The Molycorp story and government policy risks in mine or business valuation

UPDATED 12/28/15

Molycorp stock continued to fall so much that Molycorp now trades under a new ticker symbol (MCPIQ) on the OTC Markets.

ORIGINAL POST FOLLOWS

In recent days, I have read a lot of news stories on the fortunes (or misfortunes) of Molycorp Inc. (OTC: MCPIQ). More than any other, Molycorp represents the story of the rare earth sector outside of China and how government policy (or lack of one) has affected the companies that own mining assets in that space. What seemed to be a “hot” investment, has turned cold overnight and Molycorp and others like Lynas (ASX: LYC) are now struggling to stay in business. Where did it all go wrong for these companies and their investors?

In the early parts of this decade, there was significant concern in the US, and other countries like Japan, over the dominance of China in the rare earth elements (REEs) market. In particular because REEs are important for many national security technologies (e.g. advanced missile systems); but also because of their importance in many renewable energy technologies. In the US this culminated in several hearings in Congress in mid-2011 to early 2012 on REEs and US’ dependence on Chinese mining and processing capability. Overnight, everyone was looking for REE resources and how to bring these to market as an alternative to China. Molycorp, with its Mountain Pass Mine, seemed like the logical company to invest in. Lynas and others also benefited from this momentum.

REE prices from 2008-2014 &copy BBC & Bloomberg

However, besides a few committee hearings, Congress did nothing to ensure US REE production. Particularly, nothing was done to address the lack of processing capability to ensure that any ore mined in the US can actually be turned into useful product. Also, the Chinese relaxed the export restrictions on REE that made everyone panic. This ensured that REE prices fell from the highs of 2011. Over time, the same mines that had been seen as sure bets became non-performing with rising production costs (something that happened across the entire mining industry over the period as I spoke about in this post) and lower prices.

There are many lessons one could learn about the Molycorp story, however it ends. But for me, it illustrates how government policy risks should be properly accounted for in project evaluation. Often, people think about this when the feasibility study or project valuation is for mines in developing countries. However, recent history and the story of REEs shows that this is even the case in the most advanced democracies. Government policy (or the lack of one) can impact what companies can do, commodity prices, tax regimes, regulatory environments etc. For as long as that is true, project valuation should consider the risk of government action or inaction.