The Mining Report: The nickel industry has been through tectonic changes in the last 10 years, including large corporate takeovers and fundamental changes in supply available to the market. Can you summarize where the nickel industry has been and where it is going?
Mark Selby: Over the past five years, we've seen continued robust growth in nickel demand. Over that period, global nickel demand grew in the high single-digits, while Chinese nickel demand grew at double-digit rates. Stainless steel, which is increasingly used across all sectors of the economy, accounts for approximately 70% of total nickel consumption.
Everyone is familiar with stainless steel appliances like refrigerators, but there are thousands of tons of stainless steel used in less obvious applications in the chemical, manufacturing and service sectors. A good example is just about every fast food outlet in the world, with their expanse of stainless steel counters and food prep equipment used throughout their operations. The nickel is there; it's just not always easy for consumers to see.
There are a lot of exciting parts to the nickel story. From an economic point of view, one of the most interesting is price: nickel has historically been one of the most expensive of the common base metals (copper, lead, zinc, aluminum, etc.), which has steered its use in high-value applications such as jet engines, gas turbines, nuclear power plants and medical devices. As the Chinese economy moves up the value chain, the per capita consumption of the higher quality nickel alloys is increasing. In 2010, Chinese per capita consumption of nickel was only one third of the way to German or Japanese consumption levels, which China had already achieved in less value-added materials like carbon steel. Over this decade, we expect China to add at least a million tons more nickel demand as the economy continues on the path of industrialization.
There has been a lot of talk of a slowdown in the Chinese economy over the past few years. However, over that same timeframe, the Chinese nickel demand annual growth rate was in the mid-teens and added over 100,000 tons of nickel demand growth every year. No matter how you look at it, the demand side of the nickel story is robust. We don't see any reasons why that will change in the near future.
TMR: Can you discuss the evolution of the supply situation in the nickel market? I am especially interested in the role of Indonesian ore and politics on nickel in the future.
MS: Back in the early 2000s, there was a whole cupboard full of undeveloped nickel projects that were idle. Most of those projects were discovered in the wake of a global nickel boom from the late 1960s-early 1970s. Those projects that were developed came on-line just in time for the global economy to slow down in the 1970s. As a result, there was a large inventory of deposits that sat idle.
When I worked at Inco, we saw the rapid growth in Chinese demand for nickel very early. It was clear to us that the development of nickel projects would not be quick enough to respond to the increase in demand. And that is what happened. Beginning in 2002-2004, and then again in 2005-2007, demand growth far outpaced supply growth. There were massive spikes in nickel prices as the industry just couldn't keep up with the demand. Nickel prices went from $2 per pound ($2/lb) in 2001 to nearly $25/lb by 2007. That price spike in 2007 got many of these projects (which had been sitting idle for several decades) financed and into construction. Most of those projects were laterite deposits and many utilized new technologies, such as pressure acid leaching.
TMR: So, there was new mine supply, but what about the creation of the nickel pig iron (NPI) industry in China? That was a big change to the nickel industry.
MS: By 2006, Chinese stainless steel and nickel demand were growing at breakneck pace. And the nickel industry had provided little supply growth, so the Chinese did what the Japanese did in the 1960s, which was to take boatloads of soggy dirt (technically "ore"), primarily from Indonesia, and ship it to furnaces that they already built to make pig iron for carbon steel. That's where the name "nickel pig iron" came from. The innovation was to build a low-capex, high-opex way of supplying nickel to their domestic industry. They created a Chinese ferronickel industry. Most new ferronickel plants in China use existing Rotary Kiln Electric Furnace (RKEF) technology to produce NPI. The only real operational innovation was to take the NPI all the way to stainless steel in a single facility while the NPI is molten. Even with improving technology and operational efficiency, NPI is a relatively expensive commodity to produce compared to nickel sourced from conventional mines.
The end result was a huge change in the industry. Starting in 2007 and then exploding over the next four or five years, the Chinese added a lot of capacity. For most of that time, they had a willing ore supplier in Indonesia that seemed willing to ship as much ore as the Chinese needed—despite capturing very little of the export value for the Indonesian economy.
The massive growth in NPI supply combined with the new production from the projects that came on-line in 2007 relieved the supply pressure on the market. In fact, the supply dynamics have created significant surpluses in the last two or three years, making nickel one of the least successful metals based on price appreciation.
So what does it mean for the future? We have seen the project backlog cleared out since 2007. We were already bullish for the second half of this decade based on Chinese demand growth, which we expect to continue to be robust, and a lack of new projects. This was even before the Indonesian ban.
TMR: The Indonesian ore export ban was announced in mid-January. What are the implications for the nickel market?
MS: In January, the Indonesian government announced that they would ban all unprocessed nickel ore exports. This was a tectonic shift in the nickel market. I expect this action to dramatically pull forward the shortages we expected to see anyway. Under the current conditions, by the second half of 2015 we expect severe nickel shortages to emerge and will start seeing the first signs this month. That is about how long it will take to work through the inventory once 25–30% of global nickel supply has been shut in with this export ore ban.
