Graphite: Hot commodity or hyped commodity?

Lithium and rare earth metals became the “it” commodities in the mining industry over the last few years, and now there is a growing consensus among industry watchers that graphite is set to take the stage in their wake.  

Until now, graphite has been known for humbler traits, such as being the stuff in pencils or its status as the poor cousin of crystalline, pure carbon forms, compared to splashy diamond.

But graphite may be set to grab some of diamond’s sparkle as new uses are found for the material that could make it a key contributor to the economy of the future. Those who celebrate graphite’s virtues point to its use in lithium ion batteries — they contain 10 times more graphite than they do lithium — its key role in the next generation of nuclear reactors and its applications for graphene, a durable and malleable form of the material. 

But skeptical investors have, no doubt, heard about the next “hot” commodity plenty of times before, only to see the initial fervour fizzle and company stocks that were supposed to rocket to new stratospheres instead limp along, or languish.  

The best place to start when sussing out the reality versus the hype is to look at the fundamental factors of supply and demand. 

Indeed, the ground swell of interest in graphite can be traced back to an emerging supply crunch. China — the world’s largest graphite producer with 70% of global production — is mining its deposits dry, and seems intent on keeping more of what it has for itself. 

“In the short term, supply issues are driving stronger pricing for graphite,” Jonathan Lee, an analyst with Byron Capital markets, says. “Chinese companies are trying to consolidate the industry to get better control, and there are also tax and environmental issues that are factoring in.” 

China has implemented two taxes connected to graphite while slapping on a 17% value added tax on the material and a 20% export duty as well.  

The environmental issues have to do with using hydrofluoric acid when upgrading the material to higher grades fit for battery-use. The government is now cracking down and pushing alternative processes — such as hydrochloric leaches or a thermal process — that will increase production costs. 

Those higher production costs, combined with higher taxes and fewer exports out of China, have been the key drivers behind graphite more than doubling its price since 2008’s market sell-off.

But with price gains already realized, is there much time left for miners to build projects and take advantage of tantalizing margins, especially considering that graphite demand is in the neighbourhood of 1 million tonnes per year, with global production capacity estimated at 1.4 million tonnes? 

“I think the supply issue will be here for the next two years, and by that time Northern Graphite (NGC-V) will be in production,” Lee says. “And if it lasts four years, we think Focus Metals (FMS-V) will get into production.” 

In the longer term Lee sees growing demand for lithium ion batteries becoming the number-one driver for higher graphite prices.  

Hybrid and electric vehicles could strain supplies, but it is important to note that the graphite many miners are chasing isn’t generally used in battery production. 

Both Northern Graphite’s Bissett Creek and Focus’s Black Knife host high quantities of large-flake graphite which, while being the most valuable form of graphite, isn’t used in lithium ion batteries. 

Large-flake graphite is considered too expensive to use in batteries, because manufacturers can upgrade cheaper, smaller-flake graphite for their purposes. 

For now, large-flake demand comes principally from the foil market because the material is more easily pressed into sheets and can be used as heat spreaders in computers, non-corrosive lining in fuel cells and gaskets for the automotive industry. Demand here remains robust, but is more closely tied to overall economic growth — unlike the battery sector, which is expected to grow at faster rates than the global average.

Supply and demand metrics, however, only tell part of the story when trying to decipher whether an emerging industry has real substance.

For a deeper look, there is likely no better place to turn to than the old legend of industry analysis, Harvard Business School’s Michael Porter. The professor is famed for outlining the five forces that shape a healthy industry, of which three have particular relevance for graphite: the bargaining power of buyers, the threat of substitutes and the threat of new entrants. 

End-users’ power?

The idea here is that the more power buyers have, in terms of influencing price, the worse it is for the industry. 

With specialty commodities that don’t sell on spot market, like lithium and rare earths, the projects that become mines are generally those that secure offtake agreements with end users or trading houses. The offtakes guarantee a buyer for the product and secure financing for capital costs. 

So how much power do buyers have in the graphite market, and can a mine get built without an offtake agreement?

Neither Northern Graphite nor Focus have signed offtake agreements, and Lee offers that part of the reason may be that graphite hasn’t yet attracted the attention of the Korean and Japanese trading houses that often sign such deals with miners. 

Northern Graphite’s chief executive Greg Bowes says that while an offtake agreement is nice to have  — and he imagines Northern Graphite will sign one eventually — they are not as critical as they are with lithium or rare earth projects. With those two commodities, the capital expenditure (capex) associated with building mines is so high that companies need the offtakes to help secure financing.

In the case of Northern Graphite’s Bissett Creek, the capex will likely come in around $80 million, while Focus estimates that Lac Knife will cost $65 million to build. 

“The point is, if you have to raise $200 to $500 million for capex — and some rare earth projects are coming in at over $1 billion — an offtake agreement becomes a more important part of the mix,” Bowes says.  

