Cadence Minerals — A mispriced miner

Cadence Minerals is a UK-based early-stage investment and development company in the mineral resource sector. It is listed in the UK on the AIM market (AIM: KDNC) and the Aquis Stock Exchange (AQSE). It holds minority stakes in a range of exploration and development assets, principally in energy transition metals such as lithium and rare earths. It does not seek to be an operator or primary developer of assets (it has a small, investment focused team), but creates value by identifying mining assets than could rise in value through progressive de-risking. Cadence has been historically focused on energy transition metals (notably rare earth minerals and lithium), but its major non-listed investment (and a core focus for the company at present) is the Amapá iron ore project in Brazil. Its unlisted assets also include a 30% stake in some tenements that form part of the Sonora lithium project in Mexico.

We value Cadence using a sum-of-the-parts (SOTP) methodology based on the value of its investment portfolio. We use the current market valuations for its listed equity investments, a risk-adjusted (for stage of development) share of NPV for Amapá and a takeout multiple for its stake in Sonora.

We do not see any justification for applying a discount to a portfolio or SOTP valuation. Cadence’s listed equity investments are minority stakes in liquid public companies and would be realisable for full market value. Cadence’s unlisted stakes are also minority stakes and either attractive to a major partner (such as Ganfeng in the case of Sonora) or to other potential entrants, so we see possible trade sales in the longer term as clear catalysts to the realisation of full value.

Cadence’s commodity exposure is favourable in our view, with exposure to rare earth minerals and lithium, which both have strong structural end-use demand, and iron ore, where we see continued need for projects such as Amapá in the longer term. Our views for each of Cadence’s main commodities are contained in the appendix to this report.

Cadence is a relatively small investment company in a sector that is dominated by large capital, and therefore will not be on the radar of many professional and private investors who follow mining. It is also relatively small in a corporate sense, so management is focused heavily on de-risking its assets and creating long-term value. It is in this context that the de-risking and growing investment stake in Amapá has probably been overlooked by the wider market, and led to the discount emerging.

In terms of catalysts, the progression of Amapá to full DFS status would lead to a reduction in the discount we apply (and the discount that is applied by the market). The costs and timing of this are uncertain, but the orebody is well understood given its prior operating status, so the progression will centre on licensing issues and further engineering studies. Cadence could progress this itself (and has recently secured mezzanine debt funding to achieve this if it wishes) or bring in potential partners at the asset level.

The development and progression of the Sonora lithium project is more uncertain given political uncertainty in Mexico (although we understand that Sonora is not affected by the changes in Mexican legislation given its licensing status, however the market is likely to continue to treat Mexican lithium assets with some caution). Our valuation of Sonora allows for this risk, so any progression to full operation by Ganfeng would be a clearly positive catalyst. The lithium market will need assets like Sonora in the longer term, and there is potential for this asset to be larger than the BFS metrics on which the takeover was made and our valuation is based.

Cadence’s investment risks relate to development risk and commodity price volatility. Both of these are common to early-stage mining developers, and we have explicitly allowed for some political and development risk in our valuation. As with all mining firms, commodity prices can be volatile in relation to the broader global macroeconomic environment.

The largest non-commodity related risk to our valuation is probably further delay to the licensing process at the Amapá project. Mining projects in all jurisdictions do experience unexpected delays, and it is possible that the Brazilian authorities may require additional environmental studies relating to mining operations or tailings dam operations prior to granting licences to operate. We value Amapá at 15.8% of its de-risked NPV valuation (10% discount rate), but it is possible that the project could experience further delays.

There is also scope for political uncertainty around lithium mining licensing in Mexico that could cause a delay in the development of the Sonora lithium project by Ganfeng Lithium. While we believe that the operation has secure licences under the revised legislation, uncertainty could delay the development of this mine. We have applied a 50% discount to the historical takeout valuation in our base case to reflect this uncertainty.

Cadence’s investment process is focused on identifying assets with strategic advantages and working closely with management teams to de-risk assets and, once optimal valuation is reached, to exit in part or in whole to reinvest capital for further growth.

Cadence’s major listed investments include:

It focuses on assets that fit its broad investment themes, which include:

Cadence’s criteria for new investments include:

Cadence’s minority stakes in publicly listed investments are outlined below. We adopt market prices for these in our valuation of Cadence, but also note that they are in industries that we believe have strong cyclical demand conditions. The spot prices for rare earths and lithium have been cyclically weak in recent months.

