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Interview with Mark Brown, CFO and Director of Rare Element Resources April 11, 2011
This interview took place prior to the recent release of drilling results on the rare earth project and resource calculation for the gold project. Those releases can be found here for an up-to-date picture on the company’s exploration work: Rare Element Reports Inferred Mineral Resource Estimate for Sundance Gold Project
theinvestar.com: Hello Mark. I would like to first thank you for taking the time to talk with us today about Rare Element Resources. Mr. Brown: Thank you for taking the time to contact us. Don, Jim and I are happy to discuss Rare Element’s projects with writers and only a few of them actually take the time to contact us directly. theinvestar.com: Before we focus on Rare Element Resources, can you give investors a little background on the industry itself, and what attracted you to this sector of the resource market? Mr. Brown: I’m one of the founders of Rare Element and we started the company over 10 years ago. Our basic premise back then was that the Bear Lodge REE deposit had a lot of potential to be a Rare Earth mine and we were focused on how much rare earths were to be used in hybrid cars in the batteries and the electric motors. We also knew that the world supply was dominated by production from China – particularly that about 50% of the world’s REE production comes from the Bayan Obo Mine and that another 45% of the world’s supply comes from other mines in China. The REE market today has done what we thought it might do, perhaps even a lot more – REEs are more in demand than ever and there are very few sources of REEs worldwide despite many people who are currently exploring for REEs in many areas. The big market rare earths – Lanthanum, Cerium, Neodymium and Praseodymium have seen large demand growth trends while the small market but high value rare earths such a terbium, dysprosium and europium have been experiencing supply shortage issues. All of this is due to a combination of demand growth and the world production effectively not increasing, and, of course, China keeping more of their rare earths for their own use in manufacturing. theinvestar.com: So when did Rare Element Resources start looking at Bear Lodge? Mr. Brown: Rare Element began looking at Bear Lodge in 2001 and completed the acquisition of the project in 2003. It was one of our Directors who lives in Wyoming, Mr. Norman Burmeister, that introduced me to the project. Phelps Dodge had the Bear Lodge project exploring for gold before us and they retained a royalty on the project which we bought back 2 years ago so we own 100% of the project. During the early years it was very difficult to raise money for the project and while we did exploration work every year, they were small programs. We kept costs to a minimum by using contractors only as needed, doing a lot of the work ourselves, and keeping administrative expenditures as low as possible. theinvestar.com: Can you fill us in on the history of Bear Lodge (past exploration, etc.)? Mr. Brown: Prospectors looking for uranium first found thorium and rare earths (identified by the US Geological Survey) at Bear Lodge in 1949. There were searches all over the world for uranium and several deposits were found to contain low levels of thorium and high levels of rare earths. This is one reason that most significant deposits of rare earths are already known today and there have been very few actual new discoveries of rare earths around the world. Chapter 6 of our National Instrument 43-101 compliant preliminary economic assessment report gives a full history of exploration carried out at Bear Lodge after that time. In short, Duval Corporation did some work looking for base metals from 1972 to 1977 and found more rare earths in their drill holes. They brought in the original Molycorp to the project as a joint venture partner in 1978 and they explored for rare earths until 1980. From 1986 to 1991, Hecla Mining Company consolidated the land position to explore for rare earths and also gold. Hecla drilled 12 holes for rare earths and discovered some of the high-grade mineralization that Rare Element has expanded. With China overproducing rare earths and an economic recession, Hecla then dropped the claims in the early 1990s. It was Phelps Dodge (now Freeport McMoran) who staked claims in the current claim block, including most of the rare earths, in 1994 to explore for rare earths and subsequently gold but the gold price was dropping and they optioned it to our subsidiary, Paso Rico, in 2000. When we arranged the financing for Paso Rico and its public listing on the TSX Venture Exchange in 2002, we amended the terms of that option to reduce our expenditures commitments and our focus was on the exploration of the rare earths deposit of which others had only scratched the surface. Several of these companies did trenching work, geochemical analysis and most of them also did small drill programs. We compiled that data as much as we could and used it to help us explore for higher grade rare earths. Jim Clark, our VP of Exploration, worked for Hecla when they were on the project in the mid 1980s. Some significant early REE exploration