TMR: Is the ore for the Chinese NPI producers mostly from Indonesia?
MS: About 75% comes from Indonesia. There are two types of lateritic nickel ore from Indonesia—limonite and saprolite. The saprolite grading between 1.8-1.9% nickel is the most common ore. Notably, Indonesia is the only significant source for that higher grade material that's available for export in any quantity.
The Philippines can supply probably 10–20% of what Indonesia's currently supplying. The main ore there is limonite with a lower grade at 1.4-1.5% nickel. Again, whether the Philippines has the ability and the willingness to export significantly higher quantities of that material remains to be seen. We think they won't be able to come anywhere close to that.
The only other place where you see large higher grade laterite resources is in places like New Caledonia, but that's committed to local plants or they have long-term joint venture agreements with facilities located in Japan and Korea. Further down the list of potential alternative sources of ore to the Chinese NPI industry include places like Cuba or Guatemala, and those locations don't have the grade or scale of resources compared to Indonesia, but what they do have is much higher transport costs to China.
TMR: What does that all mean to prices?
MS: We think we're going to see sharply higher nickel prices to force demand in line with available supply. That happened in 2005-2007, where you literally didn't have enough nickel—prices rose and there was demand destruction. This scenario will encourage development of lower grade saprolite deposits over time. Eventually, the Chinese will be able to use the low-grade material as ore, but because of higher energy and material inputs to that process, it likely puts a $9–10/lb floor on the global nickel price. Making NPI with 1.4% nickel saprolite is not a high-margin business.
TMR: In the past, you have mentioned the Chinese cost to produce nickel in NPI was approximately $6/lb. That is about where the metal is at present. Does that mean that your new "floor" for the metal will be closer to $9/lb once the market reaches equilibrium? What are the arguments against a price increase to that level?
MS: The first of two pushbacks I hear is that alternative sources will be found. I just discussed that. The second argument against a price increase is that they'll build plants in Indonesia. The plants in China have much more than access to ore. They have ports, access to power and whole industrial networks available to tap into. The Indonesian ore is located in areas with minimal infrastructure, no power and very little skilled labor. Building a plant there will be expensive and slow compared to China. However, some plants will be built. In fact, Royal Nickel Corp has a relationship with Tsingshan, which is the leading stainless steel producer in China. They've been considering a plant for many years and they've finally started construction this past summer. That's a sign of the challenges to build a NPI plant in Indonesia.
TMR: How does Royal Nickel Corp.'s (RNX:TSX) project differ from other global nickel projects?
MS: Our flagship project is the Dumont Nickel Project. It has many attractive features for an undeveloped, large nickel project. The first is deposit type. Dumont is a sulfide deposit rather than a laterite deposit. Large, undeveloped nickel sulfide deposits are rare.
Another project differentiator is location—our deposit is located in the province of Québec, which is an excellent jurisdiction in many ways. Notably, permitting is comparatively well defined and clear path. The province provides very competitive rates of $0.045 per kilowatt hour. The project location has all the essential support infrastructure nearby, including highway, railway, water and power. We're also fortunate to be located in close proximity to a set of communities that have lots of skilled labor available at reasonable rates.
The metallurgy of the Dumont project is straightforward. Upgrading the ore to a concentrate by milling is a relatively simple task. While the deposit is low grade (0.27% nickel), the concentrate that will be produced is 29% nickel. That concentrate can be fed to traditional smelting and refining processes. The concentrate has very few impurities and doesn't have a lot of byproduct credits; it's mostly nickel. The concentrate can also be roasted to remove the sulfur. The resulting product from that process can be used by Chinese NPI makers to increase the nickel content of their lateritic ores if that is something they need in the future to keep their operations going.
TMR: The gold standard for nickel deposits is Sudbury. Is Dumont similar to Sudbury?
MS: No, it's quite different. They're both sulfide deposits, but Sudbury is mainly massive sulfide ore bodies. The ore contains lots of bright, yellow shiny minerals visible to the naked eye. The Dumont deposit is low-grade and disseminated. Dumont is analogous to many of the large and low-grade copper and gold deposits that have been put into production recently. Following that analogy, 10 years ago if you walked into most gold companies and said, "Most of the world's gold is going to come from one gram a ton gold mines" or if you walked into most copper companies and said "Most of the world's copper in 10 years is going to come from 0.3% copper deposits", you'd be laughed out of the room.
Yet, those deposits are now very profitable mines. That is partly because of higher metals prices, but also because of technology and scale. Royal Nickel is doing for the nickel industry what has already been done by the gold and copper industries—bringing large-reserve and large-scale deposit into production.
TMR: What is the path forward? What does management think about the chances of being acquired compared to building a mine as a standalone company?
MS: Most of Royal Nickel's management team are ex-Inco Ltd., so we have the experience to put the project into production but have also been through a round of M&A and realize that it is in shareholders' interest to take the right price if it comes along. At the same time, we have the team to build this project into an operation. We hired our project director before we started our feasibility study. She was involved in the feasibility study and "owns" that study, so when it comes time to build, there will not be a learning curve.
