EFR:CC - Graphex: A Lesson In Protectionism

2023-12-11 09:00:00 ET

Summary

• We hold both on and offshore positions in miners / refiners of ores / metals designated as “critical” to renewable energy; some have done very well, others not.
• I recently filled a gap in that portfolio with an investment in Graphex Group / Technologies, a processor of specialized graphite required in electric vehicle batteries.
• However, I soon sold the stock having learned that, as a US-based “Foreign Entity of Concern”, tax credits may not be available to buyers of EV’s containing their material.
• Relative to geopolitical tensions, issues of globalism versus protectionism have accentuated the need for due diligence to be an ongoing discipline.

The Energy Act of 2020 , “advances fundamental research and development activities in support of grid modernization, critical mineral security, and high-risk, high-reward next-generation energy technologies. It also takes an all-of-the-above approach to clean energy that not only considers a wide range of renewable energy sources, but also essential technologies like advanced nuclear, energy storage, carbon capture, and research into cleaner and more efficient use of fossil fuels.” The federal government went on to define “ critical minerals ” as:

“Any non-fuel mineral, element, substance, or material that the Secretary of Energy determines: (i) has a high risk of supply chain disruption; and (ii) serves an essential function in one or more energy technologies, including technologies that produce, transmit, store, and conserve energy; or, as defined by the Secretary of the Interior, acting through the Director of the U.S. Geological Survey (USGS), presents the 2022 final list of critical minerals and the methodology used to develop the list. The 2022 final list of critical minerals, which revises the final list published by the Secretary in 2018, includes the following 50 minerals: Aluminum, antimony, arsenic, barite, beryllium, bismuth, cerium, cesium, chromium, cobalt, dysprosium, erbium, europium, fluorspar, gadolinium, gallium, germanium, graphite , hafnium, holmium, indium, iridium, lanthanum, lithium, lutetium, magnesium, manganese, neodymium, nickel, niobium, palladium, platinum, praseodymium, rhodium, rubidium, ruthenium, samarium, scandium, tantalum, tellurium, terbium, thulium, tin, titanium, tungsten, vanadium, ytterbium, yttrium, zinc, and zirconium.”

Miners and enrichers of uranium have performed brilliantly over the last eighteen months as governments and the market have woken up to the fact that we need dense nuclear energy if we are to meet our goals for reducing carbon emissions. As examples in North America, I point to Cameco ( CCJ ), Energy Fuels ( UUUU ), Uranium Energy ( UEC ), and Centrus Energy ( LEU ).

At the same time, non-fuel metals essential to clean(er) energy, such as nickel and rare earths, continue to be underappreciated. To illustrate this, I also point to holdings in our book – Talon Metals ( TLOFF ), Lynas Rare Earths ( LYSCF ), Rare Earth Resources ( REEMF ), and Ucore Rare Metals ( UURAF ). Since mid-year 2022, the chart below shows the stark differences in the performance of rare earths relative to uranium stocks and the NASDAQ:

Parenthetically, to balance such plusses and minuses, we maintain holdings in larger and diversified mining companies including BHP ( BHP ), Rio Tinto ( RIO ), Sumitomo Metals ( SMMYY ), and Vale ( VALE ). Beyond that, we are about equally invested in AI, crop science, “motion” (defense, vehicles, and robotics), and utility companies. Notwithstanding our misses, this overall mix has worked very well for us.

Graphite and Graphex

Graphite is critical to the manufacture of EV batteries. Unfortunately, however, as with many minerals on the list above, the US has not developed our resources. We have not mined graphite since the 1950s, while becoming dependent on China for an estimated 80-90% of our supplies. However, we’re working on it .