work was actually carried out by the US Bureau of Mines. They completed a drill program of ten shallow holes and estimated the first resources of low-grade rare earths at the site, west and northwest of our current resource. The current resource is focused on the high-grade rare earths. In the early 2000’s our exploration was very limited due to our budget but we did hit several high grade areas of rare earths in some of our drill holes, which offset some of Hecla’s high grade holes. The work that was done at that time really helped us to understand the potential shape of the deposit and is probably one of the reasons that our current drill program hit rare earths in almost all of our 61 holes that we drilled in 2010. theinvestar.com: Regarding the fact that companies have worked on the property in the past, can you explain to our readers how the mining industry works? Mr. Brown: Sure. I should also note that our shareholder base is now largely American. I’ve had a couple calls lately asking if we are a Canadian company, and, yes, we are incorporated in Canada and our subsidiary which owns the deposit, is an American company, but our shareholders are from all over the world with a significant number being US investors and US investment funds. Our exploration team, including Don Ranta and Jim Clark, is actually almost entirely Americans as are several of our Board of Directors members. Many mineral deposits are found by studying outcrops of mineralization at the surface and then drilling around them to understand the shape, size and grade of the deposit. At Bear Lodge, there is very little outcropping rock and there is generally a 2-3 meter thick layer of soil or colluvium that covers the mineralization that may otherwise be easy to find. As a result, explorers take surface soil, rock and trench samples to target their more expensive drilling but drilling programs are generally limited to a certain amount of holes and the targets can be small. In the case of Bear Lodge, several of the previous explorers were looking for gold or base metals so the rare earths were of no interest to them. When Molycorp was on the project, their exploration was cut short due to not finding the higher grade rare earths mineralization and the takeover by Unocal. Hecla Mining Company did do some very good work at Bear Lodge but their budgets and staying power were limited, and they found only the low-grade mineralization. Many exploration properties go through having several companies exploring them before the geology is understood and an economic deposit is found. Another example last year was a major gold discovery in Mexico that was found by a junior exploration company after three major mining companies had previously optioned and explored the project and all three had walked away from it. The junior explorer hit approximately 300 meters of approximately 1 gram per ton gold in their first drill hole. theinvestar.com: So at the time you were looking at Bear Lodge, you guys did not have a lot of competition in regards to claiming these REE deposits correct? Mr. Brown: Not only did we not have competition, it was hard to get anyone to even look at the project at that time. Most of the calls we made to generate interest in the project and to get financing started with a 30 minute explanation about rare earth elements and that their uses were growing in many of the new technologies out there. We had to educate each investor. At one point in the early 2000’s we dropped some of our claims to save paying the annual claim fees but we re-staked these a few years later. theinvestar.com: So Rare Element Resources was an early mover in the industry with your pick of the available deposits? Mr. Brown: We were really focused on the Bear Lodge project in the early 2000s but we have always kept files on many of the deposits around the world. Jim Clark and Tony Mariano, one of our consultants, have been to many of the rare earths deposits and occurrences around the world and advise us on what makes sense. We have had a hard time finding any projects that we would want to acquire but have a short list of projects if they come available. The other problem in the early days was that even if we knew of a good project, it was very difficult to get funding to acquire it or to explore it. In the beginning, there was really just the original Rare Earth Metals Inc., which is now VMS Ventures, Great Western, Lynas, Avalon and Rare Element Resources. theinvestar.com: Ok, so fast forward to today. There is a lot of competition for deposits and the attention of the market. Looking at the industry as a whole where does Rare Element Resources stand? Mr. Brown: There is a lot of competition among the rare earth companies out there but our belief is that action speaks louder than words so we are just working hard to advance our project towards our stated goal of producing rare earths by 2015. Molycorp and Lynas are well ahead of us in advancing their projects to production. There are a few Australian companies and Canadian companies that are close to where we are (Prefeasibility Stage) and several of us have the target of going into production by 2015 but my view is that there will still be shortages of rare earths at that time. We will have our