Advanced Energy TrendWatch – Q4 2017

Electric Vehicle Sales Accelerate

It’s no secret that a once-in-a-century shift is coming to the transportation sector. By 2030, the annual sales of electric vehicles (EVs) could easily hit 24 million, according to Bloomberg New Energy Finance. That’s a thirtyfold increase over today’s volumes…

Longtime readers know I’m a big fan of what I like to call “pick-and-shovel plays.” They are stocks or funds that allow an investor to profit from a sector by investing in something every manufacturer requires.

In the case of EVs, it’s the battery pack. And it’s a big one. Take a look at Tesla’s battery pack for its Model S sedan…

The current battery technology for EVs is lithium-ion. Knowing that, it’s easy to see how the demand for lithium is going to go through the roof.

The long-term investment thesis for lithium remains very compelling. The number of manufacturers announcing big EV model programs just continues to increase.

Battery costs continue to drop. By next year, EVs will be very cost-competitive with internal combustion engine (ICE) vehicles. That will spur EV adoption to take place at a much faster rate.

The EV adoption tipping point will begin in 2018. Many countries have already set dates beyond which ICE vehicle sales will be banned.

Norway is banning them after 2025. China recently announced it will ban the sale of ICE vehicles, although it has yet to specify a date.

Rest assured, China will eventually announce a date (probably 2030 or 2035). That will further increase lithium demand and provide a big boost to individual lithium stocks as well as lithium exchange-traded funds.

That’s why our portfolio already contains lithium and cobalt stocks. But as you can see, lithium makes up only about 1.25% of the battery pack by weight. Cobalt takes up slightly more space.

However, there are other essential raw materials used in the typical lithium-ion battery. In this quarter’s report, I’m going to be adding three new companies that produce one of those materials that’s needed for lithium-ion batteries to work.

That material is graphite.

There is about 10 to 15 times more graphite than lithium in a lithium-ion battery. As you can see, it comprises 100% of the anode in a typical lithium nickel cobalt aluminum oxide battery cell…

The enthusiasm around graphite is exciting, but the industry has been here before. Many of the companies that are entering the production phase today have deposits that were close to production back in the early 1990s.

That’s when China, the No. 1 graphite producer, raised its output. Prices promptly fell to $600 per metric ton from more than $1,300 per metric ton in the 1980s.

That sent many would-be producers out of the business. However, today we have a situation completely different from what was in place 30 years ago.

The electrification of transportation is underway. That is going to place incredible demands on graphite as well as lithium and cobalt.

Even with EV sales just starting to ramp up, flaked graphite prices are already in the neighborhood of $1,750 per metric ton. Before I get into the details on the three companies I’m recommending in this report, I want to educate you on graphite and the current market for it.

What Is Graphite?

Graphite is really just a form of carbon found in veins in metamorphic rock.

It was named by Abraham Gottlob Werner in 1789. Its name comes from the Greek verb graphein, meaning “to write.” Today, one of graphite’s most common uses is in pencils.

Graphite is a very soft mineral. When crushed, it breaks into small, flexible flakes that slide easily over one another. This is known as “basal cleavage” and it gives graphite a distinctive greasy feel. It’s the reason that graphite is an additive in many lubricants. It’s also used on its own in powder form as a dry lubricant.

Graphite also has the highest natural strength of any material and the highest stiffness. It can maintain that strength and stability at temperatures higher than 3,600 degrees Celsius.

Graphite is also one of the lightest of all reinforcing materials. That’s why Airbus uses it to construct a majority of the A380 fuselage.

Historically, graphite is used by the steel industry as a liner for crucibles and ladles. It is also one of the materials used in the manufacture of refractory bricks. These are used to line furnaces.

Additionally, graphite is used in steel itself. Its presence increases the carbon content of steel.

In the automotive industry, graphite is found in brake linings, clutch plates and gaskets. In addition, it’s used to reinforce plastic and as a component in fire-retardant materials.

Industrial demand grows at roughly 5% per year. The overall annual market for graphite is roughly 1 million metric tons annually. That is split between flake graphite (60%) and amorphous graphite (40%).

Amorphous graphite is the low-value graphite. It’s the type used for some of the industrial uses detailed above. It is not useful in lithium-ion batteries.

