Interview with Patrick Wong, former Chief Investment Officer at Dacha Capital
Patrick Wong co-founded Dacha Capital in 2009 where he served as the company's Chief Investment Officer through November 2010. Pat lead Dacha's building of the world's first strategic stockpile of rare earth metals and oxides. Asian Metal’s Phil Arnheim talked with Patrick about his future plans, the rare earth industry, and the prospects of constructing a shared rare earth separation facility in North America.
Patrick Wong: A peek into the future of rare earths: Opportunities for a centralized separation facility
----Interview with Patrick Wong, former Chief Investment Officer at Dacha Capital
Asian Metal: You helped found Dacha Capital; tell us about the business model you developed there.
Wong: The concept behind Dacha was to form of an investment vehicle that gives investors exposure to certain rare earths without having to take on mining risk. This idea actually came up four years ago when I was working on an investment methodology called Strategic Positioning. I basically looked at various products and broke down the value chain to identify parts or processes that represented a small percentage of the cost but was difficult or impossible to substitute and supply was limited. That was the basic premise but the investment methodology grew to become a multi-faceted model that uses a point scoring system to help rank what inputs should indeed be deemed strategic. Some rare earths fit that bill and is the reason why we have targeted the heavy rare earths.
Asian Metal: What was Dacha’s strategy in purchasing and stockpiling rare earths?
Wong: The strategy was fairly simple and direct. We went to the source and buy material with as little transaction cost as possible. We hired someone with 15 years experience in the industry who knew whom to call and whom to trust.
Asian Metal: Was it effective?
Wong: Yes, I would say so. We were able to spend the capital we had raised in the spring of 2010 and allocated it within a few months exporting valuable material to our warehouse in South Korea.
Asian Metal: How has the rare earth industry changed since the export quota cut?
Wong: Well, an export quota cut does not change the size of the demand pie, it just changes who gets a piece of pie. On the demand side, things have not changed that much. For many products that use rare earths, global growth rates are fairly average being between 2-5% and higher for some applications that use magnets.
Asian Metal: What part of the rare earth market saw the most fluctuation?
Wong: Where things did change was in the FOB market particularly for the lower priced light rare earths like lanthanum and cerium. When people quote the 700% increase in prices for these items, they usually don’t notice that the vast majority of that increase was due to a quota surcharge that was slapped on low priced material. Exporters did not want to use a potentially scarce quota to ship out low valued material so this is the reason why you see a direct correlation in the percentage increase in FOB prices and the domestic prices inside China. The more expensive heavy rare earths did not change much in price as a result of just the quota cut. In addition you can see that domestic prices inside China did not move that much either from when the quota cut was announced which tells you China did not really benefit from the drop in quotas at all.
Asian Metal: Are rare earth consumers more or less vulnerable since China cut the export quotas?
Wong: People tend to group rare earths together as one big bunch, but the end markets and uses are so different for each one that it requires some differentiation to make any valid statement. In my opinion, the users of the light rare earths have more risk than before since quotas will first be used to ship higher priced material or prices will just move higher so that using a quota becomes worthwhile to ship the cheaper product. That being said, if there are enough quotas to satisfy export demand, the fact that hardly any heavy rare earth oxides are exported means that these customers will not run into too much trouble. I don’t see any particular reason to drop quotas beyond their estimates for foreign demand. Dropping quotas did not affect domestic prices and just created new wealth for exporters by allowing them to place a surcharge on to export quotas granted to them by the government.
Asian Metal: What do you see as some of the risks rare earth consumers face in 2011?
Wong: I think the real risk is that we run out of time before a structural shortage comes for certain heavy rare earth material. According to my demand forecasts, we will face a shortage before any meaningful production comes online so we cannot waste time and future planning is integral to mitigating any shortage of supply that makes product extinction a very realistic possibility.
Asian Metal: What about problems regarding bringing rare earths to the market?
Wong: The real bottleneck is processing and is something I’ve been harping on for years. We have this amazing chance to affect a fledgling industry before it even starts. How many times do we get that sort of opportunity? There’s a term out there called “Path Dependency” which basically says that going down certain routes creates situations that make it impossible to retrace steps. I can see that happening in this industry where we completely waste this chance by not thinking ahead. If a future producer teams up with a customer - who invariably will not use 100% of the output of any RE mine - to develop their asset and set up a separation plant, it will forever change the playing field. This will not force all producers to have their own separation plants as they would never depend on a competitor to process their concentrates. Perhaps it would be different if it was a small amount of heavy concentrate that is a fraction of the light rare earths a mine would be producing but for any heavy rare earth mine, you would not want to depend on someone else to process the majority of your product.
Asian Metal: What about risks for prospective mining ventures?
Wong: There are many, many risks, which is one of the main reasons why I wanted to create an ETF-like vehicle that only purchased finished product. It is because I am a risk averse person so I wanted to have something that I could invest my own money into. But for these junior rare companies, you have the same types of risks as in other junior mining companies, but in addition you have the added complexity of separating and marketing your product in an industrial minerals market that’s very different than, say, gold or oil.
Asian Metal: How important is a mechanism for price discovery in the international rare earth market?
Wong: As production ramps up outside of China, it will automatically start to reduce the materiality of product sold inside China. With some heavy rare earths, the majority of global production in a decade could come from non-Chinese sources. This is a huge swing from today where China supplies more than 97% of the heavy rare earths. It will be extremely important to have a pricing mechanism developed outside of China that reflects this new supply and demand regime. It is also an opportunity to change things and deal with strategic metals differently than we do with other regular supply issues. My biggest pet peeve is in the way we think of buying strategic inputs the same as we do for buying our paper clips and toner. We need to think outside the box.
Asian Metal: How can such a system for price discovery be implemented?
Wong: This goes back to my centralized refinery concept. There are many industries that use centralized refining. For example, you don’t see all oil and gas producers own their own refinery, do you? It is because refining in general scales and if we throw away the opportunity for a customer-owned refinery, we will end up having a higher cost, less competitive industry that will be more expensive for customers and produce lower returns for shareholders. This refinery is also a good place where such a system of price discovery can be implemented and I have a few solutions for this but would rather save those comments for later.
Asian Metal: Where do you see bottlenecks taking place as some of these mining projects become more developed?
Wong: There are several choke points but the obvious ones are access to financing (linked to the health of the equity markets) for exploration and resource definition; time to market (by the time a junior does its feasibility, BFS, construction etc, the market may be saturated); construction financing (if you think getting an off-take is difficult for one commodity, try 15 and all with customers where the largest buyer is a fraction of your overall revenues); Separation into individual commercial products and Marketing.
Asian Metal: Are there any moves that rare earth consumers and prospective producers can take to ensure supply?
Wong: Definitely! I hope to announce something shortly where we are looking to organize customers that will show their interest in securing their supply by financing only the portion of a Separation facility that corresponds to the amount of material they use in relation to the optimized feedstock. In return for financing only their share, they will secure their supply yet not be committed to purchasing from this source. It is the most flexible option customers have and the most efficient one. Producers will have the benefit of a much lower cost to Separate and commercialize their product while also working with an entity that can organize off-takes and handle Marketing and Logistics. The centralized refinery will guarantee processing volumes to the producers so it’s really a win-win situation.
Asian Metal: How would a shared separation facility operate?
Wong: There are several levels of collaboration and it begins with only a simple MOU that is non-committal yet gives customers first rights to secure their supply. Only and I stress ONLY once feedstock is confirmed, will we look to building the facility so when people ask what source of feedstock we have locked up, the answer is simply… none yet, but when it comes we will be ready to Separate it and Market it. The reason why you need to establish this group beforehand is because of what I described earlier as Path Dependency. This tolling, cost based facility will also share a very large R&D program that will not only benefit producers but will benefit all customers by researching new ways to use these elements that have some truly remarkable properties.
Asian Metal: What is required to get the program started?
Wong: Very little. That’s the beauty of forward thinking. We only need to establish a well thought-through concept to change the industry forever. Never has a customer been offered a chance to directly finance a refinery to lock in volumes. It is this type of thinking that’s non-linear which should be used when creating solutions for strategic supply issues. The only thing that needs to be done for the wheels to be set in motion is to see general acceptance by customers where no firm commitment is needed.
Asian Metal: What about the producers?
Wong: Producers will see that this consortium is not only powerful in that it will dictate where material is processed but that it is also a group where opportunity through organized off-takes can make all the difference in their mine development. From the buyer’s standpoint, the fact that the customer base is so fragmented that there is protection in numbers and no longer will they need to constantly keep track of what new production is coming online. Once this type of facility is put in place it will be nearly impossible for any other heavy focused rare earth separation plant to be built given this will be owned by customers.
Asian Metal: What are the construction time and costs?
Wong: I actually initiated a Scoping Study that was recently announced by a junior producer and the figure came out to more than USD350 million but I have been in discussions with Chinese partners who say they can build a 25,000t/y facility for much less and in much less time than we originally thought.
Asian Metal: What benefits would rare earth consumers and producers see from a separation facility?
Wong: Lower costs. It is cheaper to build one 25,000t/y plant on a per unit basis than to build five 5,000t/y plants. Lower costs also mean a more competitive industry which means a lower cost of capital, more stable returns and ultimately higher valuations. It also will serve as a centralized point to share information. There is not enough sharing of information with respects to the market dynamics of strategic inputs. I don’t mean sharing technology secrets, I’m talking about situations where if someone were to introduce a new product like Magnetic Refrigerators, there would be a place this manufacturer could go to that would help them determine if there is enough Gadolinium for their sales projections.
Asian Metal: Whom do you see as potential partners for the facility?
Wong: I have no issues with the initial financing required for the Feasibility Study. The cost to bring this to full BFS should be less than USD5 million. The only partners will be customers and future producers. We have Chinese companies who have offered to not only construct the plant but to help manage it. Governments will also benefit since we will reserve 30% of the capacity to fund government stockpile programs and help them manage this inventory. I don’t think the governments realize that there are issues with long term storage of RE oxides and that a centralized refinery can assist them in managing this stockpile by recycling material.
Asian Metal: How necessary is such a facility for the non-Chinese rare earth industry?
Wong: A centralized facility would definitely benefit the overall industry and its consumers but it isn’t absolutely necessary. The other alternatives are just higher cost, less efficient operations and the wasted opportunity that buyers had with truly securing their supply for the lowest cost.
Asian Metal: Are there any risks you see to the development of a separator in North America?
Wong: The risk is that a concept like ours takes precedence with buyers and our facility is capable of taking multiple feedstock and guarantee delivery of product to a customer base that owns the facility itself. It will be tough for anyone to compete with a customer-lead Separation facility.
Asian Metal: Do you see any conflict with some of the other North American rare earth producers, including Molycorp?
Wong: Not at all, in fact this shared facility would be an excellent place for Molycorp and even Lynas to ship their relatively small amount of heavy concentrate to for processing and sale.
Asian Metal: How does a shared separator fit in with your long-term forecast for the rare earth market?
Wong: This shared facility could be a game-changer. It will put the power back into the hands of the consumer and allow them to focus on creating product and researching new technology that will benefit everyone. I have no doubt that there are technologies that would radically change the way we live if more R&D were done and where a secure supply of resources could justify production. I do have one other chapter in mind when it comes to the development of the strategic metals market but I’ll save that until its time has come.
Asian Metal: Thanks, Patrick!
Wong: Thank you!
Patrick Wong can be contacted at 647-278-6060 or firstname.lastname@example.org