I am big fan of metallurgical (met) coal. Two of the top percentage gainers on the TSX in the past two years have been coal stocks - both Grand Cache and Western Coal are each up approx. 1500%. Investors easily forget about coal and with only a handful of public coal companies around, they get little attention. Unfortunately it takes an earthquake in Japan to thrust the commodity into the spotlight.
Compliance Energy (TSX: V.CEC, Stock Forum; 37 cents)
www.complianceenergy.com
In January we started following Compliance at 25 cents through my paid Microcap newsletter but the stock remains very attractive in the 30-cent range. The company has two giant industry partners from Japan and South Korea and together they own a large met coal project on Vancouver Island.
They are in the permitting process with the Provincial and Federal governments to develop an underground coal mine in the Comox Valley. The region needs the jobs and the local MLA and Province (so far) seem to support it. However, you can't put a mine in British Colombia and not have environmentalists involved.
We won't know if approval is received until Q2/12. If a mining permit is declined, the stock will take a hit. How much so is unknown because even now the market assigns very little value to the coal project. However, if a mining permit is awarded, $2 to $3 is a realistic share price target for 2012.
The project’s large coal resource only carries a value of a few million dollars. The reason the stock trades in the 30-cent range is because Compliance owns a large share position in Copper Mountain (TSX: T.CUM, Stock Forum; $6.14).
Over the next 30 to 60 days we should see the final feasibility study on the coal project (this will be an important event) and then this summer they will start drilling their copper targets on Vancouver Island. This same group helped build Copper Mountain from a tiny company to a large producing mine in British Colombia (one of the first in a decade).
This is by no means a short-term trade and we're not looking for gains in the pennies as much as we are in the dollars over the next 18 months. Until they start drilling their base and precious metals targets this summer, we should continue to see good liquidity in this price range.
Overview
> Shares outstanding: 53 million/Market cap: $20 million
> Cash & receivables less debt (Sept 30): $600k [a penny/share]
> 2.3 million shares of Copper Mtn: $14 million [26 cents per CEC share]
$3.5 million financing at 35 cents and 40 cents announced March 10 – placed with corporations and institutional investors.
Compliance is a penny stock run by blue-chip management. This team is using the same highly successful business model as they did to grow Copper Mountain from 40 cents to $7.48 within two years. The main asset of Compliance is the large Raven underground coal project on Vancouver Island. Their secondary focus is copper exploration (also on the island).
The 2011/12 outlook for metallurgical coal (coking for steel) is very strong and demand across Asia has pushed it to record high prices. Compliance Energy's Raven project contains over 120 million tonnes in the measured and indicated category. Throughout 2011 they are finalizing an economic feasibility study along with completing the environmental and mining permit applications. The deposit has very close rail, shipping, water and power access.
The market's valuation of Raven's coal makes CEC a very attractive speculation. Compliance owns $14 million worth of Copper Mountain stock. If we pull this from the current $20 million market capitalization of CEC, the investing public is saying CEC's large coal project is only worth $6 million. This is where huge value may lie in waiting but the true potential will only be known once a mining permit is in place.
On its own we could say this coal project is worth dramatically more than $6 million. However, Compliance Energy is leap years ahead of most exploration projects because they have two industry giants as partners from Korea and Japan. The Raven coal project was setup under the "Comox Joint Venture" (CJV). Compliance controls 60% of CJV, and 20% each is owned by Itochu of Japan and LG International of South Korea.
IComox Coal - 100% owned subsidiary of Itochu Corporation of Japan. Itochu's 2010 trading of energy metals and minerals accounted for $35 billion. They have extensive experience in the development of coal mines, marketing and sales.
LG International Investments Canada - 100% subsidiary of LG Korea. LG is Asia's largest coal trader.
We now have a very large met coal project with tremendous shipping access to Asia, partnered with two of the most powerful Asian companies in the world. The market believes this is worth $6 million. They are grossly mistaken.
The Comox Joint Venture (CLV) acreage consists of almost 75,000 acres (coal, minerals and gas). It contains the Bear Coal deposit and the Raven Coal deposit (which the joint venture is currently trying to develop). The reported tonnage of Raven (120 million tonnes) is 43-101 compliant based upon drilling to date. There is a report from 1975 that is not 43-101 compliant but estimated tonnage of the entire Comox Basin at 890 million tonnes.
An added bonus to the CLV is that they have all mineral rights to depth and "fee simple" ownership. This is very hard to acquire and the company spent considerable money ensuring freehold ownership that not only gives them ancillary rights (over-riding surface rights), but they would pay no mineral tax (saving 13% of all net profits).