Cadence Minerals holds 6.5% of European Metals Holdings (ASX: EMH, AIM: EMH), with a current market valuation of £5.2m. This holding was placed in escrow as security for Cadence’s mezzanine debt facility (see the discussion of this in the Financials section below). Cadence’s CEO Kiran Morzaria is a non-executive director of EMH.

EMH holds 49% of the Cinovec hard rock lithium project in the Czech Republic. Czech power company CEZ Group holds the balance at the project level and is heading a consortium to build a lithium battery plant. CEZ Group is 70% owned by the Czech Republic and is one of the 10 largest energy companies in Europe, with 28,000 employees and a market capitalisation of approximately €17bn.

The Cinovec project is fully funded through to final investment decision (FID). It is a significant lithium project in a global sense and of strategic importance to European lithium supplies. The project also enjoys strong political support, and was visited in May 2023 by Czech Prime Minister Petr Fiala, who commented publicly on the role of the project in creating an entire value chain for the production of lithium batteries.

Cinovec is the largest hard rock lithium deposit in Europe and the fifth largest non-brine deposit in the world. Its characteristics include:

Cadence had long held a stake (30%) in several mineral concessions that form part of the Yangibana rare earths project in Australia. In January 2023, it exchanged this stake for 2.45m shares (1.9% of the issued shares) in ASX-listed Hastings Technology Metals (ASX: HAS). This stake has a current market valuation of £2.1m. We are adopting the market valuation for this holding, although we highlight below that Hastings’ share price is highly correlated with neodymium and praseodymium (NdPr) prices, which we see as cyclically weak and well below longer-run prices.

This trade of assets for a share in the listed entity was a win-win trade in our view, giving Hastings full control of mining tenements surrounding its core asset as well as providing Cadence with a visible market valuation for its rare earths assets.

Yangibana is a high-quality rare earths project that, in our view, will be needed as a source of global supply of critical raw materials. Rare earths are important for the energy transition (see the appendix of this report for a full discussion), and Yangibana is a project with advanced support from both consumers and governments. First production is planned by the end of 2025. Hastings has recently announced a staged development strategy and revised capital costs, which the market has reacted to negatively (and NdPr prices have also been cyclically weak); however, this is a high-quality project that is needed as part of longer-term NdPr global supply. Any issues with Yangibana are a reflection of wider challenges in building new sources of rare earths supply (and will ultimately be more than compensated for by supply constrained price rallies in our view).

The ‘staged development strategy’ announced on 31 May separates the development of the mine and concentrator (Stage 1) from the development of a hydrometallurgical plant to crack the concentrate into a mixed rare earth carbonate (Stage 2).

Stage 1 was indicated to have a capital cost of A$470m, a post-tax NPV of A$538m and annual EBITDA of A$174m, which would provide cash flow for the funding of Stage 2. This plant will produce 37ktpa of 27% total rare earth oxide (TREO) grade concentrate, with first production in Q125. Hastings entered into a binding A$210m engineering, procurement and construction contract in May 2023 with GR Engineering. This reduced the construction cost risk for this portion of the project considerably. This contract includes the design, construction, installation and commissioning of the Yangibana beneficiation plant.

Stage 2 will cost an additional A$478m (for a total product capital cost of A$948m). The total capital cost is 40% higher than 2020/21 estimates. This product will be shipped to a downstream hydrometallurgical plant in Onslow on the Western Australian coast to ‘crack’ the concentrate to a 59% mixed rare earth carbonate (MREC) product (15ktpa). This will contain 3,000–4,000tpa of NdPr (the rare earths critical for high-strength magnets), representing 6–8% of global demand when it comes online.

The project has received strong government support, including a A$100m non-binding conditional letter of support (in March 2023) and a A$220m debt commitment from the Northern Australia Infrastructure Facility (NAIF), under the original integrated project plan. Hastings is working with lenders and funders to complete funding for Stage 1 by the end of September 2023.

NdPr are metals critical for energy transition, as they form the basis of the strongest commercial magnets available. These are not battery metals, but are used in electric motors and generators. They enable wind turbines to increase efficiency and lower maintenance costs, and increase the efficiency of electric vehicle (EV) motors by approximately 3%, extending range or cutting the need for additional battery capacity. Please see the appendix of this report for further information.

The Yangibana project DFS assumes an NdPr oxide price of US$112/kg over the life of mine and its updated project economics presentation (31 May 2023) assumes US$129/kg. Spot prices have been falling since a peak in early 2022 and at US$80–85/kg are now below the prices assumed by Hastings in the original DFS and updated projected economics release. In our view this represents cyclical market weakness rather than a more permanent structural decline.