But flake graphite is useful in battery manufacture. That’s because it’s the only nonmetallic element that is a good conductor of heat and electricity.

Graphite is found in nature in three distinct types. Each occurs in a different type of ore.

The first is amorphous graphite. It’s the most common form of graphite. It has the lowest carbon content of any type of graphite at about 70% to 80%.

It’s also the least pure, and there’s no visible crystallinity. This makes it unsuitable for most applications.

The second form that graphite is found in is flake graphite. It’s less common than amorphous graphite, but it has a carbon range of 85% to 98%.

It’s used in most of the applications listed above. Consequently, it’s priced about four times higher than amorphous graphite. It’s typically the graphite being used to produce lithium-ion battery anodes.

The third form is high-crystalline graphite, found only in Sri Lanka. It has the highest carbon content, ranging from 90% to 99%. Because of its scarcity and high cost, it is economically unviable for most applications.

Graphite can also be produced synthetically by treating amorphous carbon materials at extremely high temperatures. But it’s expensive and can cost up to 10 times the price of natural graphite. This makes it unappealing for most applications.

Current Market Conditions

In 2016, the global graphite market was valued at $15.8 billion. During the next decade, the market is expected to grow at a compound annual growth rate (CAGR) of 6.7%.

Graphite for batteries currently makes up just 5% of the global demand for graphite.

Lithium-ion battery anodes use both synthetic (55%) and natural (45%) graphite. Manufacturers generally prefer synthetic graphite because it is purer and more consistent than natural graphite.

However, modern chemical purification and high thermal treatment can produce natural graphite with a purity of 99.95%, compared with 99.0% for synthetic graphite. Battery manufacturers want the highest purity possible and are willing to pay more for it.

On a volume basis, I expect demand for graphite to increase more and faster than the demand for lithium and cobalt. That’s because there is far more graphite in the battery than there is either lithium or cobalt…

It’s clear to me that owning as much of the battery supply chain as possible makes sense. Our lithium and cobalt stocks are proving my thesis.

The graphite companies I’m profiling in this issue are also part of the EV battery supply chain. In addition, the steel market is recovering, and there are graphite production issues in China.

It’s all setting up to be a very favorable supply-demand picture for graphite at a minimum. But I believe that as EV demand increases from a trickle to a steady flow and then to a torrent, the supply-demand picture for graphite will turn into a perfect storm for much higher graphite prices.

Consider this: Until recently, there had been no new exploration or new graphite mines opened outside of China during the last 20 years. Any mines opening now have a golden opportunity to capitalize on the EV boom.

And that boom is going to do for graphite what it’s already doing for lithium and cobalt. And as a result, I believe the value of our EV material companies is going to absolutely go through the roof.

Finding and Mining Graphite

Graphite is found all over the world. However, China mines 70% to 80% of the world’s supply.

About 70% of Chinese graphite is amorphous. Only 30% is flake, and most of that is very fine, which is less desirable for use in lithium-ion battery anodes.

After oversupplying the world during the last decade, China’s production is now in decline. In order to curb pollution, China has restricted production, has imposed export duties on existing mines and is limiting the opening of new mines.

Unfortunately, China’s antics have resulted in the dependence of Western manufacturers on Chinese graphite miners. And China is milking this as much as it can.

It has a 20% export duty on graphite. In addition, it has a 17% value-added tax on the mineral.

This has the potential to create a gap in supply as demand increases due to increased EV adoption. The U.S., Japan and Europe are almost completely dependent on imported graphite.

Unfortunately, there are almost no substitutes for graphite. And at present, there is little recycling of this critical material.

High-quality flake graphite is the type of graphite used to manufacture lithium-ion battery anodes. It has a high carbon percentage and is generally spherical in shape.

This type of graphite is also used in fuel cells and pebble-bed nuclear reactors. The typical lithium-ion battery uses 30 to 40 times more graphite than lithium by weight.

Tesla’s new “Gigafactory” is expected to supply enough batteries for the company to make 500,000 EVs annually. That one factory will require about 100,000 metric tons of flake graphite or 38,000 to 42,000 metric tons of spherical graphite… annually. That’s equivalent to six new graphite mines based on today’s average mine output.