Coal expertise
John Tapics (President and CEO) has more than 30 years of mining experience and was responsible for a large portion of TransAlta's coal mining activities in the Province of Alberta. He was an officer of TransAlta for 11 years (responsible for generation, transmission, and distribution) and spent four years as CEO of Alberta Electric System Operator. Mr. Tapics was also a director of the Coal Association of Canada and the Western Electric Power Institute.
Compliance Energy's Chairman is Jim O'Rourke, who is also the CEO of Copper Mountain (www.cumtn.com). Copper Mountain (Princeton, B.C.) is a joint venture with Mitsubishi Materials and contains five billion pounds of copper. The mine will employ several hundred people and be in production summer of 2011.
Raven coal project
- Vancouver Island (7600 acres): High quality Grade A Bituminous semi-soft coking coal
- 72 million tonnes measured/indicated and 59 million inferred
- Life of mine is 18 years with average annual clean coal sales of 830,000 tonnes
- Estimated Operating Costs (FOB ship) $75/tonne
- Average (estimated) selling price is $142/tonne
- Total estimated capital (life of mine) $272 million
- Close to power, major highway, rail and 50 miles from deep water port
- Port Alberni has distance advantage over Australia when shipping to Japan & Korea
- The mine will create 350 full time direct jobs and 500 spin off jobs
Pre-feasibility study (Oct 2010) shows very strong economics with a capital cost payback of seven years and annual earnings of almost $50 million on revenue in the range of $100 million. Infrastructure construction would start in 2012 subsequent to receipt of all necessary permits. Mine construction would take one year with first coal shipments in 2013.
The coal quality is very similar to New South Wales Australia (semi-soft coking) and would be used as a high-quality thermal coal for power plants. Many characteristics of Raven coal are also similar to premium Australian hard coking coals used in the steel industry (this is selling for more than $200/tonne). Raven thermal coal is expected to track pricing of coal shipped from Newcastle, Australia - giving them a very good handle on sales forecasts and competitive pricing.
Several opportunities exist at Raven to generate additional revenue, improve economics, and lower capital costs.
Environmental process
The environmental review process is the largest hurdle faced by any mining company and this is no different for Compliance Energy. Mining has been an economic driver on Vancouver Island for over a century and with significant 2010 layoffs in the forestry industry (within the Comox Valley where the Raven coal project sits), a mining project is critically important to government for health care and education tax.
A major hurdle was crossed in November when the Canadian Environmental Assessment Agency (CEAA) confirmed that the Federal government would not require a federal review panel. Stating "...the agency and other federal departments have not identified significant adverse environmental effects that may result from the project after applying standard mitigation measures."
In the past, Federal and Provincial governments have worked independent of each other when reviewing large mining projects. Compliance Energy believes the Raven project will be unique in that both levels of government will be working in tandem with each other. If all goes well, this will set an important precedent for the Canadian mining industry.
The Raven coal mine would leave a minimal footprint because it is an underground project and only 200 hectares of the facilities are on surface. Everything else is underground. The environmentalists and a percentage of those in the valley will complain simply because its coal or mining related.
You will see from the video below (December 15, 2010) that the streets are not over-run with protestors. However, the squeaky wheel will always get the grease (and media attention). This news report is typical of environmentalists but more important to us are the comments from the regional MLA and the Provincial Environment Minister. Liberal MLA Don McCrea says the mine is needed to fund education and healthcare. MLA Murray Coell (Environment Minister) says coal has a long and important history in British Colombia and will remain so for economic reasons. They will work to minimize risks but the project he says is critical to the economy.
https://www.youtube.com/watch?v=BhlfgNDMsDA
Timeline
- Environmental Assessment Application & Review - Q1/11 to Q2/12
- Final Feasibility Study - April 2011
- Mining Permit Application - Q3/11 to Q2/12
- Receipt of Permits - Q2 or Q3/12
- Construction - Q3/12 to Q3/13
- Mine Operation - Q4/13
- Community Consultation - Ongoing
Coal - Merger & Acquisition activity
November 2010 it was announced that Vancouver-based Western Coal (TSX: T.WTN, Stock Forum; $11.61) was being bought out by coal mining giant Walter Energy - creating the largest pure play met coal producer in the world along with BHP and Teck.
Global demand for both thermal (used in power plants) and metallurgical (coking - used to make steel) coal is booming. Thermal coal prices rose 48% in 2010 and both India and China continue to consume huge quantities of both thermal and met coal. The world's largest producers of coking coal, BHP Billiton and Japan's Mitsubishi, recently settled prices for Q1/11 at $225 a tonne, the second-highest level on record.
We have now seen Walter Energy buying out WTN for $3.2 billion. Vallar (backed by Nat Rothschild) is paying $3 billion to pickup Indonesian assets, U.S. based Massey Energy is looking at a sale, and privately-owned Drummond is looking to sell their Colombian coal assets for $6 to $8 billion.
