Posted by Latha Do NADARAJAN , Year 3 undergrad at the School of Accountancy, Singapore Management University
Minerals, Oil and Gas bubble?
Media report has it that Monetary Authority of Singapore (MAS) and the Singapore Exchange (SGX), are conducting an “extensive review” of the securities trading activities of three penny minerals, oil and gas (MOG) stocks – Blumont Group, Asiasons Capital and LionGold Corp. There are believed to have some common shareholdings, overlapping directorship/management and their business orientation centers on mining sectors. All have asserted their operations and financials remain sound. What befuddles me, market observers and punters alike is why their share prices spiked to astronomical heights this year, arguably, way out of alignment to their fundamentals or at least to trend seen in their global peers. Were the stocks cornered and manipulated to unsustainable heights before allowing them to crash in the first week of October? I have no clue. This is a matter for MAS/SGX’s “extensive review” to discover, if there is.
Is the Market Not Fully Informed?
Blumont, Asiasons and LionGold were reclassified by SGX as “designated” stocks on October 4, effectively banning contra trading and short-selling. Did that action aggravated the price fall spiral in panic market reaction? It is debatable. The meltdown of these “three glamour” penny stocks wiped out more than S$8.5 billion in their market valuation in a few days, now mostly trading at 10% to 20% of their pre-crash levels – notwithstanding collateral damage to the rest of SGX’s penny stocks flight to safety in fear stale liquidation selling. Subsequent lifting of designated status of these stocks saw a strong rebound, albeit from much depressed levels, only to collapse back again on news of MAS/SGX engaging in “extensive review” of trading behavior of these securities. No explanation was made public on why the “designated-security” status of these three MOG shares were lifted whilst “extensive review” was apparently still ongoing in full swing. The regulator was reportedly to be “concerned that there could be circumstances that would result in the market not being fully informed.”
Meltdown, SGX’s Response & Damage
A lot of uncertainty was thus re-introduced into the careful trading of penny stocks and shares in Blumont Group, Asiasons Capital and LionGold Corp in particular. It is bewildering to say the least of the sudden imposition and equally quick (unexplained) lifting of SGX’s reclassification of this trio’s “designated-security” status. The market obviously misread the “all clear” signal which does not seem to be the case of the regulator’s intense interests in trading behind the shares of the three MOG stock. All told, unverified media report has it that some big institutional investors and very high net worth individuals were caught off guard losing perhaps tens of millions each in princely sum. A lot of greedy, naïve punters must have been badly hurt too either buying into these MOG stocks and/or punting penny stocks and receiving the collateral damage of market meltdown of these speculative investments.
SGX’S Action – Too Little, Too Late & Lessons from Jade Technologies Holdings episode forgotten
There is a strong view out there that SGX’s action came too little and too late. I agree but a lot also has to do with market players/punters not comprehending the true complexity of MOG businesses. There is a long history of that dating back to the days of Jade Technologies. Let me re-visit that chapter with your readers in exploratory re-learning.
Allow me to refer all to this long-dated past announcement on SGX on Jade Technologies Holdings Ltd’s diversification into coal-mining opportunities – the announcement from this entity of 19 January 2009. It dealt with the “UPDATES ON COAL MINING PROJECT AT MOUNT GALUGUA, INDONESIA” which Jade Technologies Holdings Ltd withdrew from this venture. http://infopub.sgx.com/FileOpen/Coal_Mine_MOU.ashx?App=Announcement&FileID=111302.
The reason for withdrawal was attributed to deficient quality of the coal deposit after it was drill-tested by contractor/planner, PT Bintangmandiri Perkasa, to “validate the quantity and quality of the coal deposit at Mt Galugua and to design a mine plan so that mining could be carried out cost-effectively.” It followed “preliminary geological surveys carried out” by Giproshaht, a reputable Russian coal institute.” Jade Technologies shares spiked up on high volume trading only to suddenly collapse subsequently. The aftermath of that will not be discussed here BUT SUFFICE TO NOTE that mining operations and its business investment as a business sector is a very complex animal that the local investing public, mostly had little comprehension, and which the industry participants themselves may not be fully knowledgeable as well. Stock investors in Jade Technologies should not have given any weight to what was called “preliminary geological surveys” when one looked with hindsight now of the published findings of PT Bingangmandiri Perkasa. It established that:-
– while the Mt Galugua coal mine is estimated to have 988,817 metric tons (“MT”) of coal reserves, the economical-mineable coal reserves is only about 64,525 MT, which is much lower than that estimated in the preliminary Giproshaht survey;
– the coal has very high sulphur and ash content which render it unattractive to buyers. While the sulphur content may be decreased by blending it with better quality coal, this process may decrease its calorific value and thus, its price;
– with its low calorific value, the coal is unsuitable for use as coking coal; and
– the challenging terrain of the concession area, positioning/depth and inconsistency of the coal seam thickness requires the more expensive blasting method instead of the more economical open-cut method of mining.