third resource report out in the spring of 2011. We have completed our preliminary economic assessment and are now working on a bulk sample pilot plant test and our pre-feasibility study. The Bear Lodge deposit has the second highest grade of any deposit in North America, and our location and infrastructure are outstanding. The real issues for getting into production are the permitting timeline and the metallurgical or recovery process that must be developed to produce rare earths. We are currently advancing nicely on both these fronts – the details of this progress are in our recent news releases. theinvestar.com: So what is your timeline to production? And who do you see being in production before you? (Please be real specific on timeline if you could) Mr. Brown: At the latest industry conferences I have learned the following: Lynas plans to produce 20,000 tonnes per year starting in November, 2011. Molycorp is producing about 3,000 tonnes per year now and plans to increase that to 20,000 tonnes by the end of 2012, and to a total of 40,000 tons per year at some point in the future. Rare Element plans to produce approximately 10,000 tonnes per year starting with about half that in 2015. We still have permitting, more exploration, and more metallurgical studies to do, but at this point, the project looks like it will be one of the top REE mines in the world outside of China. Could we be delayed? - of course we could, and so could everyone – Molycorp and Lynas have both pushed back timelines in the past year. It is pretty normal for complicated mining projects to take a year or two longer than plans call for. If that happens to a few of us, the market will be even more desperate for rare earths. Our timeline is as follows: 2011 – Complete our pilot plant test; update our resource calculation; begin permitting processes; continue to confirm and improve our metallurgical process; complete additional exploration and in-fill drilling; and complete our pre-feasibility study. 2012 – Continue with many of the same items from 2011 plus complete our full feasibility study. 2013 – Finish permitting, metallurgical testing and prepare for financing construction. Also, complete anything that is unfinished from 2012 in case of delays. 2014 – Begin and complete construction of the mine and mill. 2015 – Begin production at the mining rate of 500 tons per day which will produce about 5,000 tonnes of REOs in the first year. This is 50% of our planned capacity. 2016 – 2017 – Increase production to our life of mine rate of 1,000 tons per day to produce about 10,000 tonnes per year REO. We initially plan to produce a concentrate for sale but then after a few years construct an extraction and separation plant to produce the individual elements in the form of oxides (REO). Arafura and Alkane are on a similar timeline as Rare Element, and Arafura may be in production a year or so earlier. Alkane will be a small REE producer. Avalon is on a similar timeline to us and so is Quest Rare Metals. Great Western has a very small project in South Africa planned to satisfy their manufacturing needs, but it is very high grade. India has a small project that is supposed to be online in the next few years at a very small production rate. There are also projects in Vietnam and the old soviet block countries that some of the Japanese groups are working on. I understand those will be quite small producers if they are successful. There are other companies with good projects that are advancing nicely and have just done resource reports such as Tasman and Hudson. Both of their deposits are reported to be growing and they have very good management teams, as do several of the other companies that I’ve mentioned. Stans Energy and UCore are working on their resource reports also I believe. There are also some large exploration projects in Greenland and Russia but I’m not sure if they are active, or if so, how active, at present. There have been very few new discoveries of REE deposits but we have been watching closely a few companies that are starting to report higher grade intersections from drilling. It just seems to me that most of these projects have been around for some time and now are moving ahead faster, but that there are still very few of them to meet the estimated growth in demand for all of the rare earth elements. At least most of the companies now have more capital to move the projects ahead – it was pretty hard to get funding for rare earth projects until recently. I don’t think that people realize how critical the elements are to our everyday life to ensure that there are good new sources of rare earths being produced. Without rare earths many of our current technologies would be much less efficient and cost much more – including gasoline refining, wind energy production, magnets for small electric motors in many types of cars that make them more fuel efficient by being smaller and stronger, but I’m getting off topic. theinvestar.com: Currently Rare Element Resources is planning more drilling, both for the REEs and the gold which will change your NI 43-101 reports, but will it be enough to move up the resource calculation in terms of Indicated versus Inferred? What percentage of the drilling is infill, exploration and