NdPr markets are historically very volatile; the charts below show how Hastings’ stock price has been strongly correlated with NdPr prices in recent years, and NdPr oxide prices over 15 years. Prices gravitated towards US$50/kg from 2013–20, prior to the acceleration in demand and in nominal terms. The cost inflation and delays in bringing on a high-quality project such as Yangibana are industrywide, and will lead to a rise in market equilibrium prices and incentive prices needed for new projects. NdPr demand is accelerating due to its use in both energy generation and energy transmission in EVs. We value Cadence’s stake in Hastings at its current market valuation, but see significant scope for commodity prices as well as project advancements to be positive catalysts for this stake.

Cadence Minerals owns approximately 15.8m shares in ASX-listed Evergreen Lithium (equivalent to 8.7% of the issued capital), with a current market valuation of £2.7m. Cadence established this position by selling its interests in two private companies (a 31.5% stake in Lithium Technologies and Lithium Supplies in June 2022. Evergreen listed on the Australian Securities Exchange on 11 April 2023. Cadence has a two-year lock in for its stake in accordance with ASX rules.

A further A$3.47m (£1.86m) of shares in Evergreen are due to Cadence on the achievement of certain performance milestones by Evergreen (the pricing of these shares is based on a defining pricing mechanism, and depends in part on the date these performance milestones are achieved). We have not included these additional shares in our valuation.

Evergreen is a relatively early-stage lithium exploration play and is focused on advancing three hard rock lithium prospects in Australia, namely:

On 28 June, Evergreen Lithium announced it had released results from preliminary Ambient Noise Tomography (ANT) geophysics surveys at its Byone project. This technique is a ground geophysics approach that uses natural or man-made seismic noise to measure the seismic velocity in three dimensions, with the intention of identifying lithium-bearing pegmatites (or blind pegmatites) at depth. At Bynoe this work appears to have enabled the imaging of the subsurface down to 500m, which, along with geochemical and geological interpretations, will help guide a maiden drilling program. Preliminary analysis of the ANT surveys indicated multiple large scale potential pegmatite targets at Bynoe, which is located continuous to Core Lithium’s (ASX: CXO, market cap $A1.8bn) Finnis project (30.6Mt at 1.31% Li2O).

Cadence owns 30% of the Amapá iron ore project in Brazil. It is a mothballed iron ore mine rather than a greenfield project. The mine first operated in 2007 under its original owners, MMX Mineracao e Metalicos SA (MMX) (70%) and Cleveland-Cliffs (30%). Anglo American bought MMX’s stake in 2007 and operated the mine until a ground failure at the port in March 2013. This eventually led to the cessation of mining in 2014. Importantly, the mine operated for just five years, so while the processing plant, railway and port require extensive rebuilding, the unmined portion of the orebody is still in-situ.

While historical valuations do not read straight across into current values (and we value the operation using its PFS data below), this operation has been valued by major players in the mining industry as a near operating or fully operating asset. A few examples of previous valuations include:

Subsequent to the sale to Zamin in 2013, approximately 70% of the port was rebuilt, with some iron ore concentrates shipped from late 2013 and early 2014 using an interim barging solution. The Amapá project borrowed US$125m in senior debt from a syndicate of banks to complete this. This debt is secured on the project, and the negotiation of a method of settlement has been a key part of Cadence Minerals’ focus with the project (and a precondition of some of its equity purchase stakes). The treatment of this debt is described more fully below and is included in our valuation.

An appropriate valuation of Cadence’s stake in the Amapá project is core to our valuation of Cadence overall. We value have modelled Amapá and come to the following conclusions:

The Amapá mine is owned by DEV Mineração (DEV), which is owned 100% by the JV entity Pedra Branca Alliance. This JV is owned 30% by Cadence Minerals and 70% by Indo Sino, a Singapore based commodity trader. Indo Sino entered into its ownership through the acquisition and conversion of debt from Zamin, and we understand it sees Cadence as the right partner to focus on de-risking the asset through advancing the approvals and licensing process.

Cadence’s entry into the Amapá project has involved a somewhat complex and protracted process of purchasing a stake at the same time as brining Amapá out of administration. This has involved increasing its stake alongside satisfying creditors of DEV by shipping iron ore out of existing stockpiles, while also progressing plans to restart the shut mine.