Bowes also says that buyers have less power than they do in lithium and rare earth markets because graphite sales are generally done directly between buyers and sellers, without using trading houses, and it is a big market.

“At over a million tonnes of demand a year, the graphite market is almost as big as nickel. It’s not a small specialty market like rare earths and lithium. There are literally hundreds and hundreds of people that buy graphite,” he says.  

The threat of substitutes

Part of the graphite story that isn’t always talked about is the fact that the material doesn’t need to be mined at all — it can be made. 

Synthetic graphite is made from petroleum coke mixed with coal tar pitch and baked at extremely high temperatures. 

“In most applications, synthetic and naturally sourced graphite do not compete. The one area where they can compete is in lithium ion batteries,” Bowes explains. 

Lee says
synthetic graphite is already used in lithium ion battery production, but he believes the market trends towards the naturally sourced material. 

“The biggest challenge for electric vehicles is range anxiety and cost, and batteries using synthetic graphite are more expensive to date,” Lee says. “We believe that any cost savings that can be done on the manufacturing side will lead battery manufacturers to use natural graphite over synthetic.”

With the lithium ion battery market expected to grow at 15% per year going forward, that could translate into massive new demand for emerging miners. 

Bowes contends that the higher cost of synthetic graphite isn’t its only drawback. He says that synthetic doesn’t perform as well as natural graphite, and that there is a limited capacity to make synthetic. It will be difficult to increase that capacity because of a furnace’s high capital costs. 

“It’s cheaper to build a mine than to build a furnace,” he says. 

The threat of newcomers

So just how rare are graphite deposits? And is there a danger that recent higher prices will spur the market into oversupply in a relatively short time span?

“I don’t think graphite in the ground is in short supply around the world,” Lee says. “There are certain belts that could expand. Many companies haven’t done compliant resources so there are likely companies that could expand production.”

Focus Metals chief executive Gary Economo echoes Lee’s sentiment, but argues that cost advantages will determine which mines survive in a worse-case scenario. 

“There is a danger of too much supply,” Economo says. “That is a concern in the industry. But there’s not much of a concern from our point of view, because our [projected] costs are just US$350 per tonne. So regardless of how much supply comes on and impacts pricing, we are sheltered.”

Bowes contends that while there may be a lot of graphite in the ground, most of it is best left there.  

“Graphite is common, but economic deposits are rare,” he explains. “China has over exploited near-surface deposits so much, that even though prices have tripled, there’s been no supply response from China.” 

When graphite prices spiked in the 1980s, many deposits were discovered and proven up. Indeed, both Bissett Creek and Black Knife were discovered and advanced during that last cycle. 

The situation means that the graphite world already has a good idea of what deposits are out there, and Bowes says there simply aren’t that many. 

“We need new mines just to replace old ones that are winding down,” he says. “Then we need more to meet new demand. Over the next five years, there is easily room for five to ten new mines.” 

The next wave

Armed with a better sense of how the graphite industry stacks up, let’s take a closer look at some of the company’s best positioned to take advantage, should the bullish trend continue.  

Of the emerging junior companies trading in Toronto, Lee favours Northern Graphite, and Byron Capital has a speculative “buy” on the stock, with a $1.90 target price.

“It’s a near-term producer that should be in production by the end of 2013, and we think it has some legs,” he says. “The metallurgical work is already done so the feasibility study will be the next catalyst.”

Bissett Creek is a large-tonnage, lower-grade deposit with a 26-million-tonne indicated resource grading 1.81% graphitic carbon, plus 55 million inferred tonnes grading 1.57% graphitic carbon. 

“The uniqueness of the project is that almost the entire grade is large flake,” Bowes explains. “That makes for simple metallurgy. We can produce large-flake concentrate with 94% to 98% carbon, and that is the el primo, highest-priced stuff.”

Bowes is also bullish on lower mining cost associated with having a “flat-line” graphite deposit at surface. 

“We can produce 20,000 tonnes per year for 40 years, and we can double production by spending less than half of the initial capex,” he says. Initial capex is estimated at $80 million.

The company is considering a project that would mine at a strip ratio of 0.5 to 1, and produce large-flake concentrate at a US$1,000-per-tonne cash cost. 

Northern Graphite plans to have a bankable feasibility study out in a few months.

Bowes is adamant that the deposit’s relatively low grade won’t hurt the mine’s economics.   

“The point people often miss is that this isn’t a base or precious metals mine where everyone gets the same price for their production and grade is king,” he says. “With industrial materials you have to look at the chemical composition of the ore. Other projects may have higher grade, but only 20% to 40% of their production is large flake.”

Bowes questions whether the economics for a project that produces large quantities of micro flake — typically defined as graphite that is less than 80 mesh — will offer the types of margins that a mine needs to be profitable. 