Up until a decade ago, lithium-ion batteries were still a very small part of the overall graphite market. But since then, graphite for batteries has been growing about 20% annually.

Remember, no other material can be substituted for the graphite in a lithium-ion battery anode. It’s the graphite that gives the battery a very smooth, flat voltage profile.

EV designers love this trait. Lithium-ion batteries provide nearly full power until they are completely discharged.

Graphite is the second-largest component in a lithium-ion battery. As I detailed above, the average lithium-ion battery contains 10 to 15 times more graphite than lithium.

Cellphones, cameras, laptops, power tools and now EV batteries are responsible for the growth in graphite demand. Today, those lithium-ion batteries account for about 25% of the lithium demand.

And it’s only going to grow rapidly from here, primarily on the back of increased EV adoption and grid storage solutions. And both of those markets use very large battery packs, compared with what the cellphone and laptop markets use.

One of Canada’s Top Graphite Mining Projects

Canada and its graphite mining companies are positioning themselves to take over as the top suppliers to global lithium-ion battery makers. The market has experienced several decades of near-dormancy.

Now an increasing number of Canadian graphite miners are scrambling to produce the purest form of natural graphite: flake graphite. As I mentioned previously, flake graphite has extremely high heat resistance.

It has very high conductivity. It’s very light – a key consideration when talking about EV batteries.

I hope I have piqued your interest in graphite. So let’s take a look at the first of the three companies I’m profiling in this quarter’s report…

Northern Graphite Corp. (TSX-V: NGC; OTC: NGPHF) trades on the U.S. pink sheets and the Canadian Venture Exchange. Its trading volumes are similar on both exchanges.

Northern Graphite bills itself as “the only large flake graphite company.” It’s based in Ottawa, Canada.

Northern Graphite has a flagship graphite project called the Bissett Creek Project. The project is located fewer than 8 miles from the Trans-Canada Highway, between the cities of North Bay and Ottawa.

It’s easily accessed via an all-weather road. Good labor, electric power, water and rail lines are all readily available.

Northern Graphite had a full feasibility study completed on the Bissett Creek property back in 1989. As one would expect, extensive drilling and metallurgical testing was done by several prestigious engineering firms.

Estimated proven and probable reserves were determined, and the engineering firm initially deemed it economically feasible. Then the Chinese started overproducing graphite, and Northern Graphite shelved the project because of the subsequent drop in global graphite prices.

As graphite prices began to recover, Northern Graphite decided to reactivate Bissett Creek. It conducted an additional 21,650 feet of drilling in an additional 118 holes.

I think higher graphite prices are a distinct possibility based on the coming wave of increased EV adoption. Remember, both lithium and cobalt prices have started to increase as EV demand has increased.

But as you can see from the chart below, graphite prices have significantly lagged behind. And they are far below the $3,000 per metric ton level that graphite prices hit back in 2011 and 2012…

The last drop in price occurred toward the end of 2015, when the Chinese economy slowed, resulting in lower demand for steel. This initially offset the increased demand that occurred from the growth in EVs.

However, prices have nearly doubled from their 2016 lows. This is due to several factors.

The first is that the outlook for Chinese steel demand is improving. But perhaps the most important factor is the continued growth of lithium battery production for EVs.

Northern Graphite’s management team brings a lot of experience to the project. CEO Gregory Bowes formerly held the position of senior VP at Orezone Gold Corporation.

The board of directors consists of five people, all of whom have experience in the mining industry.

The bottom line for Northern Graphite is simple. It’s an advanced-stage project with fairly reasonable capital costs.

It’s located in Canada, an extremely mining-friendly country. The Bissett Creek Project has favorable economics at current graphite prices.

The company has a proprietary graphite purification technology and an attractive share structure. That’s why I’m adding Northern Graphite to the Advanced Energy Strategist portfolio.

Action to Take: Purchase shares of Northern Graphite Corp. (TSX-V: NGC; OTC: NGPHF) using a limit order only. Use a 50% trailing stop to protect your principal and your profits. 

