Cobalt, Payables, Orange Juice and the DRC

I wanted to try and explain things around “payability” in laymans terms, and I by no means claim to be an expert, just piecing things together as I’ve been learning about this industry myself.  Payability is simply what you will be paid for metal contained as a % of the metal contained.  

So if you’ve got 1 tonne of dirt which has 10kg (1% grade) of a metal called X, and you go to a smelter, they may offer you terms that only means you get paid for 1kg of metal, even if you have 10kg in the dirt.  Why - because they have costs involved in upgrading that 1% dirt to a saleable product and a sale price determined by the rest of market.

Now go back to the FS.   As of the FS Nzuri are putting out a Copper/Cobalt concentrate with 19,360t of Copper and 1507t of Cobalt annually for 7 years.  

Now using one indicative quote from an off-taker, given/tendered when cobalt was $15/lb, Nzuri are expecting to be paid for around 50% of the copper in the concentrate and a range of 7-15% of the cobalt.   

Using last LME prices this gives us a pre-tax NPV of ~A$180M or A$47M in avg. annual profits.

Now for arguments sake, what if hypothetically Nzuri was paid 60% for contained copper and 40% for contained cobalt?  

Using last LME price this gives us a pre-tax NPV of ~A$520M or $112m in avg. annual profits.  

(Note this is all relating to the FS which is stage 1 only, no cobalt stockpiles or tailings or satellite deposits)

So a simple thing like the terms of the offtake contract have a very large impact on the Stage 1 project.  Not that my personal expectation is quite that high but just showing why its important.

To understand what conditions could occur to allow such an uplift in value, I am going to look at oranges and orange juice, this is how I have to explain things to myself, with things you can eat.

Say there is an orange farmer and an orange juice producer.  (note this is all a a vast simplification of the juice supply chain).  Now normally the orange farmer sells his oranges to the juicer for a price related to the yield of his fellow farmers and the demand for oranges as a whole. This price is not so volatile.  

Say for arguments sake this price is ~ $2/kg.  

Now picture a situation where for some reason only the farmers in one particular valley, lets call this valley “Katanga” can produce enough oranges consistently enough to satisfy a big orange juice maker.  

In this valley you have different kinds of orange production, some of them use immigrant labour to harvest, some use pesticides, some are completely automated, sustainable and organic.

It so happens that a new fad diet emerges called the “OJ cleanse” and the proponents of this diet insist that only sustainable, organic oranges can make the right orange juice, and you need to drink copious amounts of juice to be awesome.

The juice makers immediately secure supply with the organic farmers and start charging more for the organic juice.

The fad is wildly successful.  The juice maker is able to charge over triple the amount they could have normally, but are still paying the farmer around $2/kg.   

Now something interesting happens, other entrepreneurs notice the ridiculous margins the organic juice has and new juice makers start being established.

Now there’s only one valley, the Katanga valley, that has the consistent and scalable production.   To make matters worse, they can only use farmers who are sustainable, organic, which is again a subset of the Katanga subset.   To make matters even worse there are market speculators stockpiling organic oranges understanding that juice makers can afford to pay much more.

Now the organic, sustainable juice farmer in the Katanga valley has multiple parties knocking on his door asking for organic oranges.  He only has a certain sized orchard but now far more customers than he has oranges, so he tries asking for a higher price - $4/kg, the bidders are all still keen.  Then he tries something interesting.  He asks them to give him a 50% share of the margin on the fad orange juice, because without him, they don’t have a market.  

One of the juice makers agrees and offers to buy a years production upfront, deal done. and farmer is now getting paid multiples of the $2/kg.  The other parties will have to start with planting new trees or try experiment in an unproven valley that takes years to prove up with no guarantee of success.

So coming back to the cobalt  and the battery market.

The katanga valley is the DRC.

The orange farmers are the mines producing copper/cobalt concentrate.

The orange juice makers are the cobalt chemical producers/ cathode material producers.

Organic, sustainable juice is the equivalent to traceable, mechanically/heavy equipment mining (non-artisinal as Glencore operates)

The fad is the battery boom and the margins are disgustingly high for the chemical producers at $35/lb for cobalt and paying just 7-15% for contained cobalt in concentrate.

The competition has arrived, two SXEW plants looking to start pumping out juice, with no sources of “Organic, sustainable” oranges or mechanically mined copper/cobalt concentrate. To make matters more urgent, one major juice operation that had its own farms, Metorex has actually screwed up their mine plan and are buying their organic oranges on market (at coles) at a huge cost premium, still making bucket loads but needing to lock away feed.

The customers are insisting on organic, the options are limited, the margins are skewed towards juice makers and the competition is coming very very fast.   