Key points in this ownership structure are:

In early September 2020 DEV and its owners agreed in principle to settle outstanding claims by secured bank creditors. This was a pre-condition to Cadence vesting its initial 20% investment in Amapá. DEV was allowed to ship sufficient iron ore from stockpiles to realise a US$10m profit (after deduction of all shipping, regulatory and sales costs). This was to satisfy approximately US$2.5m small and employee creditors and allow for approximately US$6m recommissioning studies on the Amapá producer and the restart of maintenance and monitoring of the current tailings dam facilities. Any balance could be used for working capital and a payment against outstanding amounts due to bank creditors.

On 29 December 2021 Cadence announced a binding settlement agreement had been reached with the secured bank creditors of DEV. This agreement included the reduction in the total principal owed to the secured bank creditors with the repayment of some this balance coming from the cash flow from the ongoing sale of DEV’s iron ore stockpiles, with the remaining to be paid by DEV prior to project financing. Unsecured creditors will be paid from DEV cash flow over a period of nine years (year seven to year 17 of operations).

The liabilities for this debt payment are included in our NPV analysis (as it is in Cadences published NPV). Cadence can also utilise the shipping of existing historical iron ore stockpiles to reduce this liability. In April 2022, Cadence reported it held approximately 1.24m tonnes of 58% product at its port at Santana and we understand the stockpile is still largely there (1.18Mt). On a gross basis at long-run prices (US$85/t for 58% product, which typically trades at a 15% discount to benchmark prices), this could be worth approximately US$100m in revenue, but taking into account shipping costs, a net realisable value is likely to be much lower (possibly in the region of US$30m at typical transport and ocean freight rates). In our view Cadence (or ultimately the secured creditors where the commercial decision on the timing of shipments lies) is likely to be opportunistic and sell this stockpile during periods of high prices. To be conservative, we have not included the realisable value of this stockpile (which is owned by secured creditors) in our valuation.

We value Cadence’s interest in the Sonora lithium project in Mexico at US$9m. This valuation is based on the takeout valuation share of the mine tonnes feeding the Sonora project based on Ganfeng’s purchase of the project’s owner Bacanora Lithium in May 2021 (see exhibit below), with the following adjustments:

Cadence has an interest in the Sonora lithium project in Mexico, through the part ownership in some of the mining tenements. The Sonora project includes 10 concessions covering nearly 100,000 hectares. Key properties include:

Mexalit forms part of the Sonora project and according to the last published feasibility study (January 2018) will be mined in years 9 to 19 of the mine plan (the Megalit concessions do not form part of the mine plan). Cadence Minerals’ overall share of ore feed to the plant is 12% over the life of mine and peaks at 44% in year 12 of the mine plan.

The mine plan included in the 2018 feasibility study may no longer be relevant. Ganfeng may choose to mine a different section of ore, or potentially mine at a different rate to the 2018 plan. As Exhibit 9 shows, the mineral licences in which Cadence owns an interest surround the core licences for the mine plan.

In April 2022, the Mexican state approved a bill to nationalise lithium reserves, providing for a state-run enterprise to have exclusive rights over lithium mining and requiring the issue of new permits for lithium exploitation by private firms. The government did exclude firms that had active mining permits (which we understand includes Sonora), and in February 2023 the government passed a presidential decree confirming that within a 900 square-mile lithium mining zone in northern Sonora state, existing concessions would ‘remain safe’.

In our view, the Sonora project will be needed to supply the growing deficit in the lithium market that looks very likely in the late 2020s. The project is now less visible as it no longer sits within a dedicated public company pushing ahead with its development, but when construction commences, the perceived risk of the project is likely to fade quite quickly.

We value Cadence using a SOTP methodology based on the value of its investment portfolio. We use current market valuations for its listed equity investments, a risk-adjusted (for stage of development) share of NPV for Amapá and a takeout multiple for its stake in Sonora. As summarised in Exhibit 1, this results in a valuation of £55.7m or 32.2p/share.

If we removed the PFS to BFS stage discount for Amapá (84.2% to 55%) and adopt a higher scenario valuation for Sonora (accounting for lithium developer appreciation and removing political risks) our valuation would rise to £98.7m or 57.1p/share.

Cadence is an investment company and its financial accounts represent its ongoing funding needs for general and administrative expenses (G&A) as well as investment spending for advancement of its portfolio of mining assets. Its current strategy is to bring in a partner at the JV level to continue the advancement of Amapá, naturally depending on price and timing. In the interim, and to minimise equity dilution through share issuances or the sell down of some of its listed equity holdings in a period of cyclically weak prices, Cadence has chosen to use a mezzanine debt arrangement as a bridge towards realising value at Amapá.

