Lead in the graphite pencil

PORTFOLIO POINT: A number of Australian miners have been riding the global graphite boom, and some investors have achieved huge returns. An industry shake-out is looming.

Graphite, a mineral best known for its use as “lead” in pencils, has been a speculator’s favourite this year for very good reasons. However, the next few months should see a shake-out of pretenders, leaving a handful of long-term winners.

Separating survivors from casualties in what has been a classic case of investors “discovering” a commodity that has the potential to be a star, but is not quite there yet, can be done if a few basic rules are followed.

Ore grade is the first test – the higher the better. Access to infrastructure is the second, closely allied to a third factor, which is proximity to customers who want a source of graphite separate from Chinese suppliers who currently dominate the business.

Tick off those basic rules and you quickly get down to a handful of Australian-listed companies with a chance of actually going into production, including:

• Syrah Resources (SYR), which has rocketed up by more than 1500%, from 16c to $2.73 (down from a high of $3.10 in August) over the past 12 months, thanks to the discovery of a world-class graphite deposit in the east-African country of Mozambique.
• Talga Resources (TLG), up 150% from 12c to 30c (down from a high of 77c in May), thanks to work on a well-located and very high-grade graphite deposit in northern Sweden.
• Archer Exploration (AXE), up by 72% from 11c to 19c (down from a high of 45c in May), thanks to a high-grade graphite discovery on the Eyre Peninsula of South Australia, and
• Kibaran Resources (KNL), up 250% from 3.7c o 13c (down from a high of 65.5c in September), thanks to a graphite discovery in Tanzania.

Those share price moves, especially the high points reached over the past 12-months, illustrate the trading frenzy triggered by news (and speculation) swirling around what is actually a fairly common commodity that is enjoying its time in the spotlight.

The speed at which graphite burst on the investment scene, and the risks attached by such a sudden surge, can be seen in the stampede of junior Australian and Canadian explorers into the sector this year.

At this time last year there were a handful of companies with graphite assets on their books, perhaps as few as 20 around the world. Today, there are more than 100, mainly Canadian, but with about 20 ASX-listed, including the four mentioned above and others such as Lincoln Minerals (LML), Lamboo Resources (LMB), Castle Minerals (CDT), Monax Mining (MOX), and Bora Bora (BBR), which is the latest day-trader darling that has doubled to 47c in the past three weeks after announcing the acquisition of a graphite deposit in Sri Lanka.

A combination of events underpin the graphite boom, with some of those events seen in earlier bursts of interest in particular commodities, including rare earths and lithium. These also blossomed as buyers poured in, only to fade as the herd headed for the exits.

The dominant role of China as producer and customer is one of the common threads linking graphite with earlier booms in rare earths and lithium. Emerging high-tech uses is another link.

In the case of graphite it has been production cut-backs in China, and the rapid rise in the production of electric cars (and other devices which need long-life batteries), which has seen the benchmark graphite price double since 2007 to around US$2200 a tonne, with premium-quality material used in high-tech applications fetching much higher prices.

Price, however, is one of the first hurdles for investors trying to understand the graphite market. An abundance of the material in many countries other than China is a second consideration, and the potential for gross overproduction IS a third tripwire if demand from new technologies does not emerge as rapidly as tipped.

The major use of graphite today, either in its natural, mined, form or as a synthetic produced as a by-product of petroleum refining, is in mundane applications such as electrodes in metal smelting (33% of consumption), refractory bricks (20%), followed by uses in carbon fibre, and heat-resistant products for high temperature applications such as in engines – and, not to be forgotten, pencils, which consume around 7% of global production.

Technically, graphite is a form of carbon, belonging to the same family as diamonds and coal, with an early use being as a source of heat despite being hard to ignite.

But, what has really caught the imagination of speculators is the use of graphite in long-life batteries such as lithium-ion batteries, thanks to its excellent properties as a conductor of electricity and, more recently, its astonishing atomic structure and potential as a super-material in multiple applications.