Note: Since our original purchase of Northern Graphite Corp. we have hit our trailing stop on the stock. We will no longer be following this company in our portfolio. However, we remain bullish on the graphite market and the long-term prospects of the company. But keep in mind, this is a junior miner and shares can be very volatile. If you decide to buy shares I suggest using a 50% trailing stop to account for the volatility and prevent you from getting prematurely stopped out of your position.

The Lac Guéret Project

The second company I’m profiling in this quarter’s report is Mason Graphite (TSX-V: LLG; OTC: MGPHF). Its shares are slightly more liquid on the Toronto exchange.

Mason Graphite is in the midst of developing what it believes to be one of the highest-grade graphite deposits in the world. It also believes it will be one of the lowest-cost producers. More on that below.

So far, it has 35 institutional shareholders. Many of them are local, and they include government-sponsored entities. Many have mandates that are in line with the company’s financial needs.

Its project is called the Lac Guéret project and is located in northeastern Québec. It is about 300 miles north of Montreal…

Québec is a very mining-friendly jurisdiction. As evidence of that, the Lac Guéret project has received strong support from the local community.

Adapting to Buyers

The top three managers at Mason Graphite all have plenty of experience in the graphite business. One of the things that the Mason Graphite management team is sensitive to is that finished graphite products must be adapted for each and every buyer.

One of the first requirements is developing a strong customer relationship with every single client. The Mason Graphite team has years of experience in customer relations and a huge “black book” of past customers at previous companies. The team has experience selling all different types of graphite for every type of application all around the world.

The other thing that’s required is the right finished product. The best graphite miners and suppliers keep an inventory of different size flakes for different uses and customers.

End users typically sign one-year supply contracts. These establish specifications, volumes, delivery quantities, delivery timing and, most importantly, price.

At present, graphite is not an openly traded commodity. However, there is a market for every type of graphite and all different sizes of flake graphite.

In advance of production, Mason Graphite has undertaken a huge study based on large-scale production of value-added graphite products. It originally budgeted more than $1.07 million.

What I find compelling about this study is that none of the potential added value is included in the current economics of the Lac Guéret project. As part of this study, Mason Graphite is working closely with a number of lithium-ion battery customers from both the consumer side of lithium batteries as well as the EV industry.

Mason Graphite plans to design a generic grade of graphite for use in common lithium-ion batteries. More importantly, it’s developing a separate, higher-grade product aimed solely at the EV industry.

It intends to produce sample quantities based on customers’ specifications that Mason Graphite and the National Research Council gathered from EV industry companies. Once it has a sufficient understanding regarding volumes required, it will design the appropriate production capacity for value-added products.

Late this year, construction will begin on the mine and concentrator. Construction is expected to take anywhere from 13 to 16 months.

More definitive information as to dates will be available upon the completion of the study currently underway.

I find the whole Mason Graphite story, from the low-cost flake production to the value-added graphite products, very compelling. There is no question that we are early on this.

However, I would rather be early than miss out on what I believe will be some eye-opening gains.

Note: Please use a limit order when purchasing shares of Mason Graphite Inc. If you fail to do so, you could end up greatly overpaying for your shares, cutting into your ultimate profits. This is a junior miner, and shares can be very volatile. I am using a 50% trailing stop to account for the volatility and so we don’t get prematurely stopped out of our position.

Action to Take: Purchase shares of Mason Graphite (TSX-V: LLG; OTC: MGPHF) using a limit order only. Use a 50% trailing stop to protect your principal and your profits. We will follow the Canadian listing in our portfolio.

Mining Graphite Down Under

I’ve saved the most exciting company for last. I’m talking about Syrah Resources Limited (ASX: SYR; OTC: SYAAF).

Syrah Resources is far more liquid on its home exchange, which is the Australian Securities Exchange. It trades roughly 1.87 million shares daily on that exchange. On the over-the-counter markets exchange, it trades a mere 10,000 shares daily.

I highly recommend that if you want a position in Syrah, you purchase your shares on the Australian exchange. It is far more liquid, and you will likely get a much better price. Now let’s take a look at the company.

Syrah Resources is an Australian-based mining company headquartered in Melbourne. It has a simple vision: Be the world leader in supplying superior-quality graphite products.

Syrah’s leadership is extremely broad and deep. Its chairman of the board is Jim Askew, a mining engineer who has more than 40 years of experience as a director and CEO of a wide range of mining and mining finance companies.