On 26 May Cadence entered into a mezzanine debt facility to fund the continued development of the Amapá iron ore project. Key aspects of this facility include:

Cadence’s strategy has been to bring in a JV partner at the asset level to assist with funding the full DFS and we see the mezzanine debt facility as a bridge towards this longer-term aim. Cadence’s other option to continue to fund the DFS progression could be to either sell stakes in its listed assets or issue its own equity, but we would highlight that its listed assets look cyclically weak at present and its own equity is not reflecting its underlying assets. In our view, therefore, this mezzanine debt facility looks like a sensible strategy.

The Amapá project is a mining venture in the Amapá State located in north-east Brazil, encompassing an open-pit iron ore mine, processing and beneficiation plant, railway line and export port terminal. The mining site is situated around 125km north-west of the municipalities of Macapá and Santana. Previously, processing and beneficiation were conducted on-site, and the final products were conveyed through a regulated railway line to Amapá’s integrated export port terminal located at Santana.

Amapá State is mostly covered with rainforest, while the remaining areas are covered with savannah and plains with a typically tropical climate. Geographically, Amapá bounds French Guiana to the north, the Atlantic Ocean to the east, Pará to the south and west, and Suriname to the north-west.

Located at a complex near the towns of Pedra Branca do Amapári and Serra do Navio, north-west from the municipalities of Macapá and Santana, the Amapá mine complex consists of various open pits. Previously, iron ore processing and beneficiation occurred on-site, with final products being transported along a dedicated and controlled railway line to Amapá’s integrated export port terminal at Santana. At the time of production, the mine benefited from well-developed power and water infrastructure as well as tailings waste management. Following its closure, the process plant, rail and port suffered oxidization, vandalism, theft and damage. Investigations are ongoing to identify the extent of rehabilitation required to bring the site back online. These primarily include:

The Amapá project is located in the north-east section of the Amazon Craton, Guiana Shield, within the Maroni-Itacaiúnas province. It is comprised of Paleoproterozoic greenstone belts, containing banded iron formations (on the Vila Nova Trend), underlain by Archean basement rocks, and overlain by Tertiary lateritic deposits and Quaternary alluvial materials.

The iron-bearing Vila Nova Trend is composed of volcano-sedimentary rocks metamorphosed in green schist to amphibolite grades comprising the greenstone belt terrain. The main lithologies that compose this group are mafic and acid rocks on the base and oxide/silicate facies banded iron formations, quartzite, conglomerate, greywacke, marble and schists. They occur morphologically as elongated hills with north-west to south-east and west-north-west to east-south-east directions. These units have undergone brittle-ductile deformation in the form of north-west shear zones. Underlain by Archean basement rocks consisting of granulites, gneisses and migmatites derived from Archean igneous protholiths, both groups are intruded by a series of granites, correlated pegmatites and metabasic dykes. Tertiary lateritic deposits and Quaternary alluvial materials overlay these units.

Iron mineralisation in the Amapá state is hosted within the Vila Nova Group. This is sequence of metamorphosed volcanic and sedimentary rock where iron mineralisation occurs as a banded iron formation (BIF), metamorphosed to amphibolite grade. The Amapá System area exhibits diverse iron mineralisation types, including itabirites, powdery haematites, colluvium and canga. Typically formed in ridges with a NW-SE strike, the BIFs are bounded by a lower unit of para-amphibolite and an upper unit of quartz mica schist. At the Amapá project, these metasediments are seen to have been subjected to several episodes of folding and shearing. The prominent iron-rich structure is located within a 14km-long synform known as the Boomerang Structure (owing to its shape, Exhibit 15), divided into northern and southern domains. Totalling 8km in length, the northern domain is orientated North-South due to the combination of a folding patterns and a North-South shear zone compared to the 6km southern domain, which naturally trends NW-SE. Pegmatite intrusions crosscut the itabirites. This intrusive event has formed hematite bodies and the boundaries of pegmatite and country rock. These intrusions (with associated intense hydrothermal alteration) are understood to have introduced elevated levels of common iron ore contaminants to the system. Additionally, gold mineralisation is reported to occur along the western boundary of the Vila Nova Group, most notably within the Taperebá West prospects.

The mineral resource and ore reserve statements have been prepared and presented in accordance with the guidelines of the Australasian Code for Reporting of Exploration Results, Mineral Resources, and Ore Reserves (the JORC Code), 2012 Edition.