To bolster the finances, we engaged Rothschild two years ago. Initially, we tried to advance the project financing based on the prefeasibility study, but it is more typical in the industry to wait until the full feasibility study is complete. Rothschild has been our project finance advisor through this entire time period. We are advancing the project as though we will bring this into production ourselves.
In terms of financing, the whole project requires approximately $1.2 billion ($1.2B) in capital expenditures, which we believe can be financed through $500-600 million ($500–600M) of project debt, offtake financing and lastly equity capital raises. We've been in talks with several Asian mining houses. We have good relationships with a number of companies from our Inco days, and Rothschild has brought several other possibilities to the table.
One option would be to sell 30–45% of the project and bring in a partner to finance their share of the capex. The remaining balance would be financed by a combination of debt, equity and royalty streams.
The other part of the finance package is from Resources Québec, the government of Québec fund. Resources Québec participated in our IPO and provided royalty financing to us. We sold them a 0.8% royalty about 18 months ago and we continue to expect they will be supportive going forward.
TMR: Where are you on the project timeline?
MS: The feasibility study was completed in mid-2013. The permits should all be in place by the middle of 2014. Contingent on financing, we will be ready to start construction before the end of 2104.
This is a good place to note that Québec is a mining-friendly province. Permitting in Québec is faster and lower risk than most other locations in North America. For example, in many U.S. jurisdictions, timely permitting is a big risk, many projects have taken as much or more than seven years in permitting. By comparison, Québec has permitted half a dozen mines in the last five years, and many of those mines are similar in capex and scale to Dumont.
TMR: What do you say to skeptics of a deposit with 0.27% nickel grade and 45% recoveries? Without any context, those look like tough numbers.
MS: That is pushback that we have heard in the past, and it is easy to address. Take a step back and look at the revenue per ton of ore mined. On that basis, Dumont compares favorably to several base metal deposits that were all acquired.
TMR: What are the three things that you want to get across to an investor interested in nickel and/or your company?
MS: My first point to get across to investors is that nickel in early 2014 is one of the best "long" metals trades in the last 15 years. I've been in the commodities sector since 2000. During that time, there have been five great commodity metal trades. Palladium is one. In the late 1990s and early 2000s, Russian supply disruptions boosted prices. Another was nickel. In 2002-2004, nickel prices went up from $2-8/lb, followed by a rally from $5-25/lb again in 2005-2007. A third was copper. Around the same time (2005-2006), everybody thought there was a million tons of copper concentrate supply coming on-line that year. Inventories got down to 60,000 tons globally on all three exchanges. Prices had stalled out at $1.50/lb, but within nine months prices shot up to $4/lb. The next was pretty much any metal that saw prices rally from 2005-2007, which was attributed to Chinese impact on the market.
The molybdenum situation from 2004-2007 is the most analogous to the current nickel market. During this period, molybdenum went from $5/lb to approximately $30/lb and stayed there for four years. At the time, many analysts of the molybdenum market ascribed the market behavior to demand and lack of substitution. Fundamentally, the real driver was a Chinese province that produced about a third of Chinese mine supply started shutting mines down for safety and environmental reasons. That took a third of Chinese supply, or about 7% of world supply, out of the market. That was enough to push the market from $5-30/lb for four years. Compare those numbers to the implications of the Indonesian ore shipment ban. About 25% of world supply of nickel went offline in January 2014. That's the equivalent of all of the OPEC Gulf States stopping oil exports.
Another analogy would be Chile stopping copper exports overnight. Chile has just over 30% of world copper production. The importance of the Indonesian announcement does not seem to be appreciated by the investment community.
The second investor takeaway is that there are very few advanced base metals projects that have completed a feasibility study. When the development cycle turns and acquiring companies need a new base metal project, they're going to find a very small pipeline of projects that will meet their needs. The Dumont project is one of the few base metal projects (not just nickel projects) that's ready to go.
The third takeaway is the standout project specifics of Dumont. We are not in a remote, high altitude region needing a couple of billion dollars of infrastructure. We have all the infrastructure in place. We can build a 50,000/ton per day mine/mill now for $1.2B, which will generate $300-400M in EBITDA annually. There are very few base metals projects of that scale. It's the third-largest nickel reserve in the world. It will be the fifth-largest nickel sulfide mine. There's a billion tons of reserve, a billion tons of resource and there's still a massive amount of exploration potential. The capital markets will turn for the better and we've got one of the few projects that's in a position to be able to take advantage of it. Recent news like the announcements from Indonesia, once fully recognized by the market, will potentially reinforce the trend toward higher metals prices, a trend we expect to develop over the next few years.
TMR: Thanks for speaking with us, it has been interesting.
MS: It has been a pleasure.
Readers interested in learning more about the global supply/demand dynamics of the nickel market in light of the Indonesian ore ban should look to the presentation section of the Royal Nickel Corp. website for additional information and analysis.
