KWG Resources Revisited

What is it worth?  I still really don’t know.

Chromite properties in the Ring of Fire area

Data from http://www.mndm.gov.on.ca/mines/ogs/resgeol/rfe/documents/Chromite.pdf

  1. Black Thor.  Owned by Cliff’s.  69.6Mt @ 31.9% Cr2O3.
  2. Big Daddy.  Cliff’s 70% KWG 30%.  39.5Mt @ 39-40% Cr2O3.
  3. Blackbird.  Noront 100%.  11.05Mt @ 34-36% Cr2O3.
  4. Black Creek.  Probe Mines 100%.  8.44Mt @ 40-41% Cr2O3.  *Probe’s 2010 NI-43 101 Resource Estimate has higher numbers.
  5. Black Label.  Cliff’s 100%.  I haven’t been able to find information on the size or grade of this deposit.

*Note that these figures include Inferred resources.  The actual economic tonnage may be a lot lower.

Economics of the deposits

Cliff’s has indicated that it will mine Black Thor first.  This probably makes sense.  As to which deposit is the most economic, it comes down to various factors:

  1. Size of the deposit.  Mines benefit from economies of scale.  A larger mining machine will still require the same number of operators and support personnel.
  2. Strip ratio.  I am guessing that the Black Thor deposit is attractive here as it is larger and wider than the Big Daddy deposit.
  3. Grade of the deposit.  All of these deposits will have some ore that is relatively high grade (>40% Cr2O3) as well as lower grade ore.  The high grade ore can be shipped directly to a ferrochrome processing facility or smelter without any processing at the mine site.  Lower grade ore will need to be processed at the mine site to increase the concentration of chromite (as transportation costs of the product is very high).  Processing costs will be higher than normal as Cliffs will be using diesel generators to power the processing plant (more expensive than grid electricity).  The lower grade ore will obviously be marginal though it should be possible to turn it into a concentrate product that can be sold profitably.
    I don’t think that there is enough information to determine which deposit is the “highest grade”.  Using a higher cutoff value will increase the overall grade (and vice versa).
  4. Impurities in the ore (e.g. silicon, sulfur, etc.).  I can’t find much information here.  I’m pretty sure the companies themselves do have such information (they are probably assaying their drill core for impurities)… they just don’t bother reporting this information publicly.
  5. Distance to processing facilities.

Black Thor will probably be mined first.  This makes the other deposits (e.g. Big Daddy) have a lower  present value as they won’t be mined until the future.

Black Thor will likely be mined with a combination of 2 mining methods: open pit and underground mining.  In open pit mining, costs increase as you go deeper and deeper as more waste rock has to be moved aside / the strip ratio increases.  Eventually you hit a point where it makes sense to switch over to a cheap form of underground mining (e.g. Cliffs is thinking of blasthole stoping).  The cost of underground mining should be relatively steady after the initial capital costs.

What I think will happen is this: Cliffs will mine Black Thor as an open pit, then it will start mining Big daddy as an open pit.  Eventually (at least 10-15+ years from now) both will be mined with an underground method.  Cliffs may also be interested in Probe’s deposit (it sits between Black Thor and Big Daddy).  Maybe Cliffs will mine it too as an open pit operation before switching to underground mining at Black Thor.  However, Cliffs hasn’t shown much interest in Probe as it has not done a private placement with Probe nor has it tried to acquire Probe (unlike KWG and Spider).

Size of the mine

A larger mine will have lower operating costs due to economies of scale.  And there is a lot of chromite in the region that could support a very large operation.  However, the overall size of the chromite deposit is so huge that Cliffs would risk flooding local markets and therefore getting a lower price for its chromite.  (As transportation costs to the customer are very high, I would expect chromite to be somewhat of a local market.)  Cliffs has to determine what mine size would be appropriate based on its expectations of the elasticity of chromite prices to supply, inflation, the appropriate discount rate, etc.

In 2010, the USGS reported worldwide chromite ore production to be 23.7 million metric tons.  Cliffs has indicated that it may produce “up to” 2.3 million metric tons of concentrate per year.  This would be roughly 10% of the world chromite supply.  (Technically you have to normalize the figures for the different grades between Cliffs’ concentrate and the USGS assuming 45% Cr2O3.)  If Cliffs mines at half the rate, then it might only account for 5% of world supply.

There is also the risk of a competitor opening a chromite mine, thus increasing local supply and driving costs down.  When Cliffs bought out Spider Resources, it became the operator of the project and didn’t have to worry about a combined Spider+KWG becoming one of its competitors in the region.