The Amapá project has undergone several periods of exploration, and subsequent mining from 2007 to 2014. The geological factors influencing mineralisation are well understood and supported by drilling and sampling procedures following modern industry standards. The completed work is adequate to define the boundaries and features of the mineral deposit, with the associated data confirming its accuracy and sufficiency for estimating and disclosing a mineral resource.

The Amapá project has been extensively drilled from a spacing of 200m x 100m down to 50m x 50m for the geological modelling and resources update completed in 2012 by Anglo American. As of June 2012, 1,064 diamond drill holes accounted for 77,845.15m. Prominas Mining was commissioned and produced a new mineral resource estimate (MRE) in 2022 in accordance with the guidelines of the JORC Code (2012). Mineral resource classification included a review of assay data quality, the geological interpretation, geological continuity, grade continuity, drill spacing, model validation and reconciliation against production using the drill hole database and study of the old sections provided by DEV. The study involved the preparation of a 3D geological model using the aforementioned data to outline the updated limits of the resources.

This research resulted in the Amapá project having a total mineral resource (reported as wet tonnes), prepared in accordance with the guidelines of the JORC Code (2012), of c 276.24Mt at 38.33% Fe (229.5Mt is classified as measured and indicated mineral resources, Exhibit 16). Mineral resources were further limited based on an expectation of eventual economic extraction to an optimised open pit shell generated using appropriate economic and technical parameters.

The following insights are useful when comparing the 2022 and 2020 resources estimates:

In conjunction with the mineral resource estimate, Prominas also prepared an ore reserve estimate in accordance with the guidelines of the JORC Code (2012). Indicated and measured mineral resources have been modified to estimate proven and probable resources, respectively, with inferred resources set to waste. Ore reserves are affected by the following factors: metal prices, changes in interpretations of mineralisation geometry and continuity of mineralisation zones, geotechnical and hydrogeological assumptions, the ability of the mining operation to meet the annual production rate, operating cost assumptions, mining and process plant recoveries, the ability to meet and maintain permitting and environmental licence conditions, and the ability to maintain the social licence to operate. Taking these variables into account, an ore reserve of 195.8Mt at 39.34% Fe reported to a cut-off grade of 25% Fe has been declared.

DEV has some operational agreements with the neighbouring gold mine owner, Great Panther, located in Pedra Branca do Amapari, Amapá. This allows DEV the opportunity to evaluate and ask for exploration and mining permits for all the iron ore minerals that exist within the Great Panther permits or tenements. These include exploration agreements, joint operation agreements and iron ore concentrate supply agreements.

As previous mining suggests, the continuity and geometry of the orebodies is amenable to bulk open pit mining with low dilution and ore loss, and a low strip ratio (0.41:1 waste to ore ratio). In line with the resource estimates outlined by Prominas, Cadence has undertaken a mine design associated studies to the accuracy and level required for PFS, confirming that design, fleet requirements and production rates are in line with industry standards. Capital and operating costs are considered suitable for a project of this scope given climatic and local conditions regarding all aspects of the mine design and scheduling. The planned mine layout and mine operations are typical of other open pit iron ore operations of a similar scale.

The proposed conventional open pit mining method will span a 16-year life of mine, involving drilling, blasting, loading and hauling ore and waste. Operations (including production fleet) will be conducted via a specialist mining contractor on a continuous basis at a planned ore production rate of 12.6Mtpa with an average total mining rate kept below 19.0Mtpa. Prominas estimates mine operating costs of US$15.40/t of product produced (wet) and US$17.05/t on a dry basis.

Mine operation specifics are as follows:

Overall capital costs required for the Amapá project are estimated at US$ 669.1m (according to the 2022 PFS and based on current level of the project, the expected accuracy is ±25%), which include certain engineering, procurement, construction and commissioning, as well as sustaining capital costs and closure and reclamation provisions. Initial capex totals are US$424.7m, with US$25.6 available in recoverable taxes (assumed to be recovered within 48 months), bringing final initial capex costs to US$399.1m. Notable costs include US$155.1m on the beneficiation plant and mining, US$113.9m for the redevelopment of the port and US$28.5m on the rail network. Deferred and sustaining capital costs were estimated at US$244m, including reclamation and closure costs of US$62.8m. As outlined in our valuation, we have included a reduction in port capital spending of US$28m, as announced by Cadence after the publication of the original PFS.

This appendix outlines our views on Cadence’s major commodity exposure. Given the relevant importance of Amapá to Cadence, this is largely focused on iron ore but we also summarise our view on lithium and rare earths. For the latter two, additional information can be found in two recent thematic reports, with the key conclusions summarised below.