In simple language, the deposit size was uneconomic, the quality deficiently unattractive to potential buyer’s demand and the geological mining terrain costly to design an economic mine plan and extraction – ALL CRITICAL VARIABLES which the “reputable” Russian Coal Institute should have addressed.
Did their consulting geologist(s) make a field visit to Mt. Galugua coal project? What due diligence of geological test-drillings and samples obtained for metallurgical assessment? I had no interest then in Jade Technologies Holdings other than a curiosity passing interest of awareness it was usually the “hottest trading” stock hitting SGX’s daily top volume stocks. Too frightened to touch it with a proverbial 10 foot barge pole, I shall confess WITHOUT REGRET. It was too hard a stock for my little comprehension. I surmise that it is the same for those heavy speculators who bought Jade Technologies Holdings on rumors of huge billions of profit potential of this coal venture opportunity (someone told me once-in-a-life-time but I remember the Bre-X scam instead), punting this exciting stock. The Bre-X deception of a mother of all gold deposit discoveries in Indonesia did brilliantly and successfully conned top analysts and lots of super dumb fund managers on Wall Street. http://www.businessinsider.com/bre-x-6-billion-gold-fraud-indonesia-2012-7
How could I possibly be so stupid to even contemplate any thought of dabbling into a coal project in Indonesia – just on the back of a “preliminary geological survey’ by a reputable Russian coal institute?
Post-Jade Technologies Holdings fiasco, there were new listings on SGX in MOG, but was there any listing guidelines governing the admission to its Mainboard listings or was its listing requirements tightened up? I don’t recall there was – at least not until as recent as early September this year. http://business.asiaone.com/news/sgx-unveils-new-mainboard-rules-mineral-oil-and-gas-firms. Now that was more than 4 years since Jade Technologies episode but before the latest MOG penny stock meltdown in October.
SGX, it seems, is walking a tightrope between attracting new listings in the MOG sector and safeguarding investors’ interests. In drawing up the tighter listing regime, SGX must be watching with curiosity at evolving phenomena of spiraling share prices of Blumont Group, Asiason Capital and LionGold Corp. I watched with bewildered curiosity the apparent immunity of share valuations of LionGold Corp since the April 2013 meltdown of physical spot gold from US$1700 per oz to as low as just over US$1200 per oz this year when almost every other gold stocks around the world seems to have taken a big hit in valuation re-rating. Copper price has fallen from US$3.80 levels to currently UD$ 3.25 per lb as well.
There seems to be no correlation – for whatever reason/s that might be – between the share valuations of this trio and their underlying business exposure to metal prices generally. What is more curious to me is why SGX waited until early October 2013 to place the three MOG stocks as “designated security” when, arguably, one might ask why SGX had not acted earlier or perhaps, MAS flash out an “amber alert” that it is noticing that some unspecified penny stocks trading on SGX is gravity defying, leaving the market to figure out which one. That said, this writer offers no comment on the fair valuation on any of the three penny MOG stocks. I remember in the early 1970s, LKY warned of the “bubble will burst” when speculation was rife in locally listed banking/finance stocks. It did burst and a lot of naïve speculators licked their wounds for a long, long time.
Does the New Listing Regime Comprehend MOG Business Operations?
