Simon Moores on China, Tesla and Graphite Supply Chain Transparency

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In December 2013, China surprised graphite market participants by ordering the 55 flake graphite miners and processors in the city of Pingdu, located in the coastal province of Shandong, to cease production on environmental grounds.

At the time, Industrial Minerals’ Simon Moores commented that the stoppage was expected to remain in place until June 2014, “or until the companies can prove an acceptable standard of environmental controls.” He also noted that it would take 10 percent of the world’s flake graphite supply — and 20 percent of China’s domestic production — off the market.
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With the start of June now under a week away, Graphite Investing News checked in with Moores to find out what spurred the clean up, how it’s going and how it reflects the resource sector’s growing focus on supply chain transparency.

Why clean up?

As Moores explained, “it’s been known for a long time that some producers in China are a bit wasteful with their resources, some of them are polluting and it’s just kind of been an accepted fact” — so why did the government suddenly decide to step in?

Put simply, publicity. “One thing that I think was the tipping point was the Shandong situation,” said Moores, adding, “it actually got onto the front page news in Qingdao, which is the main city in the province.” That put graphite on the radar in China, and “the provincial government had to act.”

Current status

And act it did. After shutting down Shandong’s flake graphite producers, “the government then went in to review all their processes,” Moores said. “They’ve got a new regulation for equipment and they monitored their wastewater and acid disposal.”

Though “that process has been going on for most of this year,” 40 percent of Shandong’s 55 producers still remain offline.

Meanwhile, Heilongjiang, another graphite-producing province, has also been placed under review. “They’ve given a warning to all the producers in Heilongjiang, which is a much, much bigger producer, and in September, that’s when they’re going to enforce it,” Moores noted. Already, he said, “it has got to the stage where the national English language Chinese news service, CCTV, is reporting on the situation, which for me was a big statement.”

Moores does not see any other regions being affected.

Where to buy?

All that missing supply raises the question of what other producers flake graphite buyers may be able to turn to moving forward.

Interestingly, Moores believes buyers are “still … going to go to the main provinces” as “they’ve not completely turned the tap off.” That means they’ll continue to buy from Shandong and Heilongjiang, as well as from a handful of “overlooked provinces in China.” He also said that Brazil “certainly … should have some additional supply,” while Russia, which has one flake graphite mine, may be able to provide some material. Norway is home to Europe’s biggest graphite mine, but “additional supply is unlikely to come from that source.”

Further into the future, Moores said producers may look to Madagascar. Though the country currently produces only about 6,000 tonnes of flake graphite per year, Energizer Resources (TSX:EGZ,OTCQX:ENZR) “wants to build a much bigger mine there and has a pilot plant in place.” Similarly, in Mozambique, Syrah Resources (ASX:SYR) is planning to build what would be the world’s biggest graphite mine in the next two to three years. Deutsche Bank (NYSE:DB) has just produced a detailed report on the company’s plans, said Moores.

Meanwhile, he noted, Flinders Resources (TSXV:FDR) ”is very close to a restart of an old producing mine, Woxna, which could be a new significant source of flake graphite.” Woxna is located in Sweden.

Finally, Moores emphasized that “in term of the highest concentration of companies looking to build a mine, you first have to look to Canada.” Focus Graphite (TSXV:FMS,OTCQX:FCSMF) “is planning a large mine and has offtake agreements already in place,” he said, adding, “[t]he company has also just released news of their battery-grade developments, which is critical should producers want to sell into the biggest growth market.”

Also in Canada, Mason Graphite (TSXV:LLG) has “received a lot of attention from recent fundraising activities for its 50,000-tonne-per-year mine in Quebec.”

The Tesla factor

Of course, a discussion of the situation in China would be incomplete without a mention of Tesla Motors (NASDAQ:TSLA), which said at the end of March that it “plans to use only raw materials sourced in North America” for its proposed $5-billion lithium-ion battery “gigafactory.” Explaining the decision, Liz Jarvis-Shean, a spokesperson from the company, told Bloomberg, “[i]t will enable us to establish a supply chain that is local and focused on minimizing environmental impact while significantly reducing battery cost.”

Given that the announcement came in the midst of China’s clean up, many believe it’s clear Tesla is attempting to distance itself from the nation’s questionable flake graphite.

From Moores’ standpoint, that’s understandable. “How flake graphite is mined can impact your reputation, even if you’re a car manufacturer. It seems a bit unfair, certainly on Tesla, but it’s the reality of the world today,” he explained. “We’re already in an era of supply chain transparency and responsibility, and I think, certainly if you’re a public company … and if you’re in North America, you will have to be more responsible and more transparent about where you get your raw materials. It’s just a fact of the modern world today, as the Dodd-Frank Act shows,” Moores added.

A major shift?

The fact that a huge company like Tesla is focusing on supply chain transparency is a clear indication of the issue’s importance. But will it be easy for companies to show that they know where their raw materials are from?

For Tesla, Moores believes the answer is yes. “For something the size of the gigafactory, it should be on Tesla’s radar and I’m confident it is,” he said. However, he noted that “most big businesses” are not as effective as they could be at “understanding the whole supply chain today all the way upstream to the mine.”

That said, one thing that will make transparency easier is the fact that “all the juniors that are developing mines now, the next generation of graphite mines, [are] all doing so in a modern way, in an environmentally responsible way to western standards.”

Price outlook

In closing, Moores touched on where the flake graphite price is currently sitting and what may happen to it in the future.

At the moment, he said “some list prices are starting to go up in China.” Even so, just because the mineral is listed at a particular price doesn’t mean it’s being traded at that level — “the real price will be what people pay for it,” Moores emphasized.

That may sound disheartening, but in fact Moores painted a bright picture for prices longer term. He noted that while “the misconception with China is they’ll turn the tap back on and lots of production will flood the market,” he doesn’t see that happening.

“The reason is there’s consolidation at the moment,” he noted, and ultimately what’s happening in Shandong and Heilongjiang “will take a minimum of 25 percent of Chinese graphite off the market, pretty much for good. And it could be as high as 40 percent.” Continuing, Moores explained, “there’s no point in China modernizing all these companies, doing the shutdown, if production is just going to come back on in the same way as before. I think China will still be the major producer, but they will cut back and withdraw somewhat from the international market.”

And of course, though there are many juniors looking to bring mines online to fill that supply gap “all these mines aren’t going to come onstream, there’s only going to be a handful of people that make it to build a mine.”

Finally, Moores said, it’s important to consider demand. Even if demand “remains a flat line, there’s no new markets, there’s no improving global economy, the industry will need new graphite mines,” he stated. However, “there’s not going to be a flat line” — rather, “demand is going to be increasing in the face of supply decreasing.”

As market participants should be well aware, “that only means one thing for prices.”

Securities Disclosure: I, Charlotte McLeod, hold no direct investment interest in any company mentioned in this article.