Moly market ready for a rebound?

Molybdenum prices seemed to have found a home in the US$30- to US$35-per-lb. range for the past couple of years. Even as most other base metals went into freefall during the past few months, moly prices held.

However, as fears of world recession or depression spread in late October, the bottom dropped out. At presstime, moly prices had fallen swiftly through US$20 all the way to US$11 per lb., a level some market observers reckon may be very near the bottom.

Why the sudden price break? There is currently no futures market for moly, so prices are determined by current trades between consumers, producers and some traders. There is no buffering of pricing that might be expected if futures contracts were available for trading.

About 80% of world moly production is consumed in 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 jobs.

With high world economic growth and lofty oil prices (moly is used in oil-drill steel and pipelines), steel mill operators had been quite confident of a smooth stream of orders.

However, as the U. S. credit crisis has spread around the world and fears of a world recession have grown, there is a new level of uncertainty surrounding future projects that use large amounts of high-strength steel. So steel mills just stopped ordering moly and even cancelled some orders already placed. This left many moly traders with unsold inventory. Panic selling set in.

It is possible that this quick sell off could be followed by a fairly rapid recovery as the financial crisis is resolved, fears are soothed by actual knowledge of the extent of a possible world recession, and the order flow from steel mills resumes.

In the longer term, the demand for moly should outpace world economic growth. There will be a need for new oil production and nuclear plants, both of which consume large quantities of molybdenum. Governments around the world are considering 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 molybdenum 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 growth around the world.

So what does all this mean for moly project developers? In order to understand this, some historical perspective is needed.

About 50% of world moly production is generated as a byproduct of copper mining. Many of the large copper mines around the world have small percentages of molybdenum in the ore, typically 0.02-0.03% moly, and it’s relatively simple and cheap to recover the moly. Marginal costs of producing molybdenum may be as low as US$2 per lb. for byproduct producers.

During periods of low or declining demand, byproduct producers have been in control of prices. This is why moly prices were below US$5 per lb. between the early 1980s and 2000. Primary producers found it difficult to compete in such times because market prices were at, or below, their cash cost of production.

The dramatic increase in moly prices from the low of less than US$2.50 per lb. in 1999 to more than US$40 per lb. in 2005 certainly caught the attention of moly mine owners and exploration project developers. The huge price increase motivated most existing producers to expand production, and those with molybdenum prospects to accelerate the development process for earliest possible production.

However, existing producers have pretty much maxed out their ability to expand production of moly and the only real increase expected could be the restart of Freeport-McMoRan Copper & Gold’s (FCX-n) Climax mine in Colorado.

After that, 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. The marginal cost of bringing the new moly projects on-stream is estimated at something north of US$15 per lb.

World production for 2007 was 444 million lbs. moly, an increase of 8.7% over 2006. World production in 2008 is estimated at 474 million lbs., up 6.7% over last year. There are some reports of moly stockpiling in China, so it could be that world consumption will grow by something less than 6.7% in 2008.

However, in early November, Freeport announced it was suspending construction at Climax and reducing production at its Henderson mine, also in Colorado, by 10 million lbs. year, or 25%. Henderson has been the world’s largest primary producer of molybdenum.

Earlier, Freeport had committed US$500 million to reopen the Climax mine, and has spent US$150 million of that so far. Mill testing had been scheduled for the fourth quarter of 2009, and 2010 production was estimated at 28 million lbs. moly. Announced full capacity is 30 million lbs. moly per year, or about 6% of world production. If markets grow by the historical average of 4.5%, the addition of Climax production to the moly market might have created an oversupply situation in 2010.

Many industry observers believe Freeport could use the Climax mine to meter production to levels that maintain good market prices. Together, Freeport’s Climax and Henderson mines could produce about 70 million lbs. moly per year, or about 15% of world production. Freeport’s choice had been to either produce at high levels and depress prices, or cut back production and get higher prices.

Metering production at these mines would be relatively easy as they are primary moly producers; it’s more difficult at copper mines where moly is a byproduct.

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 the opening of other large moly mines.

General Moly (GMO-T, GMO-x) has been working toward bringing 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. 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.