I also believe that there is a lot of confusion and misapprehension of the true inherent nature of MOG stocks’ business operation but not captured in its newly tighter listing regime operative since September 27 this year. http://business.asiaone.com/news/sgx-unveils-new-mainboard-rules-mineral-oil-and-gas-firms. Just take a look at some of these –
MOG exploration new listing aspirants on the mainboard must have a market capitalization of not less than $300 million; disclose forward plans, milestones and capital expenditures for progression to production. These requirements appear to be in substitute of current listing rules for profit, operating revenue and positive cash flows as MOGs explorers are, by definition, non-income generating.
In addition to satisfying all other listing requirements, all MOG firms – explorers or producers or transitional, will need to have achieved “indicated resources” for minerals or “contingent resources” for oil and gas.
All MOG entities have sufficient working capital for 18 months from listing, at least one independent director with appropriate industry experience and expertise. Their IPO documents must supply a valuation report on its reserves, together with an independent qualified person’s report on significant resources or reserves.
What Are the Industry’s Realities?
All “junior” MOG stocks are highly speculative – exploration is their lifeblood to success and also the biggest destroyer of asset values. At pre-production stage, the $300 million market valuation might sustain but at commissioning, a completely different picture might suddenly emerge of risk outcome adversity.
Take a look at Australian listed copper producer as a case-study example – Discovery Metals Ltd (DML) – a real shocker of how fast market capitalization dwindles in a very short space of time. DML was still the subject of a hostile takeover bid from Cathay Fortune Investments (CFI) at a valuation value of A$870 million in February 2013 priced at A$1.87 per share. That bid failed and lapsed but by March 2013 – barely a month later – DML’s valuation fell to $165 million at 34c per share. It was a spectacular sudden fall from grace. The market reacted savagely to DML’s plant/production full commissioning failure and its impact on cash flow survivability risks. DML is heavily debt-financed project with expectation of strong cash flow to be achieved within 6 months to full commissioning predicted in its bankable feasibility study (BFS) but the actual was not expected to be cash positive of full commissioning at least after 12 months of initial start-up. Deficiencies were found in actual production of ore compared to geological model used to derive the BFS. DML encountered far more oxide ore than underground mining sulphide ore of its Boseto project. That means its geological model was incorrectly estimated both in terms of quantitative indicated resources and oxide/sulphide mix. Banking covenants were violated and refinancing was urgently needed to keep DML afloat. Redesign of the ore pit modeling cut the resources of Boseto orebody down from 131million tonnes @1.3% copper and16 g/t Ag. estimated in the 2012 BFS down to 101million tonnes at the same copper and silver grade. http://www.asx.com.au/asxpdf/20130722/pdf/42h59l0pwgtxv4.pdf
Put it another way, the mineral resource has been downgraded by 24% of its copper ore content – that must have a big negative impact on the residual net present value (NPV) of this copper production mine – all things being equal. Remember NPV derivation is always after revenue less costs of production and financing costs of working capital including bank interests from loans borrowings DML undertook to finance this project development. My guess is that Boseto copper project might be marginal to investment return using back-of-the-envelope/rule- of-thumb estimation. I believe this is correct for two reasons.
– The mineable reserves of Boseto copper project was estimated at just 15 million tonnes grading 1.3% copper and 16 g/t silver credit. See this announcement from DML to the Australian Stock Exchange of 22 July 2013.http://www.asx.com.au/asxpdf/20130722/pdf/42h59l0pwgtxv4.pdf
– By extrapolation above, the balance of 85 million tonnes of copper resources – out of 101 million tonne of resources – is deemed uneconomic, given current costs/revenue, mining dilution, other mine design parameter considerations.
It is not known if this redefinition of reserves came before or after the closure of positive hedge underpinning an estimated revenue stream lift of some $47 million. But looking at its September quarterly announcement-http://www.asx.com.au/asxpdf/20131023/pdf/42k77n4wr1fvfk.pdf – DML is running at an operational cash flow deficit of A$5.3 million per quarter. Without a strong and sustained gain in operating efficiencies to design parameters envisaged in its revised mine design and sustaining of copper price at current level at least, DML could be looking at a negative cash flow of A$22 million per year, with pressure from its bankers for periodic payment to boot unless its operation is funded out of long-term bond borrowings. DML is currently trading around 9c per share on ASX, giving it a market valuation of A$44 million.