History

Cliffs bought out Freewest after a bidding war with Noront.  At the time, Noront was trying to use its shares (which were worth a lot at the time) to buy out Freewest.  After Noront’s share price fell and Cliffs sweetened its offer, Cliffs eventually won out.  (Some of the press releases in that bidding war were a little acrimonious between the two parties.)

This gave Cliffs 100% ownership of Black Thor and Black Label.

Later on, Cliffs offered 13cents/share for Spider or KWG.  Spider and KWG decided to merge instead.  Cliffs ultimately won the bidding war by offering 19 cents/share for Spider.  Subsequently Cliffs took a stake in KWG via private placement but it did not try to buy the entire company.

Option agreement between KWG and Cliffs (formerly Freewest)

As it currently stands, KWG has a 30% stake in the Big Daddy deposit.  Since Cliffs bought Spider, it then took control of the joint venture.  This puts KWG in a bad spot.  As I understand it, Cliffs doesn’t have to bring the deposit to production.  Or it can start production at Big Daddy and then decide to stop it.  If Cliffs decides to mine Black Thor over Big Daddy, then it takes a small hit financially while its JV partner would take a huge hit financially.  So Cliffs could hold its JV partner hostage.

(The worst case scenario is if Big Daddy isn’t mined at all, or if Cliffs decides to mine it after Black Thor has been exhausted.)

The other problem that KWG faces is that it would need to put up its share of capital if Big Daddy goes into production.  If it doesn’t, its interest will eventually be watered down to a 0.5% NSR on base metals.  (Thus its 30% stake in Big Daddy would be worth far less than the 1% royalty it held on Big Daddy, Black Thor, and Black Label.)

In a way, KWG and Cliffs are frenemies.  It makes sense for them to co-operate and at other times they end up in disputes with each other.

Trying to get back in the game

KWG is in a dispute with Cliffs over whether Cliffs has the right to build a road to the chromite deposits.  I am not a lawyer so I do not know where KWG stands.

KWG also has staked railroad claims and performed engineering studies on how much a railroad to the deposit would cost.  I honestly don’t know enough about the economics of a railroad versus an all-season road to know whether or not KWG’s railroad scheme makes sense.

Cliffs has indicated that the economics of a railroad doesn’t make sense.  So ultimately I don’t think a railroad will be built as they are considered to be in the “driver’s seat” in the transportation route to the chromite deposits.

KWG has a presentation on its website that provides some numbers on the relative costs between a railroad and a road.  Adjusting their figures for a mining rate of 12kt/day instead of 10kt/day and the ore being concentrated to 60% of its original weight, the railroad would save around $84M/year.  At a discount rate of 0% (and ignoring savings from flowthrough shares and possible cheap financing from the Canadian government), the mine life would need to be 23.74 years to recoup the investment on a railroad.  At a mining rate of 12kt/day the mine life might only be 13.7 years.  I don’t think that there is enough tonnage in the Ring of Fire area to justify a railroad.  There is a really small chance that KWG obtains really favorable financing for the railroad that might justify its economics.

Mine life

Certainly I think that the mine life will be much longer than Cliff’s lets on.  6,000 – 12,000 tonnes/day of ore X 330 days = 1.98 – 3.96 Mt/year.

Black Thor – 69.6Mt  (@25% cutoff, which may be too low)

Big Daddy – 39.5Mt

Mine life could be potentially 13.7 to 27.5+ years.  (Technically not all of those tonnes will ultimately be mined offset by any expansion in reserves.)

Value of KWG’s assets

Its main assets are:

  1. 30% stake in Big Daddy.
  2. Cash.  $13.5M in cash, $16.3M in current assets.
  3. Railroad assets.  Likely worth 0 if it is unsuccessful in its claim against Cliffs.

#1 is the hardest to value especially when KWG’s PEA is wildly off (it estimated $900M for the railroad which now costs $2B) and therefore I don’t really trust it.  Regardless, the deposits will generate billions in revenue.  If you don’t think that Cliffs will chase a profit margin of less than 10%, then the implied NPV of KWG’s 30% stake in Big Daddy would likely be something very very high.  Ultimately I think that if Cliffs does offer to buyout KWG, it will be in the ballpark of 13 cents/share (its original offering price for KWG).  Since the original buyout offer, the 30% Big Daddy stake is worth more now whereas the $13.5M in cash would be worth less than the 1% royalty that KWG used to hold.

That’s a big if.

Cliffs might let KWG flail in the wind for a few years and KWG will bleed a little from all of its overhead costs.  Cliffs could mine at 6,000tpd so it will be several years minimum before it makes sense for it to start mining Big Daddy as an open pit.  It doesn’t have to buy out KWG… so they will have the advantage in negotiations.  KWG’s only alternative is to firesale itself to a senior miner with deep pockets or to somehow raise a huge amount of equity to maintain its 30% stake.