drilling, if you could? Mr. Brown: Rare Element’s geological teams drilled 61 holes on the Bear Lodge Rare Earths project, another 40 large diameter holes for bulk sample processing tests, and another 34 holes on gold targets during 2010. We had over 25 people working on the site this year including 5 drill crews, and the geological teams to track, log and analyze core and drill cuttings. We now have a large warehouse in Sundance, Wyoming which is stacked floor to ceiling with drill core. The 61 REE holes were about two-thirds infill drilling holes – those that were designed to upgrade the resource category to indicated with closer spaced holes – and the other one-third were step out holes or were at the new target called Whitetail Ridge. We spent about $5 million on the exploration and testing work at Bear Lodge in 2010. What was very interesting to us is that almost every hole hit rare earths and we hit higher grades in our program this year than we have ever hit before – several of our holes had intercepts of greater than 10% rare earth oxides. It is important that people take the time to read the news releases with the details of those drill holes and they are available on our website. There is also lots of low grade materials around 1.5% in those drill holes. I don’t know yet how much of our resource will be upgraded into the “measured” or “indicated” category but we will know that in the second quarter of 2011 when our updated resource estimate is done. theinvestar.com: Also, if you can, what should investors expect in regards to the total tonnes of REO and total ounces of gold? Mr. Brown: Well, our current resource is 17.5 million tons of inferred resource with an average grade of 3.46% REO at a 1.5% REO cut off grade, but we don’t know what kind of an increase we will get until we have our formal report issued. Our stated target for the gold project resource is that it would be around 1 million ounces or more of gold, but, again, we will only know for sure when the report is completed. theinvestar.com: So where does Bear Lodge rank among the projects out there in terms of the grade of your deposit and total size? What about specifically in regards to projects in the USA? Mr. Brown: I will give you a short list of the projects by grade but it is really important to look at the make up of that grade. For example, a 6% REO grade at Bear Lodge is roughly equivalent to the 8% grade at Mountain Pass because we have more of some of the high value rare earths (terbium, dysprosium and europium) than does Mountain Pass (Molycorp). Having said that, an 8% grade is very high. Avalon and Quest have lower grade deposits but they talk a lot in their news releases about “heavy” rare earths. While the atomic number does not actually mean much – you need to look at the actual value of specific rare earths – both of those projects do contain higher proportions of the higher value rare earths even though their overall grades are lower. So, having said that, here is the list of project by grade off the top of my head (please excuse any errors!):
theinvestar.com: Alright so you have the world-class Bear Lodge Project, but what are your plans in regards to the HREEs that everyone in the world is looking for, including China? Mr. Brown: Well we are pretty happy with the mix of elements that we have for two reasons:
61% of the estimated revenue from Bear Lodge is made up from europium, terbium, dysprosium, neodymium and praseodymium. These are the most valuable light and heavy rare earths. Neodymium, Praseodymium, Dysprosium, and Terbium all would be used in high-strength magnets, which is the largest and fastest growing market for rare earths. As I said before, it is really important to look at the specifics of these projects in terms of the actual value of the individual elements and each of their growth prospects. Prices of the elements are available at www.metal-pages.com. The capital and operating costs are also key to any mining project and must be studied to determine if a project will make it. The current prices of rare earths are so high that it looks as if many projects are currently economic. Rare Element used very low historic prices in our PEA and has a lot of focus on our input costs so that we can make it at these low prices and if prices stay high, we will have an extremely robust project. theinvestar.com: So you have not done any drilling at Eden Lake? And in regards to the grab samples, based on the field work and assays, how large is the target area you will drill test? Mr. Brown: The Eden Lake and Nuiklavik projects are early stage projects that are really prospects for us. We acquired them cheaply and our strategy with them is to option them to third parties who are interested in spending the high risk/high reward dollars to make a discovery on them. This was just a way of giving us a few more irons in the fire on projects that do look very prospective. If any drilling is done at Eden Lake, it is up to Medallion Resources who we have optioned the project to which is lead by Dr. Bill Bird, the past president of Rare Element and a good friend. He is a Phd. Geologist and a very good person to have studying that project. If there are rare earths there to be found, Bill is an excellent person to be running the exploration work. theinvestar.com: Based on the geology, what kind of target are you looking for (near-surface, etc.)