Base metals & copper exploration
To diversify and provide additional news flow while the coal project progresses, Compliance acquired approx. 15,000 hectares of exploration properties on Vancouver Island. As previously mentioned, this group was responsible for making Copper Mountain what it is today. Not only has the stock done phenomenally well, but Copper Mountain will soon become a large producing copper and gold mine near Princeton, B.C.
Compliance has already done extensive work that included geological mapping, geochemistry, and airborne geophysical surveys. Based on this work in 2010 they elected to exercise their options on the properties and will drill by summer. They are targeting gold, copper, molybdenum, and magnetite.
Within this package of properties is the Camp Lake project, which is targeting copper and magnetite. The magnetite is a very strategic move for CEC because it is a critical component in the separation of coal from rock (a slurry process). The only close source is the B.C. based Craigmont Mine, which produced copper from 1962 to 1982, but since 1993 has provided the coal industry with magnetite from the old copper tailings. An economic discovery of magnetite at Camp Lake would lower the operating costs for Raven - and any copper discovery becomes a significant bonus given the record high copper prices we're experiencing.
Conclusion
CEC will not be without long bouts of boredom. By April we should see the final feasibility study - this should generate more interest. By summer they will drill some of the new copper projects. Then we wait and watch to see how the environmental review goes with Raven (I will update through the year as I hear anything).
In a perfect world, they pass environmental review (provincial and federal in tandem), are issued the mining permit, raise the capital, and start mine development. Under this scenario, share price would jump on receipt of mining permit and then receipt of financing (combination of debt and equity).
Compliance Energy has not required brokerage financing, so very few brokerages have any interest in following the story or recommending it to clients. In addition, they have little institutional ownership. This is an extremely high-risk venture for a fund manager to bet on. It is literally like betting on red or black at the Roulette Table. Either they pass environmental review and receive a mining permit - or they do not. If it goes well the fund manager looks like a hero on big gains. If not, he losses a large chunk of his investment. Most managers will not take that risk and instead would pay the much higher price upon approvals.
For the retail investor (with patience and risk tolerance), this creates opportunity because bigger money has not pushed the stock to any type of premium. In fact, the stock can be acquired at a substantial discount to fair value. If we pull CEC's investment in Copper Mountain from the valuation, the Raven coal project carries a value of only $6 million.
This grade of coal currently sells in Asia for approx. $140 per tonne. The mine's operating costs are estimated at $80 per tonne. The Raven project hosts at least 120 million tonnes and CEC controls 60% of the deposit. If the market is valuing their project at $6 million (market cap of CEC less shares of Copper Mountain), it means the coal itself is (according to the market) worth less than seven cents per tonne.
So long as copper remains this high, CEC's investment in Copper Mountain will support the bulk of the current share price and eliminate any need for funding (dilution) before we see a decision in 2012. If their copper/gold exploration properties do well in 2011, that becomes an added bonus.
Environmental approval would be followed by receipt of a mining permit - this event would cause a significant jump in share price (estimated Q1 or Q2 2012). This rise in share price would then be followed by financing that would allow them to issue part debt and part equity.
Receipt of financing would likely then result in another jump in share price. The construction and marketing phase we deal with at the time because it is often a boring period. However, the production and earnings phase then becomes another period of share price growth.
I estimate (assuming no value assigned to the summer metals exploration program) that a person risks 50% of any investment within 18 months to try and make 300% to 700%.
Impact of Japan
This has not been factored into CEC’s potential valuation, but we cannot lose sight of what happened to Japan’s nuclear power plants. This has implications across the entire uranium sector but more so for the country of Japan and their dependency on nuclear power and coal.
There are currently 65 thermal power plants in Japan. The number of natural gas-fired power stations is increasing and roughly 30 percent of electricity is natural gas-fired. Coal remains an important fuel source and accounts for roughly 25 percent of electricity generation. Domestic coal production came to an end in 2002 and Japan imported 206 million short tons in 2008, for which Australia was the main supplier.
Nuclear
Japan currently has 57 operating nuclear reactors with a total installed generating capacity of around 49 GW, making it the third-largest nuclear power generator in the world behind the United States and France.
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If Compliance Energy becomes fortunate to receive a mining permit in 2012, you can bet their giant partner Itochu Corporation of Japan, will be very actively involved. Coal will take on tremendous importance in Japan and if/when this project receives approval, Japan could become one of their first customers.
Disclosure: Danny Deadlock owns 50,000 shares of Compliance Energy (TSX: V.CEC) purchased in 2010 with intention to hold into 2012.