Fortunately, graphite is not an especially rare mineral, just look at all your lead pencils in that jar on your desk or stuffed away in the back of a drawer somewhere. However, refined graphite is another matter due to the exacting specifications required for batteries and in non-EV applications. It is for these reason that Graphex ( GRFX ) intrigued me:

• They have over a decade of large-scale graphite production experience and are currently among the top ten global suppliers of specialized spherical graphite to the EV and renewable energy industries.
• They are building a new processing facility , in partnership (JV) with Emerald Energy Solutions, near to the automobile industry in Michigan (home of former Governor, now DOE Secretary, Canadian-American, Jennifer Granholm ).
• They have strengthened their sourcing of raw material / feedstock, including from Canada’s Northern Graphite Corporation ( NGC:CA ) as well as Syrah Resources ( SYAAF ) producing in Australia and Mozambique.
• “[Last year’s] price action in raw flake graphite concentrate indicates that the supply-demand picture is tightening, but it is not yet reflective of a deficit scenario. It’s approximately 20% higher than a year ago. While this represents a premium to last year, it is not displaying the price volatility associated with commodity production shortfalls.”
• The company’s wholly owned US subsidiary, Graphex Technologies LLC, is on the forefront of processing graphene representing a single honeycomb lattice of atoms that are strong, lightweight, conductive, and finds uses, perhaps revolutionary , not only in EV batteries but in mobile phones, laptops, sustainable energy uses, and many other items.
• Graphex displays the financial characteristics of an ore/metals company that is on the cusp of “crossing the hump”. Ahead of the escalating EV revolution and the government’s strategic mandate, it is generating revenue, gross profits, (neither operating nor net income, yet), and operating cash flow (more or less) off an okay balance sheet:

Protectionism Rears Its Head

So, I bought some GRFX without realizing that the government was about to deal the company a wild card. Specifically, on Friday, December 1 ^st , the Treasury and the Department of Energy promulgated FEOC, or “ Foreign Entity of Concern ”, rules intended: a) to reduce our dependencies on geopolitical adversaries for EV batteries and materials, while b) incenting the development of the same in the United States with all that means for jobs and economic vitality. Graphex is set up in the United States, but they are owned by Chinese interests . Consequently, FEOC rules jeopardized their customers’ ability to gain access to federal tax credits , up to $7,500 per vehicle.

One day after the government released this news, on Saturday, December 2 ^nd , I sent the following message to the company through their website: “How will the FEOC rules promulgated yesterday by DOE and Treasury impact your operations in the United States? Thank you.” Their webmaster immediately acknowledged receipt of my message, saying: “Thank you for [contacting us]. A member of our team will be in contact with you as soon as possible.” I heard nothing further from Graphex, so I began to sell out my position. Then, on Wednesday, December 6 ^th , the company announced:

“Graphex Group Limited (“Graphex Group” or the “Company”) (NYSE American: GRFX | HKSE: 6128), together with its wholly owned U.S. subsidiary, Graphex Technologies, LLC (Graphex Tech), today announced that it has entered into a Letter of Intent (LOI) with an independent NASDAQ-listed blank check company (the “Purchaser”), pursuant to which the Purchaser proposes to acquire 100% of the equity interest of Graphex Tech, which is held by Graphex Group, (the “Acquisition”).”

Their CEO, John DeMaio, went on to say that, “In light of the recent news coming out of China regarding graphite export restrictions, this move to separate Graphex Technologies from Graphex Group’s China operations to focus on anode material production in North America will further validate our commitment to build-out domestic supply chain stability for this critical component of EV batteries to our customers, partners, and agencies , and will facilitate our access to additional investors, incentives, and other financing sources, all of which accelerate our growth strategy.”

The stated terms of the deal are opaque. Nevertheless, they do not matter to me at this point because we are out. For the record, unlike Charlie Munger , I have nothing against blank check companies, per se. Indeed, over the years, we have done quite well with SPAC’s and I may reinvest in GFRX, but not now, not given the unknowns.

Globalism vs. Protectionism

The broader issue here is at the confluence of macro trends: a) the growing need for essential goods we previously sourced from now adversarial countries, relative to b) government actions – regulations, rules, subsidies, and support. At the cross currents of globalism versus protectionism, as we have seen with uranium and non-fuel metals, significant investment opportunities and threats exist. As to the inputs, processes, and outputs essential to EV batteries, the US has made it clear that it wants those supply chains controlled and within our own borders or those of friendly countries.

One final note. many investors view due diligence as an up-front, before-an-investment-is-made, discipline. In fact, it is an ongoing process and one that can lead investors to change their minds.

For further details see: