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December 15, 2005

Roca Mines - A Potential New Molybdenum Producer
by Bill McWilliam

Roca Mines Inc. recently obtained a permit to develop its MAX high-grade molybdenum deposit near Revelstoke, in southeast British Columbia. The permit enables the Company to operate a 500 tonne per day underground molybdenite (MoS₂) mine and on-site concentrator. Initial production will access approximately 72,000 tonnes of ore per year from the HG zone, which has a measured resource of 260,000 tonnes grading 1.95% MoS₂, equivalent to 6.7 million pounds of molybdenum. This is contained within a larger resource estimated at 42.9 million tonnes (measured and indicated) grading 0.20% MoS₂, which is equivalent to 115 million pounds of molybdenum.

The Company's strategy is to fast-track a high-grade mine that will have initial production of approximately 1.5 million pounds of moly, with a current market value of about US$45 million. Total operating and administrative costs are estimated at US$100 per tonne, implying a first year gross profit of almost US$38 million if the company sold the molybdenum at an average price of US$30 per pound. Capital costs are estimated at only US$15 million to start the mine and onsite concentrator. Production is scalable and, subject to market conditions, the production rate could be increased to 2,500 tonnes or higher per day. The deposit has the right combination of attributes for a successful launch and continued profitable production.

The issuance of the mine permit is good news for Roca and an important accomplishment by its management team. Roca Mines shares common management with another junior exploration company, Stikine Gold Corporation. In April 2005, I wrote about Stikine Gold with respect to its Sullivan Deeps project. Stikine drilled two deep and expensive core holes to test for the "big sister" of the $20 billion formerly producing Sullivan Mine. Although the program was a "technical success", no mine was found and the stock collapsed. As mentioned in that article, good management groups have the ability to generate new projects and bounce back from adverse situations. Based on my analysis of Roca's potential, this is more than just a rebound romance. Here's why.

Of all the risks that confront a junior exploration company, and there are many, deposit risk is the most formidable. Mineral deposits are rare beasts that require very perfect geological conditions to form. Subsequent to deposition, a number of things, such as faults, un-mineralized dykes and erosion, can affect the nature and size of the original deposit and render it uneconomic. Achieving economic status, which is another and more difficult threshold, involves a set of conditions equally important to deposit formation.

Roca Mines has an option to acquire a 100% interest in the MAX deposit, which is a medium-size developed moly deposit in an area with excellent infrastructure and a mining friendly community. And, contrary to opinions that suggest moly prices are going to crash back to the US$5 level, there's lots of evidence to suggest that high-moly and copper prices may be with us for several years. Roca is a great speculative choice at this time because there is minimal deposit risk and the economic and market conditions that could enable financing a mine currently exist.

The MAX deposit received its first serious exploration in 1969 by Scurry Rainbow Oil and Gas. In the mid-70s the property was acquired by a Newmont-Esso Minerals joint venture that conducted surface and underground drilling, mapping and extensive sampling. Surface drilling of 32 core holes (15,747 metres) from 1976 to 1979 was successful in defining the MAX molybdenite deposit and demonstrated some better grade sections. Some of the drill holes returned spectacular intervals of high-grade molybdenite:

• core hole 77-3 assayed 0.408% MoS₂ over 271 metres
• core hole 78-5 assayed 0.329% MoS₂ over 305 metres
• core hole 78-5B assayed 0.443% MoS₂ over 349 metres

These excellent results led to a decision to undertake an underground exploration and bulk sampling program. From 1979 to 1981, a total of 2,000 metres of adit (4 X 4.5 metres), crosscut and drift development were cut on the 960 Level, which is approximately 500 metres below the surface outcrop. Underground core drilling of 22,151 metres in 87 holes detailed the mineralization and explored adjacent areas. Bulk samples were taken for metallurgical testing. Work on the project was halted in late 1982 due to a low molybdenum price and a poor long term forecast for molybdenum demand. The project then sat dormant until very recently when two prospectors staked the key claims covering the deposit and optioned those claims to Roca Mines. More than US$15 million (in 1980s dollars!) was spent on the property prior to Roca acquiring its option. Historical and recent confirmation drilling by Roca have defined a high-grade molybdenum resource with favourable metallurgy.

Although the Max molybdenum deposit is sizeable at 42.9 million tonnes (and remains "open" for expansion to depth), there are many defined moly deposits in the world ranging from large tonnage (~300 million tonnes grading +/- 0.07% MoS₂) open pit deposits to underground deposits with higher grade moly that range up to 700 million tonnes of +/- 0.20% MoS₂. What sets the Max deposit apart from other primary and by-product molybdenum deposits is its flexibility, in that it contains readily accessible high-grade zones within a larger resource that enables relatively low-cost production from an underground deposit.

The market issues are:

• The current demand for moly exceeds supply
• There are constraints that restrict increasing low-cost by-product production of moly and may delay the expansion of Chilean copper-moly deposits
• The large-scale low-grade open pit moly deposits require very large capital investments
• Underground primary moly mines have much higher operating costs per pound

But the question is 'how long will current market conditions of strong moly demand exist?'

After a deposit is defined, engineering studies (scoping, prefeasibility and feasibility) are undertaken, which outline the economic and operating parameters of the mine. The studies define the optimum operations that provide the best yield for the capital employed, and include an analysis of capital costs, operating costs and an estimate of the return on the investment given certain market assumptions. Infrastructure considerations are especially important. Mines that produce large volumes of concentrate require lots of water, cheap power and transportation, preferably a railway or a nearby ocean port. Before the mine gets any cash the concentrate has to be smelted.

In terms of securing financing to develop a mine, the product has to have a market and contracts to sell the product are necessary. In cases where the mine produces a commodity such as copper, a futures market exists and some of the future production can be sold on the market. This assures a revenue stream and makes the financing process less risky. In the case of molybdenum, a futures market is not available and the product is essentially sold to the consumer, such as a steel mill or through an intermediary, such as moly processor. Given the very volatile price history of moly, agreeing on a long term contract price is difficult and involves high-risk. Most of the world's moly is sold on a month-to-month basis at spot prices.

An estimated 70% of world moly supply is a by-product primarily from large-scale open pit style copper mines. These deposits typically contain +/- 0.80% copper (8,000 ppm) and +/- 0.02% molybdenite (200 ppm), the latter of which consists of about 60% molybdenum metal. Theses mines produce a concentrate, which is primarily iron, sulphur and copper but can also contain variable amounts of payable metal such as gold, sliver and moly. A separate floatation circuit is required to reprocess the mines' copper concentrate to produce a moly concentrate. The result is a steady supply of very low-cost molybdenum from several mines. The remaining 30% of world moly supply comes from a few large underground mines that typically grade +/- 0.20% MoS₂ and many small high-grade mines (+/- 1.0% MoS₂). China, for example, has many small high-grade moly mines.

At current prices, world molybdenum production is worth about US$11.6 billion, which is larger than all other base metals except copper (US$57.7 billion) and nickel (US$17.2 billion). It is more valuable than platinum (US$5.9 billion), silver (US$4.6 billion), and palladium (US$1.5 billion). Surprisingly, it is 3.6 times more valuable than uranium (US$3.2 billion).

The structure of the supply side of the market explains moly's extreme price volatility. When demand slightly exceeds supply, price explodes from around US$4 to over US$30 per pound as is the case right now. This triggers production from copper mines that mine the higher-grade moly phases of the orebody and from the dormant moly circuits that are restarted. Small-scale high-grade mines are also rushed back into production and the marginal supply quickly creates a surplus and the price crashes. The interesting thing about moly is that historically when this cycle occurs, its price remains very low for long periods of time and the high-price spikes are short-lived, infrequent and unpredictable. This pattern clearly inhibits new production, especially from primary molybdenum mines and large low-grade open pit moly prospects.

The Collahuasi mine in northern Chile recently installed a moly circuit to treat about 4,300 tonnes of copper concentrate per day. The Capex is about US$40 million and it will produce 4,000 tonnes of moly per year (8.8 million pounds). The moly grade of the orebody is about 0.015% per tonne (150 ppm). The operating cost to produce by-product moly in concentrate is around US$3 per pound. 8.8 million pounds of moly at US$20 per pound yields cash flow of about US$150 million per year implying a payback of less than 4 months: in other words, a high rate of return and very economic.

Escondida the world's largest single copper producer (1,195,000 tonnes in 2004) is considering a moly circuit that will cost US$80 million and would produce about the same amount of moly as Collahuasi. The moly grade at Escondida is about 0.007% per tonne (70 ppm). Using the same cost parameters as Collahuasi, the payback at Escondida is forecast at 1.9 years. In both cases, the economics are very attractive as payback of 4 or less years is attractive for development of mining projects.

The Henderson mine in Colorado is a giant primary molybdenum deposit. It is an operating underground mine owned by Phelps Dodge (PD) with a mill capacity rated at 32,000 tonnes per day. The deposit has remaining mineable reserves of 165 million tonnes grading 0.21% molybdenum. In 2004, it produced 27.5 million pounds of moly or about 7.5% of world production. However, determining what it cost to produce a pound of moly from Henderson is another issue. In 2004, PD produced 27.5 million pounds of moly at Henderson and 30 million pounds as by-product from its copper mines. It also purchased 18 million pounds from other industry producers.

PD operates a vertically integrated moly business that produces a full range of molybdenum products. It blends all its segments and reports gross sales in 2004 of US$985 million for an "average" sale of US$12.65 per pound with "average" costs at US$11.30 per pound. An operating profit of US$103 million was reported up from US$8.3 million in 2003. The revenue is derived from a brand mix of upgraded moly products as well as production of technical grade molybdic oxide. Production at Henderson is forecast at 40 million pounds of moly in 2006, which is very close to its capacity. If any company is aware of the moly market and its future potential, Phelps Dodge is it. The fact that they are raising production could mean the fundamentals for moly demand may be stronger than believed and the boom and bust cycle of its price history may have changed.

A presentation by BHP in Santiago, Chile on April 15 th 2005 asked the question, "Can Chilean Copper Maintain its World Market Share?" Between 1985 and 2004, Chile's share of the world copper market increased from 16% to 37%. In 2004, Chile produced 5.5 million tonnes of copper from a reserve base of 350 million tonnes. In addition, Chile probably hosts the single largest undeveloped copper reserve in the world, possibly as large as 100 million tonnes in several deposits. Several of Chile's copper mines also produce by-product moly. As copper production soared over the last 20 years, so did the capacity to produce moly.

The most recent forecast for Chilean copper production suggests that output will decrease to 5.4 million tonnes in 2005, increase to 6.2 million tonnes by 2008 and decrease to just under 6 million tonnes in 2010. This includes Brownfield expansions at Escondida, Candelaria, Zaldivar, Collahuasi and 10 other smaller mines. It also includes Greenfield production expected from Spence and Gaby. In the rest of the world there about 30 prospects being developed but the combined production is not large enough to create a large surplus. Global copper production may have to increase by 300,000 tonnes per year just to maintain equilibrium in the market and Chile may not be able to provide that in the foreseeable future.

At the current level of copper and moly prices, one would think that the opportunity to expand current production and to bring new production on-line is significant. Most of the developed Chilean resources are likely economic at levels much lower than the current copper price. So, why would BHP ask the market share question?

Chile may have an infrastructure problem, starting with the availability and cost of water. On Thursday November 18 th 2005, Alfonso Dulanto, Chile's mining minister, said that "restrictions on water use imposed on Chile's mining companies threaten to harm future copper output, the countries principal export."

Big open pit mines use lots of power and water both of which are in short supply in the Chilean Altiplano. This is the driest place on earth and is home to most of Chile's copper production and reserves. The deposits occur at or above 4,000 metres. Chile has minimal resources of oil (150 million bbls), natural gas (3.5 tcf) and small deposits of low-grade coal. Hydro power supplies about 51% of electricity but droughts are common, making water flow and generating capability unreliable. Most of the growth in future electric capacity will be supplied by natural gas and hydro power will play a smaller role. This option is likely, however, to be much more expensive than hydro in the long term.

Only about 2.65% of Chile's land is arable but it is highly developed and consists of a significant agricultural component that is very much dependent on water. Agricultural products are also a primary export sector and many businesses and jobs are involved. There are hundred's of thousands of wells drilled into the aquifers and salars and the water resource is already heavily utilized, mainly by the mining industry. The cost of drinking water is rising rapidly in many Chilean communities. Recent reports question whether the recharge rate of the aquifers is adequate to maintain the current level of water use. A new and large volume of fresh water will likely be required to enable a major increase in copper production but the current situation suggests that this increase will affect other parts of the economy that are heavily water dependent.

Some water may be available from the salars in Argentina but this requires major pipeline construction and salt removal. Bolivia has plentiful fresh water but in the War of the Pacific (1879-1884), Chile defeated Peru and Bolivia and won its present northern lands, which victory has caused many trade issues and consultations, especially between Chile and Bolivia. Bolivia is now landlocked due its loss of territory. Providing water for mining appears to be a longer term problem for Chile. Water is one of the critical infrastructure elements and the solution is not obvious and could take a long time and great expense to resolve.

The copper futures market has recently changed from a long period in backwardation to a slightly positive contango position. This can have a few different meanings one of which is that the world copper inventory, including scrap, has been worked off and trader's can not sell spot and replace inventory with lower prices in the future. Other factors are that some mines have reworked their mine plan shifting to ore with higher moly and lower copper content to take advantage of the higher moly prices. This has two effects, one of increasing the short term supply of moly and decreasing the short term supply of copper, neither of which is sustainable. Or it just might be that the market has decided in its digestion process of all the rumours and facts, that there really is a supply problem for both copper and moly and that inventory in the future is worth more than today.

The demand side of the moly market appears exceptionally robust but for how long is the question. Steel producers account for 80% of moly demand. Annual world production of crude steel is greater than 1 billion tonnes and is growing at 2% per year or 20 million tonnes. Within this market, the demand for specialty steel products such as stainless steel and high-moly alloy steel is growing more rapidly. The rapid growth of infrastructure in China is using more alloy steel that contains higher levels of moly.

The world demand for oil and gas is driving exploration into more exotic terranes that require stronger and more acid resistant steel. The demand for oil and gas worldwide is accelerating, which ultimately will create the need for several new pipelines as the distribution and export infrastructure have to be extended to new areas.

Moly is a critical alloying metal in pipeline applications especially in cold climates. The MacKenzie Valley pipeline, for example, is in the final planning stage. It is 1,220 kilometres long and the steel may require 2 pounds of moly per tonne. The 30 inch line weights about 155 kg per metre or 155,000 tonnes per kilometre and would consume about 378 million pounds of moly for the entire project. Remember, total world production is currently about 375 million pounds, so the incremental demand for moly from this single project could keep the market in deficit for a long time. A lot of the gas from the MacKenzie Valley line will be used by companies to produce synthetic oil from Alberta's tar sands, which are now viewed by many as a critical resource for North America's oil security and the pipeline will enable production to increase from this resource. Given the secure supply status of the tar sands and its large resource, there's a strong likelihood that the pipeline will be built.

Another problem is how to value Roca? There are no comparables and the major task of financing the mine is not complete. A tonne of ore from the HG zone contains about 20 pounds of payable metal. Annual production of 72,000 tonnes should yield about 1.5 million pounds of payable moly. At US$30 per pound, it has a market value of US$45 million. If mining, milling and G&A costs are US$100 per tonne (US$4.55/lb) and Roca is able to get US$25/lb (US$500/tonne) in an off-take agreement, the return to the mine is US$400/tonne. The initial production of 72,000 tonnes could generate US$29 million in gross profit implying a Capex payback of just a few months from mill start-up (construction will take an estimated 6 months). Currently there are, fully diluted, about 50 million shares issued. At the current price of C$0.30 per share the market cap is only C$15.0 million.

The economics look robust but the trick is getting someone to finance construction with as little dilution as possible to current shareholders. Because the project has not gone through the process of a full feasibility study, a bank loan is not an option. Whereas in many commodities an organized futures market exists for the product (e.g. copper, gold, silver), there is no such market for moly. If this were a copper or gold mine, the company could forward sell approximately one third of its first year's production at current prices to finance the entire mine and mill complex. However, because moly prices have historically been so volatile, consumers are generally uneasy about such forward contracts.

The facts suggest that markets for base and precious metals will remain strong, and many other financial options are available to the company with a mining permit in hand, including joint ventures, convertible debt arrangements, equity or some combination thereof. Worst case scenario would be a large equity financing which could still leave Roca with approximately 100 million shares outstanding, but having 100% control of a high-grade producing mine. The company could then use internal cash flow to finance a larger mining and milling operation based on prevailing molybdenum market conditions in 2007.

Roca's controls a high-grade moly deposit situated near substantial infrastructure and it could be in production in less than a year. The ore for initial production has a very high gross value and small-scale production offers a rapid payback of start-up capital. The deposit is much larger and production can be increased according to market conditions.

Roca looks like an excellent speculation at this level and an announcement with respect to a favourable financing arrangement should cause a substantial rise in the Company's market cap.

Disclaimer: I recently participated in a Roca Mines financing and I also hold an option to purchase additional shares.

Bill McWilliam
SafeHaven.com

Bill has been involved in virtually all aspects of the investment business as a pension fund manager, broker, analyst and underwriter for the past 30 years. He has also founded, co-founded and financed successful start-ups in the technology and mineral exploration sectors.

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