? Mr. Brown: The target at Eden Lake is an at-surface carbonatite with minerals that contain rare earths. This is the old VMS Ventures project that they had for years before they could no longer fund it. theinvestar.com: More importantly what type of rock do your models tell you it should be hosted in? (If eudialyte, does Rare Element or Medallion have a process or any lab work giving you confidence this could yield something economical?) Mr. Brown: Interesting question. You seem to be aware that no one has ever processed rare earths from eudyalite minerals, or so I’m told. That is not the target at Eden Lake. Dr. Bird of Medallion did some preliminary work and is shifting his focus to the potential of the area to host a carbonatite type deposit. REE bearing minerals include apative, britholite, and allanite. Remember, though, that is currently a prospect – there are indications that something may be there but a discovery has not yet been made. As for eudyalite, I’m quite sure that someone will soon come up with an economic process to recover rare earths from it, especially if current prices continue into the future. theinvestar.com: The company recently raised $50 million plus. This isn’t enough to get you to production, so what is the plan for this cash and when will you have to return to the market? Mr. Brown: Well, we still only have 43 million shares outstanding which many people seem to forget. We don’t like to issue a lot of stock, and have a tighter capital structure compared to most of our peer group. Today, we have roughly $70 million in the bank. Our budget is $15 million for 2011, another $15 million for 2012, another $10 million for 2013, and we should have about $25 to $30 million left when we finance for construction. Our initial capital costs at Bear Lodge are estimated in our PEA at $87 million for a concentration plant, and if we then choose to construct a separation plant, we would also need another $150 to $200 million. We would likely finance some of the $87 million in 2014 by way of equity, but debt financing for a portion of it would also make a lot of sense because it would avoid further shareholder dilution and potentially be more tax effective for the shareholders. theinvestar.com: Your stock really took off after the Preliminary Economic Assessment, many were apparently surprised by the numbers. Can you explain to investors what the PEA indicated? Mr. Brown: Any investor should really read the Preliminary Economic Assessment and I strongly encourage them to do so, or at least read the summary section. The PEA was based on open pit mining from the top portion of the deposit about 5 million tons of oxide ore over a 15 year period. The revenues were based on a pricing basis of $5.51 per kilogram of REO concentrate (three year historic average to August, 2010) with a grade of 42% to 45% REO. The capital costs to build the mine and mill were estimated at $87 million and the sustaining capital which comes from the profits of the project, is estimated at another $87 million. Our operating costs were $213 per ton of ore which is high. We expect to be able to reduce this as we do further optimization work and have already made some progress on this. The net present value (at 10% discount rate) of the after tax cash flows were $213 million in our model, and the internal rate of return was estimated at 40%. The payback of capital was estimated to take about 3.1 years with a three-year scaling up to full production. We were conservative in all the assumptions used in the PEA. The biggest factor that we were very conservative on is the price of the rare earths. Firstly, if we do go to the stage of producing refined rare earth oxides, the prices are generally 35% higher than for concentrates, but we will also have another $150 to $200 million in capital needed. Secondly, the current price of concentrates is $38 per kilogram versus the $5.51 we used in our PEA. theinvestar.com: Now the pricing models used in the assessment, can you explain how those prices were arrived at? Mr. Brown: We took an average of the last three years prices for rare earth carbonate concentrate containing 42% to 45% REO from the data provided by Metal-pages.com. This included 2008 and 2009 which had very low prices for all metals. theinvestar.com: So these prices were conservative. How do the numbers in your report compare to others in the industry in their PEAs? Mr. Brown: I’ve only looked at two other PEAs and they used much higher, projected prices to arrive at their NPVs, and some used REO prices when their studies indicated they would produce concentrate. In fact, they may be right and we are in great shape if the actual prices we get for our products are closer to what they used. I won’t quote the prices because you cannot compare them directly without first looking at the mix of elements in each project. theinvestar.com: So looking forward, where is Rare Element Resources planning for prices to settle at? Lower, around the current level, or higher? Mr. Brown: I can see prices continuing to increase for some time but I also expect a pull back for some of the elements at