Syrah CEO Shaun Verner joined the company in October 2016. Prior to that, he spent 20 years in a variety of executive roles at BHP Billiton. He has a familiarity across a wide range of commodities, including copper and other base metals, thermal and metallurgical coal, and uranium.

Dr. Christina Lampe-Onnerud is a nonexecutive director and board member. She is a U.S.-based expert on battery system design. Her expertise includes 20 years in the research and development and commercialization of lithium-ion batteries. Her knowledge spans battery technologies for consumer electronics, EVs and energy storage applications.

Lampe-Onnerud founded Boston-Power Inc., a developer and manufacturer of cost-effective, high-energy, long-lasting and safe battery “building blocks.” She is currently the founder and CEO of Cadenza Innovation, an early-stage company. Its goal is to develop low-cost, high-performance battery technologies.

Now you can see why Syrah is not simply a graphite miner. It is also a technology company. Let’s look at the company’s flagship graphite project.

The Balama Project

Syrah’s flagship graphite deposit is located in the Cabo Delgado province in northern Mozambique. Mozambique became an independent country in 1975.

After gaining its independence from Portugal, a 15-year civil war ensued. That ended in 1992. Two years later, the country held multiple-party elections, its first since becoming independent.

Ever since, the country has enjoyed political stability. It now has one of the fastest-growing economies in all of Africa.

Today, its economy is largely agricultural. However, other industries are growing. These include petroleum and aluminum production, chemical manufacturing, and tourism.

Mozambique’s Balama graphite deposit was first discovered more than a century ago. At the time, Mozambique was owned by the Portuguese.

In 1893, an engineer and geologist working for the Nyassa Company was exploring the territory. John H. Furman was doing an inventory of natural resources for Nyassa for possible future development by the Portuguese government.

Here’s what Furman said in his report about the area: “North of Mualia [now the village of Maputo], I discovered the greatest deposits of graphite, of a most excellent quality, which I think have ever been found. They extend several miles in length and will aggregate more than 700 feet [214 meters] in thickness.”

It turns out that Furman’s observations were spot on. In 2013, Syrah announced the discovery of the world’s largest graphite deposit.

Initial mineral resource estimates were that Balama contained 1.05 billion metric tons of graphite (at 10% total graphite content) and 0.23% vanadium pentoxide.

It’s actually two deposits that were originally identified in 2011. They are identified as Balama East and Balama West.

The two areas are about 1.4 miles apart. In addition to containing graphite, the resources contain one of the largest deposits of vanadium, an element that is useful in other types of batteries.

So far, more than 59,000 feet of resource delineation drilling has been completed at the Balama site.

The purpose of the FEED study was to confirm and update the initial capital expenditure estimate provided as part of the feasibility study. It also provided an estimate of future processing plant operating costs.

Here are the initial measured, indicated and inferred mineral resource estimates contained in the 2015 feasibility study…

In addition to the mineral resource estimates, the Balama feasibility study estimated the proven and probable ore reserves…

Boiling the above figures down, the Balama Project contains a combined (East and West) proven and probable reserve of 81.4 million metric tons of graphite ore. The ore has an average grade of 16.2% total graphite content. That means the deposit contains 13.2 million metric tons of pure graphite, making Balama the largest known graphite reserve in the world.

Having the graphite in the ground is one thing. We also have to evaluate the cost of getting it out, how long the mine will last and how much capital Syrah will need upfront. The feasibility study provides those key financial and operating metrics for the Balama Project…

Once the graphite is mined and run through the processing plant, screens will sort it into five particle sizes. The five sizes were determined based on extensive conversations with numerous graphite end users across all graphite markets.

Syrah has designed its processing plant with enough flexibility to ensure that demand for all five grades will be able to be met. The process itself includes mining, crushing, screening, grinding, floating, filtering, drying, classification, screening and final product bagging.

The process requires water in order to separate graphite particles from the surrounding ore. The Chipembe dam and reservoir will supply water to the processing plant.

It’s located approximately 5.5 miles from the plant site. The project’s water license permits 530 million gallons to be drawn from the reservoir annually, which is more than sufficient for Balama’s projected volumes.