Iron ore is an internationally traded global commodity with transparent pricing. Prices can be relatively volatile in the short term (driven by economic and industrial stocking cycles), but in the longer run reflect supply/demand dynamics, notably economic growth in developing economies and the production performance of a relatively concentrated group of major suppliers.

Iron ore is used almost exclusively in steelmaking (steel is c 96% iron). Global iron ore production reached c 2.3bn tonnes (Bnt) in 2020, of which 1.5Bnt (or 65%) was traded and shipped intra-regionally, most typically in large bulk shipments commonly referred to as seaborne iron ore. At average annual prices (US$112/t 2022 year to date average for 62% Fe fines), this represents a market size of c US$258bn for the global market and US$168bn for seaborne trade.

While some steel producers have their own integrated sources of iron ore, the global iron and steel industry is largely unintegrated (ie separate ownership of raw materials mining and metal processing). Steelmaking tends to be located close to centres of demand (owing to a wide variety of product types and complex logistics) and widely distributed globally. In contrast, iron ore mining naturally occurs where high-quality orebodies and large logistics systems enable efficient transport and shipping.

Iron ore exists as many underlying mineralisation types, the most common being haematite and magnetite (both of which are iron oxides), with the latter usually lower grade in situ but able to be concentrated and upgraded owing to its magnetic properties. These ores require reduction to metallic iron as part of the steelmaking process, the most common method being through the use of coke as a reductant in a blast furnace. This method of ‘primary’ steelmaking accounted for 71% of steel production (1.95Bnt) in 2021.

The other major method of producing steel is via the electric arc furnace (EAF) route, which accounted for 29% (0.57Bnt) of crude steel production in 2021 (source: World Steel Association). EAFs use steel scrap as a primary raw material. While this production route has grown in mature markets (eg it accounted for 69% of steelmaking in the United States in 2021), its growth in market share in individual markets is constrained by two factors. Firstly, scrap availability is a key limitation. Steel is a relatively highly recycled material in all markets, with global average recycling in the order of 78–80%, more than double the recycling rates of non-ferrous metals. There is relatively little steel that is not already entering existing recycling chains, so improvements in collection and recovery rates are typically slow and limited. Secondly, many steel applications (eg infrastructure and construction) have long life spans (eg more than 40 years) so scrap arisings can sometimes be generated a significant period of time after initial demand. This is one key reason why China’s steelmaking is still heavily dependent on the primary steelmaking/blast furnace route (89% of production in 2021) and so iron ore-based steelmaking will continue to dominate production for some time.

Steel is a low-cost, technologically proven material for construction and a key material for economic development. Construction accounts for c 50% of end-uses globally, and steel is a vital material both as a primary construction method (eg steel I- and H-beams) and as a key part of steel-reinforced concrete structures (steel reinforcing bar). Steel intensity in construction increases with the height of buildings, so the development of high-density urbanisation would not have been possible without the use of steel. Consequently, China’s urbanisation has been a key driver of its economic growth over the past 20 years, with the large-scale movement of populations to high-rise residential structures to preserve agricultural land. Other significant end-uses include machinery (20%), transportation (10%) and consumer goods (6%).

Steel demand has accelerated structurally since the emergence of China as a major economy. Global steel demand grew at a compound annual growth rate (CAGR) of 1.9% in the 1970s and just 0.7% in the 1980s, reflecting the de-industrialisation of mature economies. This accelerated to 3.2% in the 1990s, 5.5% in the 2000s and moderated slightly to 3.2% in the 2010s. China accounted for 52% of the global end-use of steel in 2021, with other Asian countries accounting for 9.5%, the United States, Canada and Mexico 7.5% and India 5.8%.

While China’s growth has eased (a CAGR of 8.4% in the 2010s versus 12.1% for the previous decade) and a decline was recorded in 2021 (-5.4% to 950Mt), it is not clear that this signals peak steel demand or an inflection point. Peak Chinese steel demand was expected to be 400–500Mtpa in the late 2000s and has continued to surprise on the upside for the past 15 years. Cumulative Chinese steel demand since 1990 totals 13Bnt, which equates to 9t/capita, still less than the 15–18t/capita of steel in place in mature economies such as the United States and Japan. Also, while some continued maturation of China is to be expected, India (with a similar population of c 1.4 billion people) currently consumes only c 100Mtpa of steel, or c 11% of current Chinese demand. Similarly, India’s cumulative steel demand for the past 30 years represents only 1t/capita, or just 11% of the total for China and 6% of that expected for a developed economy. While India has many specific characteristics that will mean its steel demand may not accelerate in the same manner as China, it nevertheless remains a significant potential future prospect for steel (and hence iron ore) demand over time.