some point. Cerium will likely be in oversupply after Molycorp and Lynas are in full production. Other elements that may have softer prices include samarium and possibly lanthanum, gadolinium and yttrium. The question is where will prices settle, and I’m not sure of the answer. My best guess is that they will be about 3 times to 4 times the historic prices that we used. theinvestar.com: Among the REE experts there is a bit of a debate raging about companies bringing production online and how far down the value chain they need to go to be successful in the business. Rare Element Resource’s plans are currently to focus on mining the ore and making REO concentrates, correct? Mr. Brown: That is what we modeled in our PEA but we do plan to also construct a separation plant at some time. We have a history of delivering on our promises and targets, good news or bad, and we would not want to promise to be a mine to magnets company unless we were 100% sure we could become that. A mining company is typically a mining company and leaves the more detailed processing to others, up the next step of the value chain. At this point we have no plans to become a specialty product company and we are keen to take samples of our product from our pilot plant test this summer and begin to talk to potential customers for our concentrates. theinvestar.com: Is the magnet, alloy or specialty product sectors something you will look at entering sometime down the road? Mr. Brown: We are not looking at that at this time. There is a big difference in the skill need to be a mining company and the skills needed to be a specialty products company and our group is made up of Phd. Geologists, metallurgists, and mining engineers. theinvestar.com: What is management’s ownership in the company? Mr. Brown: Management and the Board own about 2.5 million shares in the Company or about 5.8%. theinvestar.com: What is the current share count after your financing? Mr. Brown: After the financing our fully diluted common shares outstanding is about 46.6 million shares and we currently have about 43.2 million shares issued. theinvestar.com: So over the next 5 years, where do you see Rare Element Resources and the industry? Who is in production? Mr. Brown: We see us in production or very close to it; likely Molycorp and Lynas, and hopefully 2 or 3 others, maybe Arafura, maybe Quest and/or Avalon and one other Australian company, on top of small production from India, Africa, and maybe Vietnam. theinvestar.com: We really haven’t seen any consolidation in the industry, when do you think companies start filling their strategic needs by acquisition? Or do you think it will be via the joint venture of projects? Mr. Brown: I think that there won’t be a lot of consolidation in the industry for a while yet. The potential buyers can just wait to see who can actually deliver, and the mining companies generally have their hands full just trying to evaluate their projects and get them into production. Consolidation is inevitable and we see it more as the large multinational companies looking to secure supply that do the buying, instead of the mining companies buying each other. theinvestar.com: How will this affect Rare Element Resources? Will you be consolidators, stay as you are, or be a seller? Mr. Brown: Right now we are near the top tier among our peer group of the mining companies but we are still a pretty small fish for the large chemical or manufacturing companies, so we could be either, or neither. Is that vague enough? theinvestar.com: At current prices, how do you feel your shares are valued? Fairly valued, undervalued or overvalued? Mr. Brown: We calculated the net present value of our cash flows on a portion (about half) of our deposit in our Preliminary Economic Assessment and we did that calculation using historic prices of a mineral concentrate of rare earths. The historic price was $5.51 per kilogram of rare earths concentrate and the current prices are about 7 times higher at $38.00 per kilogram. While our estimated capital costs may be a little higher as we update our reports, we do expect that our historic three year average price will be quite a bit higher. Our NPV in the PEA was $213 million but even if you just increase it to $11.00 per Kilogram our NPV increases by a lot – and this is with last year’s resource which we expect to increase from our 61 hole drill program that we finished in 2010. It is also possible that our operating costs could be reduced as we continue our tests for processing our minerals. It will definitely be exciting for us to get our next resource report done, expand the deposit with additional drilling, and complete our preliminary feasibility study by the end of the year. In terms of our share price, we noted that we only have 43.2 million shares outstanding and our market cap it much less than Avalon’s and a fraction of Molycorp’s so I still see a lot of room to build the value of our company for our shareholders. theinvestar.com: Mark, once again thanks for taking the time to tell your company’s story to our readers. Mr. Brown: Matthew – thanks for taking the time to look at the fundamentals of the company. I hope that this is useful for your investors.
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