There will be some creative deals done by Farmer Arnesen to capture this value currently being locked away by the juice maker.  Last I spoke to Farmer Arnesen he said that there is a lot of interest and desperation to secure offtake now, but in his experience the best way is to leave it to the last possible stage.  The binding offtake is the prize and the suitors need to compete.  You meet the suitors, you are polite, you discuss the product and the market and if they look like they can afford it you put them on the shortlist.

This waiting game raises in my mind the possibility of a takeover, at some stage it will be simply a matter of - “these Nzuri guys are holding out, there’s more and more competition coming, lets just take them out and start making juice!!  there’s plenty more oranges coming in the 2nd orchard (stage 2 kalongwe), and the ground is fertile (ripe for more cobalt discoveries), and the price of “Juice” is only getting higher, lets pay what we need to pay to put this away”.

Now some smart Bob will inject their 2c and say Nzuri is too small.  That's actually wrong, Nzuri already has defined 40,000 tonnes of contained cobalt, that is roughly 2.5 - 3M electric vehicles worth.   That is extremely significant and there is more to come from the ground we hold, see for example the 7m at 1% cobalt intercept from a few weeks ago that all the canadian and european cobalt explorer's would have loved to report.

We are also fortunate enough to have greedy private equity holding a controlling stake in the company and they will want to have their cake and eat it, and have some cake for later too.  So they could not care less what Bob has to say, Bob should go back to speculating on bitcoin.

Our job is to simply hold onto our shares and tune out the anti DRC melancholics.   

The top 20 hold 90% of this company.  How often do you hear “tightly held” but this is the real thing.

We barely need a handful of HNW to recognise the speculation here and it will rip upwards with every move in cobalt price, every development in the DRC market, exploration result or similar positive catalyst.

What are the risks - wholesale collapse of govt and society in DRC and Katanga.  

The DRC can make you feel hope and despair at times in equal measure.  It is a young country in age and in demographics and I believe the best years are ahead and the long term trend has been upward since the conflicts post Mobutu / Rwandan genocide.   

It was encouraging to see that Alphamin have secured 80% of the $200M they need to finance a world class tin mine at the epicentre of conflicts in Kivu region.   

There is tragedy and progress.  I believe Kabila plans to remain in his position for many years to come but at the same time he will have to make improvements to security, transparency, food, water availability and power infrastructure for all citizens if he hopes to actually stick around.   If he doesn’t, the most popular alternative figure to lead the country seems like he will.

My personal view is to think positively.  We have recently opened an office in Lubumbashi looking at investing and starting up mineral and agriculture projects because we prefer to engage and reap the benefits of understanding the risks while operating ethically to sustainably build a business.

The way I see it, without the DRC all the EV bets are completely off.   China wants to breathe clean air and I think they will have some pretty strong influence on ensuring stability.

Why is the EV market toast without the DRC share of production?  All the other non-battery customers for cobalt can afford to pay much more than battery makers.  

Battery makers will have to switch to less marketable, less energy dense and not as safe chemistries with zero cobalt as they wouldn’t be able to pay for cobalt and compete with ICE.  LFP (Iron Phosphate chemistry with no Cobalt) has been proven to be most successful in commercial applications but not really mass market.   

Should Katanga prove unable to continue supply, IMO TSLA, Panasonic stock would take a massive hit and that would be the first of many dominos.   The EV and battery metals market at large has a lot of future growth already priced in and this would be cause a correction.   Luckily Nzuri as of today still does not even have the base case at low payables and $18/lb priced in.

Re Substitution - Will cobalt be the best speculation in the electrification theme forever?  I don’t know, but the next 5 years is a safe bet.  The NMC chemistry still has a fair few years of improvements on the roadmap thanks to Panasonic.  This period happens to cover the juiciest parts of our stage 1 project, which is light on CAPEX $50m and very quick to get online.

Bottom line - I’m not telling you to buy shares in Nzuri.  Its not for everyone, I grew up in Africa and understand the landscape.

If you don’t have the conviction, don’t come near Nzuri.   It is hard to build a position and you drag us all down if you chicken out and leave.

If you have the conviction and understand the risks, please hold strong, we don’t want to sell our oranges for $2/kg and let the juice makers make all the profits.

I’m saying, if you plan to buy, buy and hold because just like the cobalt market at large, there are not many shares available and through simple supply and demand dynamic we can get a much better price, this is a very exciting possibility for me, two choke points with many catalysts ahead to create pressure.  

The main catalysts are simply:  Exploration, Offtake and Financing.  Of these three there will be joy from one or all avenues.   

My guess is that this will all be finally topped up by a bid at a significant premium to market to end the misery off a lucky orange customer / juice maker.

Ok enough waffling, this cafe is closing.