Consensus has typically been too bearish on iron ore prices for the past decade, partly as a consequence of an overestimation of supply growth and misreading the strategy of major producers. The conventional approach is to consider the high profitability and expansion potential of the major seaborne iron ore producers (which include Vale, Rio Tinto, BHP, Fortescue Metals Group and Anglo American) and allow for significant production growth from this group. However, several factors have led to supply growth being lower than forecast.

Firstly, these major producers have often experienced unexpected disruptions. They have large complex production systems, involving multiple orebodies, rail networks and port operations. Major producers have focused on automation to lower production costs (eg driverless trains and trucks) and have often competed for critical engineering resources (particularly in the Pilbara region of Australia). Also, significant tailings dam failures (BHP/Vale’s Samarco dam failure in 2015 and Vale’s Brumadinho dam failure in January 2019) have led to a significant review of tailings dam methodology by the industry. These factors have contributed to planned production increases underperforming expectations.

Secondly, these producers are fighting grade decline. Their systems are typically focused on shipping direct shipping ore (such as haematite), which is high grade (ie high iron content) in situ and requires little or no upgrading (such as ore washing or minor concentration). Given the rapid growth in demand, higher-grade orebodies have been in decline and producers have begun to blend ores to maintain product quality. This ore blending and sorting has added to complexity and has slowed production growth.

Lastly, these producers have an incentive to delay growth. As large incumbent producers (the five producers mentioned above account for 1.1–1.2Bnt pa of iron ore production at present, equivalent to c 70–80% of the seaborne iron ore market volume), the natural incentive in a large commodity market is to not overproduce or drive spot market prices lower. This has been the explicit policy of producers (Rio Tinto, Vale and Fortescue have all used the term ‘value over volume’ to describe their strategy in recent years) for several years.

These factors led to the sustained participation of a wide variety of smaller iron ore producers in the market, and the price being set at levels that allow for the incentivisation and sustained profitability of producers that have a smaller scale and higher costs.

Until 2010, iron ore prices were largely set through annual contract negotiations between major buyers and sellers. Since then, prices have shifted to more regular and transparent price discovery, with prices for spot transactions being published by a number of service providers and a futures market developed on the Singapore Exchange.

Iron ore is typically quoted and priced on the basis of delivered sales to China (CFR) and priced on the basis of product tonnes (not iron content). Prices for ocean freight (which is also cyclical) need to be deducted before reaching a netback price to the producer. There are separate price quotes depending on the quality of the product, with major indices for 58% and for 62% iron content. The price premium for 62% iron ore has averaged 20% (or US$14/t or US$3.50 per one percentage point Fe unit) over the past decade, well above the 6.9% premium expected for the difference in iron content.

The median price differential between 66% and 62% iron ore fines delivered to China for the past five years has been US$23.98/t, or 21.8% of the average spot price over this five-year period. A product with a 65.4% iron grade is 85% of the rise in iron content between these two grades. While the rise per unit of iron is neither linear nor stable, in our view it is a reasonable approximation to apply this 85% to the average premium (21.8%) of the past five years, which yields a premium of 18.5%. Applied to our long-run price of US$100, this results in an iron ore premium of $20.3/t, which we round to US$20/t.

These indices reflect broad pricing trends, while individual transactions reflect particular producer products and a close evaluation of iron content and other impurities. This ‘value in use’ adjustment can incorporate factors such as alumina and phosphorus content. In general, steelmakers will pay a premium for high iron content and lower impurities, reducing emissions and minimising the need for blending or adjusting other raw material contents.

Spot iron ore prices (62% Fe basis, delivered CFR China) averaged US$113/t in 2022, down from US$153/t in 2021 (which was helped by a restart of the global economy post COVID-19). The average spot price for the past 10 years has been US$94/t in nominal term and US$104/t in real terms (using a US GDP deflator). Extending these datasets back to 2006 does not significantly change these averages (US$93/t in nominal terms and US$110/t in real terms).

While spot prices are likely to continue to fluctuate with economic cycles, we still see both growth in end-use steel demand globally over the next decade and continued restraint by the major iron ore producers. In our view, this is likely to result in average annual prices similar to historical prices (which have seen both demand and supply growth moderating, with iron ore majors unwilling to push out higher cost producers). As such, a long-run iron ore price of US$100/t (basis 62% Fe fines CFR China) is a reasonable assumption for long-run asset valuation. In addition, we see continued upward pressure on grade premiums.