Large-flake graphite that is greater than 100 mesh sells for between US$2,500 and US$3,000 per tonne, while fine flake at less than 100 mesh sells for between US$2,000 and US$2,400 per tonne. 

But Gary Economo of Focus metals contests that point. Focus’ Lac Knife is one of the world’s highest-grade deposits, and Economo says those grades are the key to a future mine’s economic success. 

“Other factors always come in, but at a base level you have to have the grade,” he says. “If you don’t have the grade it’s not even worth spending capex to set up a mine, because the production costs get too high.”

Economo says that an average 2% grade of technological-grade graphite can’t be manufactured for less than US$1,500 per tonne. 

Focus plans to produce graphite at a pure, 99.99% level for the battery industry at cash costs of US$350 per tonne. The company expects to have a preliminary economic study done by April. 

Positive results there will allow Focus to push for production before 2014. With two non-compliant historic feasibility studies already done on the project — one in 1990 and the other by Cambior in 2000 — Economo says the company will likely push to production without doing another. 

A resource estimate released last December outlined 4.97 million tonnes of measured and indicated resources grading 15.67% graphitic carbon, with 3 million inferred tonnes at 15.58% graphitic carbon. 

Like Bissett Creek, Lac Knife has good infrastructure. The company plans to truck ore from the deposit to a processing plant that would be built 26 km north near Fermont, Que. Bissett Creek and Lac Knife have good access to roads, power and water, and do not require mining camps.

Focus wants to start up the operation at a 25,000-tonne-per-year production rate, and is considering an upgrade facility at the mine that would get ore from the 16% graphitic carbon grade up to 60% before it leaves the site. Such an upgrade would boost production by 60,000 tonnes to 70,000 tonnes per year. 

Economo says the technology used in the upgrad
e facility has been used with diamonds but not with graphite. He expects to have a feasibility study done on the process by year-end. 

While Northern Graphite and Focus are the most advanced graphite plays trading in Toronto, they aren’t the only way to play the commodity. 

Energizer Resources (EGZ-T) in Madagascar has discovered what could become a large-scale graphite deposit. 

Until recently the company was known in the market for its Green Giant vanadium project. But Energizer’s chief executive Kirk McKinnon says vanadium is now on the back burner as Energizer shifts its focus to large graphitic showings to the south and east of its vanadium deposit.

Energizer was always aware of  its graphite — even its vanadium deposit had graphite — something that the company originally viewed as little more than a nuisance. 

But with the growing interest in the material Energizer began to take notice of large-surface showings near its property boundaries. The company then worked diligently to lock up the prospective land, and last December it completed a joint venture with Australia-based Malagasy Minerals for the ground, which it has placed under the umbrella of its Green Giant project. 

For Energizer, the agreement secured a 75% stake in the ground for $2 million in cash and 7.5 million of its shares. 

The company has $7 million in cash and plans to spend it on a preliminary economic study. McKinnon says it will focus not just on the material in the ground but also on all the issues around production, such as its chemical composition and metallurgy. 

“At the end of the day, its not just how much graphite you have — and we have a huge amount — it’s the quality of graphite as it relates to applications in the marketplace,” he says. 

To ensure that it gets that part of the story right, Energizer is working closely with DRA, one of the largest mine construction firms in Africa. DRA is taking a small equity position in Energizer and will be handling engineering, procurement and construction management at Green Giant.  

And while it is early, the company states it has 17 graphitic zones over a strike length of 320 km. Of the 17 zones, Energizer is drill-testing seven, with Fondrana showing the most promise owing to the thickness of the graphitic zone.  

Fondrana’s initial results show a 119-metre highlight intercept grading 6.24% graphitic carbon. Trenching on the zone returned a 106-metre highlight assay grading 7.11% graphitic carbon. 

Energizer expects to have a resource estimate out by October. 

Other names in the space

In December Lara Exploration (LRA-V) acquired the Caninde graphite project in Brazil. The company describes the project as early stage.

Orocan (OR-V) has 12 graphite projects in Ontario and Quebec. For 2012 the company plans to fly an airborne electromagnetic study and launch first-phase drilling on 10 new targets. 

Vancouver-based Lomiko Metals (LMR-V) has the  Quatre Milles graphite property in Quebec. The project has seen historic drilling of 26 diamond drill holes for 1,625 metres, with a 29-metre highlight intercept grading 8.07% graphitic carbon. 

Zimtu Capital (ZC-V) has been an aggressive facilitator in the space, and has taken surging interest in the material to farm out several projects. 

Last September it farmed out Deep Bay East and Simon Lake in Saskatchewan to Strike Graphite (SRK-V). 

In November it farmed out the Black Donald and Little Bryan to Orocan, and in December it farmed out Quatre Milles in Quebec to Lomiko.