The volatility of market capitalization is also obvious in oil and gas sector. Just take a look at Kairiki Energy Limited (KIK) as another illustrative example. Commencement of its Tindalo off-shore oil field off the Philippine waters saw its share price rocketed from a few cents to 18c per share giving it a market capitalization of A$100.8 million based on its then issued capital of 560 million shares in 2011. It encountered production commissioning problem which saw water ingress into its well, flooding it to inhibit economic rate of oil extraction. http://www.asx.com.au/asxpdf/20100830/pdf/31s5zvf2v6wt7b.pdf.
It had to be finally plugged and abandoned. KIK’s market capitalization collapsed back when its share price dwindled to 5c per share. After massive recapitalization via capital raisings, KIK attempted another well opportunity at Gindara project nearby. KIK struck a huge intersection of gas bearing zone of some 187 metres but poor porosity in low quality reservoir rocks. Guess what the market capitalization of KIK is now with 2.983 BILLION shares in issue? At the asking price of 0.001 cents per share (i.e. a fraction of just ONE cent), its market capitalization is less than A$2.983 MILLION (if there is a buyer at the asked price) or zero if there is no bidder as it is often the case.
THE LESSON TO LEARN FROM HERE IS MOG STOCKS ARE HIGHLY VOLATILE AND MARKET CAPITALISATION at the time of IPO does not provide any measure of investors’ protection. I believe a continuous reporting regime of all stock sensitive information as to exploration and production is far more critical of investors’ protection than an arbitrarily set benchmark market capitalization of S$300 million for Mainboard listing. In any case, the risks from actual operations and variable outcome possibility in risky exploration undertaking cannot be isolated. These are random geological events and risk outcomes. If you invest in MOG stocks, you must know or should know the risks inherent – some of which could be even the results of “Acts of God”. Heavy rain and snow, for example, caused a leak of toxic cyanide from the tailing dam of Aurul gold mine in the northwestern city of Baia Mare in January 2000. The mine is 50%-owned by Australia’s Esmeralda Exploration. http://news.bbc.co.uk/2/hi/europe/642258.stm The environmental damage caused resulted in an immediate forced closure of the gold production. Overnight, the market capitalization of Esmeralda Exploration evaporated into zero.
As for the requirement of 18 months working capital from listing and forward plans disclosure of milestones target and expenditures to reach production stage – it is practically unrealistic. Look at oil and gas sector, it is a sequential process of seismic survey, interpretation of plays, prospects and leads definition, each sequence unpredictable of outcome influencing geologically-driven sequence of decisions in the next succeeding stage – sometime taking more than 2 years from the first successful exploration well to the next appraisal well to assess reservoir volume, forecast productive flow rates and other reservoir characteristics. Complications can also arise from drilling operations itself, kicking up exploration costs to levels previously unanticipated requiring additional capital raising which may not be readily forthcoming in varied market conditions. A recent case in point is Cooper Energy Limited’s drilling of its Hammamet West-3 well in just 54 metres of water depth off the coast of Tunisia. This yet-to-be-completed effort is an appraisal near horizontal sidetrack well after Cooper Energy’s earlier encountering obstructions in production testing. http://www.asx.com.au/asxpdf/20131024/pdf/42k8hcjh9z4r60.pdf. Its final costs is now estimated at US$85 million against the original costs was budgeted at under US$26.6 million. http://www.asx.com.au/asxpdf/20130328/pdf/42dydbzgn0rtcd.pdf. The well will need to be re-entered for testing when the next rig is available. The costs could be anything from another US$20 million dollars upward barring no further setback surprises. The realities is this – in oil and gas exploration – the working capital costs of exploration are notoriously difficult to estimate, and so is the forward plan disclosure milestone targets and expenditures to reach production is meaningless to talk about of explorers – not at least until all appraisal drilling has been done and a final investment decision (FID) is conclusively reached among consortium members
Tips on Spotting Energy Stocks with Growth Story – Anyone interested?
