China Uncertainty Dominates Moly Market

Molybdenum producers and developers have been on a roller coaster ride for the past year. Between 2004 and 2008, molybdenum oxide (moly) prices seemed to have found a home in the US$30-to US$35- per-lb. range. And even as most other base metals went into freefall during the summer of 2008, moly prices held. However, as fears of world recession spread in late October 2008, the bottom dropped out: moly prices fell swiftly through US$20 all the way to less than US$8 per lb.

In mid-2009, moly prices rebounded north of US$18 per lb. as Chinese exports fell dramatically and imports expanded. Then in late August, buying out of China dried up and prices began to weaken. As this is being written, prices have come down to the US$11-per-lb. range.

Outside of the past year’s wider economic disaster, what has specifically affected moly? First, the reader needs to understand that the big problem when building up market intelligence in moly is the unreliability of production and sales information coming out of China. And since China accounts for at least 30% of world production, forecasting world supply and demand for moly will continue to be difficult and frustrating.

This uncertainty is illustrated by looking at two sources of moly production data for China during 2008: The U. S. Geological Survey’s (USGS) Minerals Information Office reports 132 million lbs., while Ryan’s Notes concludes it was 180 million lbs., or a difference of 36%.

Overall world moly production in 2008 is estimated at a record 467 million lbs., a 5-million-lb. increase over 2007. But that production peak in 2008 reflects the price strength of the prior five years, as there was a very quick and large price fall in October 2008.

Why the sudden price break? About 80% of world moly production is consumed by the steel industry to make high-strength steel. Moly is bought primarily by steel mills in anticipation of, or as a result of, orders for specific projects.

In the previous period of high world economic growth, steel mill operators had been quite confident of a smooth stream of orders. So these mills kept relatively large inventories of moly and other commodities so they could be assured of their ability to meet demand and maintain market share.

However, as the U. S. credit crisis spread around the world and fears of a world recession grew, there was a new level of uncertainty surrounding future projects. So steel mills just stopped ordering moly and even cancelled some existing orders. This meant steel mills would not be ordering moly until they had consumed their inventory and their order flow picked up.

This left many moly traders with unsold inventory, most of which was financed with bank credit lines. Panic selling set in among traders as their credit lines were called in by banks which were fighting their own battles for survival. The sell-off in moly was quick and ugly.

Another factor may have intensified the sell-off. There is currently no futures market for moly, so prices are determined by current trades between consumers, producers and some traders. The published market price for moly is based largely on anecdotal reports of trades by a few trusted sources, not on any exchange-traded index. Thus, there is no buffering of pricing that might be expected if futures contracts were available for trading.

World moly production for this year is estimated at 424 million lbs., or 41 million lbs. (9%) less than 2008. Primary producers made substantial cutbacks, and did so more quickly than has been typical for mineral producers in the past. This is because mines have become more automated and can react faster to market changes. Mine productivity has also increased dramatically over the past couple of decades, so production cutbacks can be accomplished without the loss of large numbers of key personnel.

The world’s largest primary moly producer, Freeport-Mc-MoRan Copper & Gold’s (FCX-N) Henderson mine in Colorado’s Clear Creek County, produced 40 million lbs. moly in 2008, but within days of the price collapse in late 2008, Freeport announced Henderson would be cut back to 60% of its capacity. Freeport also quickly suspended the reopening of its Climax moly mine, even though close to US$200 million of the US$500 million required to reopen the mine had already been spent or committed.

In the second quarter of 2009, demand in Europe and North America began to pick up as steel mills finally worked through most of their stocks of moly and the order stream began to pick up. During the winter of 2008-09 most of these mills were operating at something under half of capacity, when before the crash, most were operating at above 85% of capacity.

This year’s moly production in China is estimated to be reduced by 30 million lbs., mostly from high-cost producers where some observers estimate the cost of production at about US$13 per lb. This may be an indication that long-term moly prices might stabilize at something above US$13 per lb.

The price rebound in 2009 has been attributed to mine closures in China and strong demand from Chinese buyers. In the first half of 2009, China was a net importer of 35 million lbs. as compared to net exports of 25 million lbs. in the first half of 2008.

The big question has been whether Chinese buyers have been building inventories or actually consuming the metal. Anecdotal evidence suggests inventories were being built as Chinese consumers were apparently taking advantage of what they perceived to be low prices for moly. The recent price decline is partially attributed to the fear that these stocks will come back into the market soon.

In 2010, increased production from copper mines that produce moly as a byproduct is forecast to increase world production to an estimated 471 million lbs., or up 10% over 2009 and breaking the previous all-time record of 467 million lbs. in 2008.

The byproduct producers are naturally more sensitive to copper prices, which are currently strong. While they may be able to stockpile moly production if moly prices weaken substantially, the incentive is to go ahead and sell the moly, no matter the price.

The largest increases in byproduct production will come from three sources: Anglo American (AAL-L, AAUKY-Q), Xstrata (XTA-L, XSRAF-O) and a Mitsui-led Japanese consortium’s Collahuasi copper mine in Chile (to 13 million from 7 lbs. byproduct moly); Mercator Minerals’ (ML-T) Mineral Park copper-moly mine in northwestern Arizona (10 million lbs. of new moly production); and Rio Tinto’s (RTP-N, RIO-L) Bingham Canyon copper mine in Utah (to 30 million from 23 lbs. moly).

The demand for moly is not expected to keep pace with this estimated production increase. Unless primary producers reduce even more than they have already, oversupply conditions may dominate the market for the next couple of years.

Project News

• Climax & Henderson mines — In November 2008, Freeport announced it would delay construction at Climax and reduce production at 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 product
ion at these mines is relatively easy as they are primary moly producers. Freeport says 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 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 lbs. 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 the 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 Magis- tral 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 forecast.

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.

While correlation does not necessarily mean causation, molybdenum ha
s significant uses in oil-pipeline and drill steel, and it is used as a catalyst to remove sulphur 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, such as Spinifex Ridge, 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 ofWestern 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 .