Graphene, a fluke of nature, is the only two dimensional (or flat-lying) substance known, just one atom thick but with a hexagonal, honeycomb structure that gives it enormous strength (200-times stronger than steel). Plus it has unique electrical conductive properties, with future applications in products such as touch-screen computers. Its discovery earned two scientists at Manchester University in Britain the 2010 Nobel prize for physics.

It will probably be many years before graphene finds a place in industry applications, though not for lack of research. More than $1 billion is being invested in a worldwide research effort, including a $55 million investment by the British government in a graphene research centre at Manchester University.

What the discovery of graphene highlights is that “graphite ain’t graphite”. It is a material which comes in many forms, from low-grade (and low-priced) “amorphous” graphite, to the high-quality (and high priced) “flake” graphite preferred by battery makers.

It is virtually impossible to wrap the many factors affecting graphite into a single, cohesive investment story because it is a work in progress, a reason why I accepted an invitation to visit Talga’s projects in Sweden earlier this month.

What I found was a small company which has got a tiger by the tail, having paid a modest $433,500 earlier this year for a parcel of exploration assets owned by the big Canadian miner, Teck. Included in the assets, located close to the Kiruna iron ore mine, was an already-proven graphite deposit called Nunasvaara.

Of little interest to Teck because it prefers major, and more easily traded commodities, such as coal and copper, Nunasvaara has caught the eye of investors because it is ranked as the richest graphite deposit in the world. The latest resource calculation stands at 7.6 million tonnes of ore assaying 24.4% graphite, with more to come as exploration continues.

Getting Nunasvaara, or one of the other high-grade deposits on its tenements into production, should be relatively easy for Talga, as should be selling material into an under-supplied European graphite market that has become reliant on imported Chinese material.

The capital cost for a starter project at Nunasvaara is estimated to be around $60 million. There is a well-established transport corridor to the port of Lulea (used to export Kiruna iron ore), and Talga has just signed a memo of understanding with the port owner.

Syrah, which has been the market favourite, also has a transport and port solution, and what looks to be a monster deposit. This is being drilled up to an exploration target of between 700 and 900 million tonnes of material assaying between 10% and 11% graphite, plus there are useful amounts of the steel-hardening mineral vanadium.

Archer’s Campoona project has infrastructure on its doorstep and an exploration target of between 40 million and 70 million tonnes of material grading between 10% and 12% graphite.

Kibaran will have the harder infrastructure challenge but caught the eye of the market this week with fresh drill results that included a 53 metre intersection assaying 10.4% graphite at its Epanko project in Tanzania.

Confronting all of the emerging graphite hopefuls, but probably not high in the consideration of speculators, is the size of the global graphite market and the chances of them actually finding an opening.

According to the respected industrial mineral consultancy, Roskill, global demand for graphite last year was 2.41 million tonnes, with high-spec (high-value) batteries accounting for just 85,000 tonnes.

The total value of global graphite production at around US$12 billion is also modest compared with better-known minerals such as copper and zinc, with electrodes used in metal smelting accounting for US$5.5 billion and carbon fibre US$3 billion.

Just how difficult it will be for the 100 or so graphite hopefuls to move from exploration and evaluation into production was outlined by a speaker at a graphite conference I attended in London last week.

Martin McFarlane, chief executive of Canadian-listed Flinders Minerals, told an audience of 200 analysts and graphite experts that he saw room for between “two and four” new graphite mines, a comment which reflected the potential for currently mothballed Chinese mines to re-enter the market.

An Australian engineer by training, with a career that includes time at Pasminco and Zinifex, McFarlane is confident that the Kringel graphite mine Flinders is re-developing in Sweden will take one of those spots, further narrowing the opportunity for new entrants.

Speculators will probably continue to play their trading games with graphite hopefuls, so long as positive news flow continues.

More cautious investors will dig a little deeper and filter out the stocks likely to graduate from explorer to miner (a list that includes Talga, Syrah, Archer and Kibaran) from those destined to be casino chips.