In Chile, molybdenum production of state-owned Codelco is forecast to be much reduced in 2008 and 2009 due to lower moly grades in its copper-moly operations. Codelco produced 68 million lbs. moly in 2006, 60 million lbs. in 2007, and is projecting 50 million lbs. in each of 2008 and 2009.

Meanwhile, the Chinese economy has grown at annual rates near 10% for the past 20 years. Data from the U. S. Geological Survey indicate that 2007 moly production in China increased by 36% over 2006, up 35 million lbs. to 132 million lbs. The USGS’s explanation is that Chinese mines that were closed in 2005 for environmental and safety concerns are coming back into production.

In July, Ryan’s Notes reported that molybdenum production at China’s state-authorized mines in the first half of this year totalled 68 million lbs., a 21% increase over 2007. If that rate continues for 2008, China would produce 162 million lbs., a 23% increase over last year. However, because of the earthquake in Shaanxi province, mine shutdowns for safety checkups in Henan province, and the prohibition of the use of explosives near Beijing around the time of the Olympics, production of moly will likely slump in the third quarter.

The author’s estimate for Chinese production is 145 million lbs. for 2008. Because of the uncertainty of production, consumption and export data that comes out of China, and the fact that China now accounts for about a quarter of world molybdenum production, the overall reliability of world production and consumption forecasts is much less than might otherwise be the case.

The credit crisis has already had an impact on new moly projects.

In early November, Inca Pacific Resources’ (IPR-V, IPRFF-o) 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.

Meanwhile Thompson Creek Metals(TCM-T, TC-n) suspended development of the Davidson project in British Columbia, and Quadra Mining (QUA-T, TC-n) took a similar step at its Malmbjerg open-pit moly project in Greenland.

It’s not unreasonable to assume that similar announcements will be forthcoming for most of the remaining larger planned projects.

If moly markets grow by the historical average of 4.5% annually over the next three years, and had the Climax mine come on-stream in 2010, and no other new mines are developed between 2009 and 2011, then markets may be balanced in 2009, an oversupply of 23 million lbs. might have occurred in 2010, and a supply deficit of 6 million lbs. would likely follow in 2011.

If moly markets grow at 7% per year over the same period, and again assuming Climax had come on stream in 2010, there might have been a supply deficit of 11 million lbs. in 2009, 2 million lbs. in 2010, and 46 million lbs. in 2011.

Acquisitions

There have been some significant molybdenum acquisitions during the past couple of years:

• Aluminum Corp. of China (Chinalco) (ACH-n) purchased Peru Copper, owner of the Toromocho copper-moly project in Peru, in August 2007. The price paid was $6.60 per share, or C36 per lb. of moly equivalent.

A scoping study for Toromocho may be developed over the next year. The porphyry copper deposit, in central Peru, hosts almost 1.4 billion tonnes of proven and probable reserves grading 0.51% copper, 0.018% moly and 7.1 grams silver per tonne. An additional measured and indicated resource of 601 million tonnes of 0.37% copper, 0.016% moly and 6.8 grams silver has also been calculated.

• In March, China’s Jinchuan Group acquired Tyler Resources, owner of the Bahuerachi coppermoly project, also in Peru. Jinchuan paid $1.60 per share for a total of $214 million, or C51 per lb. of moly equivalent.

A scoping study was completed on Bahuerachi last year and a preliminary feasibility study is in progress.

Of note, the price paid for Bahuerachi was for a project that has one of the lowest moly-equivalent grades (0.068%) of all the coppermoly projects that could be in production within the next five to 10 years. The weighted average moly equivalent grade of existing primary and byproduct surface moly producers is about 0.11%.

For example, Inca Pacific’s Magistral grades 0.129% moly equivalent, and Inca Pacific is currently valued by the market at about US3 per lb. of moly equivalent.

My company, Western Troy Capital Resources (WRY-V, WTCRF-o), has the MacLeod Lake moly-copper project in Quebec. Its moly-equivalent grade is 0.175% and Western Troy is valued by the market at about US5 per lb. of moly equivalent.

Earlier this year, Kobex Resources (KBX-V, KBXRF-o) withdrew from its agreement with U. S. Energy (USEG-q) to develop the Lucky Jack (Mt. Emmons) moly project in Colorado. Kobex indicated it withdrew because of its perception that permitting the mine would take longer than first thought.

