile, molybdenum production by the world’s largest copper miner, state-owned Codelco, is forecast to be much reduced in 2008 and 2009 due to lower moly grades in their copper-moly operations.

Codelco produced 68 million lbs. of moly in 2006, 60 million lbs. in 2007, and only 46 million pounds in 2008.

Its huge Chuquicamata copper mine, at 29 million lbs. byproduct moly in 2008, is expected to maintain and grow its moly production slightly over the next 10 years. Its Salvador copper mine, currently producing 3 million lbs. moly per year, is expected to cease production after 2011, while its Andina copper mine is expected to increase moly production from 5 million lbs. in 2008 to 12 million lbs. by 2015.

China — The Chinese economy has grown at annual rates near 10% for the past two decades. USGS data indicate that 2007 moly production in China increased by 36% over 2006, up 35 million lbs. to 132 million lbs. In 2008, China’s moly production is estimated at 170 million lbs., or a 29% increase.

With this year’s price weakness, and the closure of many small and high-cost mines, production in 2009 is estimated at 140 million lbs. As I’ve stated, all these Chinese numbers need to be viewed with skepticism.

More delays — The global credit crisis has already impacted new moly projects. In addition to the Climax delay, Inca Pacific Resources (IPR-V, IPRFF-O) a year ago announced that it would cancel its orders for long-lead time equipment at its Magistral moly project in Peru, and focus on obtaining its permits before deciding on mine construction.

In October 2009, Activos Mineros, the Peruvian government agency responsible for administering Inca Pacific’s contract, announced its intention to withdraw $3 million that the company had on deposit as security for its investment commitments at Magistral.

Activos contends Inca Pacific did not satisfy certain minimum investment and expenditure obligations in fiscal 2008 — an assertion the company disputes.

The Activos agreements involve the central core claims at Magistral. Inca Pacific controls the surrounding claims that would be needed for project development.

Inca Pacific says it is also negotiating to secure an extension to the deadline for bringing Magistral into production, currently set at Dec. 31, 2011.

Most other planned new moly projects, with the notable exception of Spinifex Ridge, have been placed on a delayed or suspended development track. Thompson Creek Metals (TCM-T, TC-N) suspended the development of its Davidson project in Smithers, B.C., and Quadra Mining (QUA-T) took a similar step at its 98.2%-owned Mamlbjerg open-pit moly project in Greenland.

However, with the price strength in mid-2009, Thompson Creek announced it would be producing a bit more from its mines than earlier forecasts.

Longer term

As outlined above, oversupply conditions may dominate the market for the next couple of years. But in the longer term, moly demand should outpace world economic growth. There will be a need for new oil production and nuclear plants, both of which consume large quantities of moly. Governments around the world have initiated economic stimulus plans that include large infrastructure projects. And new uses for the metal continue to be found.

The case for a return to high long-term moly prices depends to some extent on continued high world economic growth. But the specifics of moly demand may support higher prices in the longer term, even if we see slower overall growth around the world.

Beyond 2012, existing producers are not forecast to be able to increase molybdenum production and any increase in world consumption will require the opening of new mines.

Conventional economic thought is that the price of a commodity in an expanding market will be set at the marginal cost of bringing in new production. For moly, excluding Climax, the marginal cost of bringing the new projects on stream is estimated at something north of US$15 per lb. Some of the big swing producers are a number of smaller mines in China where the estimated cost of production is US$13 per lb. or more.

Another factor in the molybdenum price has been its very high statistical correlation (over 90%) with the price of oil (see accompanying chart).

While correlation does not necessarily mean causation, molybdenum has significant uses in oil-pipeline and drill steel, and it is used as a catalyst to remove sulfur from fuels. If this relationship continues, it implies that at US$67-per-barrel oil, the price of molybdenum oxide should be US$22 per lb.

The recent price volatility has created a problem for primary moly project developers. In order to obtain project financing, most of these projects require long-term moly prices of US$14 or more per lb. to be attractive.

Even though most long-term price forecasts for moly are at that US$14 level or higher, price risk is certainly higher and bank project-financing terms are going to be tough. The uncertainty of the production and consumption numbers coming out of China adds another level of risk.

Copper projects with byproduct moly will have an easier road, but it will be very tough for primary moly project developers to obtain financing on reasonable terms, especially when the cost of development is in the US$1-billion range.

If any new primary mines do get financed, as in the Spinifex Ridge financing described above, the prospects for financing subsequent primary projects will become increasingly difficult. These risk factors will very likely delay new primary moly mine production.

So, a long-term forecast for moly in the US$14 to US$17-per-lb. range seems reasonable. Obviously there are going to be short-term oversupply or undersupply conditions that take prices substantially above or below this level for periods of a few quarters at a time.

— The author is a registered professional mining engineer and president of Western Troy Capital Resources (WRY-V, WTCRF-O), a mineral exploration and development company with projects in Quebec. More detailed information and backup data related to this article can be found at www.westerntroy.com .