The Classic Commodity Stock Trap, With a Twist

Written by Adam English
Posted February 16, 2017 at 9:25PM

This last week, I got a great question from an Outsider Club reader that I really want to share:

Adam,

What is the difference, if any, between Pure Carbon and large graphite flake?

Please reply and let me know.  I have been an investor in Northern Graphite for years, and it is dropping with the rest of the Canadian minerals market.

Regards,

P. Merlo

It is a short and seemingly simple question, and there is a short and simple answer to go with it.

However, like virtually all things, the devil is in the details, and that is where we need to look for the full answer.

Here is my response.

Hello Mr. Merlo,

Thanks for reading and for your question. Here is the short version of my answer:

Pure carbon, in this case, refers to high-purity (99.9% or more) spherical graphite. Different producers want graphite in different forms, depending on how they are used. Spherical graphite has become one of the industry standards for battery anode production, in particular.

New applications for graphite — especially new generations of batteries — push beyond the purity levels we find in already rare deposits. That makes large flake graphite a great source for what will become purified spherical graphite because it has less contaminants than other forms, but it still has a big hurdle before battery manufacturers will buy it.

In fact, Northern Graphite seems open to supplying both forms to buyers. As far back as 2012, from a quick search online, a lab hired by Northern Graphite established that graphitic carbon from the company's Bissett Creek deposit can be purified up to 99.99% in this spherical form, and that its large flake graphite can get up to 99.83%.

Here is a bit more of what goes into the difference, if you're interested:

Unfortunately, getting to levels of purity required by manufacturers is a huge problem. Processes that can push up to 99.9% purity and beyond (military-grade applications can require up to 99.995%) involve either a whole lot of toxic and corrosive chemicals, a whole lot of heat, or both.

On the chemical side, you have stuff like hydrofluoric and hydrochloric acid, along with the grave waste water and equipment corrosion concerns that come with them.

On the thermal side, ovens that can take advantage of how carbon stays solid way past the melting point of any metal are needed to get a finished product so pure.

Carbon doesn't even melt, it sublimes at around 10,000 degrees (F). That's pretty useful here. The graphite, which is just a particular arrangement of carbon atoms, will just sit there doing nothing while everything else boils off.

Unfortunately, to really push out enough contaminants, the oven has to reach around 5,000 degrees (F). The energy requirements to bake literal tons of graphite are similarly astronomical, but there is no other way to reach the extreme end of purity requirements.

Add in the fact that the certification process for supplying purified graphite is capital and time intensive as well, and a very high barrier to entry exists for would-be producers.

Battery manufacturers determine if they will buy materials from would-be suppliers by using "drop-in samples," in which grams, then kilograms — then 10's, then 100's, then 1000's of kilograms — are introduced to the manufacturing process to see if they hold up to real world conditions at large scales.

So companies need to cover the capital-intensive mine development, along with specialized equipment to purify, all without the long-term contracts from buyers that would make securing capital far easier. It is the classic funding trap for commodity stocks, with a twist.

Gerardo singled out the company for his subscribers specifically because it has made it through the gauntlet, and has now secured contracts with buyers.

Hopefully, this has been helpful and informative.

Some Have It Easier Than Others

I can't say much about Northern Graphite. In late October, it announced the start of a testing phase for a spherical graphite facility with a handful of other companies trying to achieve full qualification of materials for lithium batteries.

I haven't fully researched the company though, so I'll just leave it there. Basically, both the company Gerardo is covering and Northern Graphite have the same goal: To sell as much purified carbon from graphite as they can.

They also face the same problems, which are just like every other commodity company out there. Exploration, permitting, and extraction cost a fortune, and take years to pan out.

Regardless of how much of a resource a deposit contains, the company must make enough money to bridge the gap between finding it and selling it.

Sometimes, that isn’t all that hard. Sometimes it is, all depending on the market the resource is being sold into.

Look at the energy industry, for example. A vast majority of the industry is vertically integrated.

Your mom-and-pop family farm with a nodding donkey out in a field is virtually guaranteed to be collecting a payment for it being there, plus hopefully a royalty for how much oil is extracted.

Through contracts and subcontracts, there is a clear chain of possession as it flows from the ground, to a refinery, to the end market.

With over a century of consolidation and capital investment, there is a robust system to integrate and utilize any oil or natural gas resource that is economically viable.

Gold producers have a fairly easy time too. Gold miners rarely refine their own ore, and refiners rarely sell to the public.

This creates a short list of established buyers. And gold being gold, there is always a market for it. It doesn’t need to do anything but sit there, and there is always room for more.

While it is conceivable that refiners wouldn’t want to buy more, you’re never going to hear about gold miners who cannot unload their product because gold’s universality creates a wide and deep market.

This isn’t the case for pure carbon, and it is, as mentioned above, a big twist in the classic commodity stock trap.

The Added (and Expensive) Twist

Graphite miners have passed into a phase where even the highest purity flakes they can pull from the ground fall short of the industry standards for their buyers.

Think of it this way. If you struck a gusher and were able to raise enough capital to drill and extract it, you could find a company to transport it and a refinery to process your crude oil.

All the refinery needs is to know the chemical makeup of what you have. Well, that and a much bigger cut of the end product’s profits than if you did it yourself, but you have a buyer, regardless.

Pure carbon producers are basically being told that they have to refine it themselves, and make the equivalent of jet fuel, before they can collect a single cent.

This draws out the time when the company realizes a nearly pure net loss from operating costs, and greatly increases the total price tag.

However, once a company crosses that hurdle, it is in a much smaller, select group of suppliers that battery manufacturers are clamoring to secure long-term supply contracts with due to the impending supply squeeze.

That is one of the key aspects of Gerardo’s pure carbon stock research for his Resource Stock Digest Premium readers, and it is the one that makes it stand out above the crowd of miners moving into this rapidly expanding market.

Take care,

adam english sig

Adam English

follow basic @AdamEnglishOC on Twitter

Adam's editorial talents and analysis drew the attention of senior editors at Outsider Club, which he joined in mid-2012. While he has acquired years of hands-on experience in the editorial room by working side by side with ex-brokers, options floor traders, and financial advisors, he is acutely aware of the challenges faced by retail investors after starting at the ground floor in the financial publishing field. For more on Adam, check out his editor's page

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