In August, Thompson Creek Metals optioned the project from U. S. Energy, with Thompson Creek able to earn 75% of the project by spending US$400 million.

My study of the moly market has led me to eight conclusions:

1) The moly supply and demand balance may be maintained for at least a few years if demand grows at around 4.5% per year. Existing producers, should be able to meet market demand through the end of 2010. After that, production will be needed from new mines and it will take a market price of at least US$15 per lb. to open these new mines.

2) It would take a drop in demand of 30-40% for byproduct producers to become dominant in setting moly prices. Current moly producers’ operating costs have risen dramatically over the past few years. So even if oversupply conditions develop in the short term, it is unlikely we will see long-term prices below US$10 per lb. for the foreseeable future.

3) At current prices, almost all identified potential new mines would be economic and could come into production by 2015. However, the financial community will likely not support any project that requires US$25 per lb. for the life of the potential mine.

There is a race among the junior moly companies to see who can get financed first. Once one or two large projects are financed, the supply of moly should be able to meet demand, and securing financing for the larger potential primary moly mines would be difficult. These latter mines would need to be delayed, but would eventually be needed as, even at the lower growth rate of 4.5%, supply shortages will occur within 10 years. Of course, potential byproduct mines may have less difficulty in securing financing, as there will be less moly price risk. Projects controlled by large companies will have less difficulty securing financing.

4) The potential new sources to watch are Climax, Mt. Hope, Bugdainskoye in Russia, and Spinifex Ridge in Australia. These are all large potential producers that could come on-stream between 2009 and 2011. If all of these mines reach production along with a number of the byproduct and smaller projects, and demand does not grow at a rate above 4.5%, an oversupply condition will develop between 2010 and 2020, and long-term prices may stay below US$15 per lb. for that period.

If a significant percentage of future production comes from highly leveraged operations, there is a risk that when oversupply market conditions occur, highly leveraged producers will face difficult choices and may have trouble meeting debt payments.

Such companies may have little choice but to continue producing, even if market prices are weak. So moly prices may fall regardless of any attempts by financially strong miners to meter production.

5) One of the big factors driving the large price increases seen in 2004 and 2005 was the shortage of molyrefining (roaster) capacity. Additional roasting capacity has been added in recent years, so there is no longer a constraint.

However, total worldwide roasting capacity is now at about 480 million lbs. of moly. Since we are estimating total world consumption to exceed 480 million lbs. in 2009, we may see another squeeze on moly consumers and thus another price spike.

6) A good case can be made for the view that, because of high economic growth rates in China, India and other developing countries, and even if we have some major bumps along the way, we may be experiencing a quantum shift in world economic growth.

This, in combination with the dramatic growth in new uses for moly, may challenge the assumption that moly demand will grow at the historic average. We may be in the beginning of one of the longest peri- ods of much higher than average growth rates that moly markets have experienced. So a growth rate of 7% or higher is not out of the question over the next 10 to 20 years.

7) The current turmoil in world credit markets may stall world economic growth but, on the other hand, new moly projects that must rely on debt for project financing are unlikely to be able to raise money for development. One industry player characterized as “moribund” the current environment for obtaining moly project financing.

8) After 2020, all bets are off. It is unlikely we will see one of the 30-40% decreases in demand that have occurred in the past. If we experience even the average 4.5% growth in demand, it is unlikely that known sources will produce enough moly to meet growing demand and prices are likely to remain above US$20 per lb. for many years.

Up until the past few weeks, most observers did not see a world recession or even a return to historically average world economic growth rates as a result of the credit crisis.

However, this view is obviously changing and we are now seeing a much greater chance that world economic growth may stagnate in the short term. But even with a world recession, demand for moly may continue to rise and new mine production will be needed — although certainly not as soon as what was being forecast just a month or so ago.

With the delay of many new projects, maxed-out production or declines expected at existing mines, and even minimal growth in moly demand, prices above US$15 per lb. are likely in the long term.

— The author is president of Toronto-based Western Troy Capital Resources, and can be reached at Rex Loesby@aol.comor tel. 416-929-3268. This report is an abridged and updated version of a full, 22-page report available at www.westerntroy.com.