Electricity for the project will be generated on-site. Syrah has purchased a 15.4-megawatt diesel generator to run the project. This will eliminate the need to connect to the local grid, which isn’t close to the project.

Syrah already has a number of key government approvals for its Balama Project…

Product made at Balama will ship from the port of Nacala, about 220 miles southeast of the project. Fortunately for Syrah, the road is paved, and the port is the deepest one in Southern Africa.

The product will be packed into 1-metric-ton bags at the processing plant. These will ship by truck to Nacala. There, they will be loaded into 20-foot shipping containers for export.

Balama: Current Status

As of this writing, the Balama Project is nearly 80% complete. Syrah has begun to commission various sections of the processing plant.

Construction has commenced on the water pipeline from the Chipembe dam to the plant site. Production is able to start before the pipeline is complete, as there is ample water storage on-site.

Syrah is already lining up potential customers. It signed a memorandum of understanding with BTR New Energy Materials.

This is the world’s largest battery anode manufacturer. In addition, it has signed a statement of sales intent with a large European trading consortium.

Initial production of pilot volumes is already underway as part of the commissioning process. But that’s just the start.

By the end of this year, the Balama Project should be up and running. In the first full year of production, the Balama Project is expected to produce 140,000 to 160,000 metric tons of flake graphite concentrate.

The BAM Project

In addition to mining graphite, Syrah is looking to downstream graphite concentrate processing as an additional source of revenue. I believe it will be a fantastic source of additional shareholder value.

The BAM (battery anode material) project is all about producing coded spherical graphite. This high-value product is what’s required to produce lithium-ion battery anodes.

As I mentioned above, increasing demand from both grid storage and EV batteries is driving the flake graphite market. However, it’s also going to be good for processed graphite products.

As a result, Syrah put together the BAM project. Key aspects of the project include…

• Appointing a top engineering firm to provide engineering and technical support at Syrah’s product qualification plant in Louisiana
• Developing a commercial-scale BAM plant with an initial production capacity of 20,000 metric tons per year
• Establishing a technology center in Perth, Australia
• Establishing a BAM pilot plant in China to serve the Chinese market
• Eventually establishing a commercial BAM plant in China.

The production of spherical graphite is raw material-intensive. Usually, 2 to 3 metric tons of flake graphite feedstock is needed to make 1 metric ton of spherical graphite.

Once the graphite is milled to a spherical form, it is chemically purified to more than 99.95% carbon content. Using a proprietary process, Syrah will coat the spherules with another layer of carbon.

As a byproduct of producing spherical graphite, natural graphite recarburizers are made. These are extremely high-quality carbon additives for use in iron casting and steelmaking.

By simply compressing, adding a binder and briquetting graphite shavings, natural graphite recarburizers are produced. It’s another value-added product that the BAM project will produce.

The Balama Project is already fully funded. Of all of the new graphite mining projects, Syrah’s Balama Project is much further along than any other, including the two other companies I’ve recommended.

We’re investing in Syrah Resources because I want to make sure we can participate in the ramp-up of graphite demand as soon as possible. An investment in Syrah ensures that we’ll be involved immediately.

Note: Please use a limit order when purchasing shares of Syrah Resources. If you fail to do so, you could end up greatly overpaying for your shares, cutting into your ultimate profits. This is a junior miner, and shares can be very volatile. I am using a 50% trailing stop to account for the volatility and so we don’t get prematurely stopped out of our position.

As I mentioned at the start of my review of Syrah, I highly recommend that you purchase your shares on the Australian exchange. It is far more liquid, and you will likely get a much better price.

Action to Take: Purchase shares of Syrah Resources Limited (ASX: SYR; OTC: SYAAF) using a limit order only.Use a 50% trailing stop to protect your principal and your profits. We will follow the Australian listing in our portfolio.

That gives us three great plays on the coming graphite boom. We have Syrah, with its Balama Project. And we have Northern Graphite, with its proprietary graphite purification technology and attractive share structure. Lastly, I find the whole Mason Graphite story, from the low-cost flake production to the value-added graphite products, very compelling too.

That’s it for this issue of the Advanced Energy TrendWatch report.

I hope you enjoyed reading it as much as my team and I enjoyed putting it together for you.

Good investing,

David Fessler