I am also somewhat amused to read of this interesting article in the media – Tips on spotting energy stocks with growth story – Invest Money, page C5, Straits Times, Saturday, October 19, 2013. http://business.asiaone.com/news/tips-spotting-energy-stocks-growth-story. There was a view therein comparing MOG investment to real estate investment trusts (REITS) – I view them as different kettle of fish of essentially different investment products, notwithstanding the comment made that the market needs time to cultivate interests in resource sector investments. REITS was a new investment frontier too but now has a significant market following on SGX. REITS are just property investments re-packaged into divisible units. MOG is different – each mine is different from every other mine and risks profile of each MOG, by definition, is again different. Even mining ETFs may buy into shares of mining entities but they seldom invest directly into risky mining operations or projects. In my view, the analogous comparison of resource investment to REITs epitomizes the reality of how scanty of expertise even among the most likely “informed” end of local investment community of the underlying complexities of risks analysis in mining investments. I saw that in the comments of that article write-up. For example, the author shared the following postulates
…the resource business is generally capital intensive: “If it is relatively easy to retrieve, then cost is low. But in most cases, if the cost is high, then it’s not efficient.”
In this context, look for firms that have several mines or energy fields under their belt.
“That way, there is a higher chance to succeed. Also, mines dry up after a while,” said Ms Lee. “One can’t count on firms with only a few mines or rights to a few mines,” she added.
In short, the more wells, the merrier.
Geographical risks also need to be well spread out as there are always regulatory risks in a business that involves “strategic assets”. The way commodity prices are going is another factor that should guide investment decisions.
MOG investments – Clarifying the Facts from Fictions
Let me address some of the misconceptions above in roughly the same order. Mining businesses is generally capital intensive? Well, maybe only. Heap leaching of low-grade ore stockpile from tailing dumps are relative low costs operation in gold mining. Bolnisi Gold made a lot of money from its 50%-owned copper-gold polymetallic Madneuli project in Georgia. http://www.mbendi.com/indy/ming/gold/as/ge/p0005.htm In tough times, mine infrastructure and ore remnants can sometimes be bought almost for the price of a song – the buyer may only have to pay for the abandoned mine’s “land rehabilitation” costs. Capital intensity has to do with market cycles, just like all other investments.
Firms with several mines and energy fields under their belt are good investment?
Not necessarily so, I shall contend. Gold Fields bought Darlot, Lawlers and Granny Smith mines from Barrick Gold for US$300 million. http://www.prnewswire.com/news-releases/gold-fields-to-acquire-barricks-granny-smith-lawlers-and-darlot-gold-mines-in-western-australia-220622451.html. These are old mines with high costs operation and marginal of profitability at current gold price. Alacer Gold Corp sold its wholly-owned Higginsville & South Karlgoorlie operations to Metal X Limited keeping only its residual 80%-owned Copler mine in Turkey. These are old mines dating back to 1970s with the highest grades of gold ores already extracted and current production of lower grade ores is marginal at best. http://www.asx.com.au/asxpdf/20131025/pdf/42k9lwz4fqqtr6.pdf.
So it is AGE, QUALITY over QUANTITY that matters more than just being capital intensive consideration. As for oil and gas, the more fields the better? Hardly is the case in reality! Exploration concessions granted to explorers are NEVER costs-free but always carry financial commitment to well drilling to maintain exploration rights within defined limited time period. Look at even shallow offshore wells in Cooper Energy‘s Tunisian portfolio – a single well commitment budgeted at US$26.6 million blew out to US$85 million with more to come! A single fault-free offshore exploration well in the Falklands can cost up to US$100 million each. http://www.bloomberg.com/news/2013-10-03/falkand-oil-s-bid-for-desire-to-speed-up-exploration.html
And even with assumed success in every exploration well (virtually impossible) in the same field, how does one forecast the equal likelihood of volumetric and reservoir quality success in appraisal drilling and production testing stage? Statistically, the odds are far smaller than most people presumed and understood. Best of impossible luck assumed, what is the development costs going to be like if exploration turns up significant concurrent discoveries? Bankers are unlikely to finance two high risks projects in one go of a virgin explorer. The realities are that it takes a long time for a MOG explorer to reach a multi-mines or multi-well production operation which, if it attained that level of operational critical mass, must qualify it easily for mainboard listing of major stock exchanges. And it is most unlikely of a junior oil and gas producer to have the capacity to undertake more than two large-scale development projects in one go to be putting out an IPO seeking a listing on SGX. And the more wells, the merrier? The more dry wells drilled, the faster is the shrinkage in market capitalization from a few hundred millions to zero! And the way commodity prices are going is another factor that should guide investment decisions? Really? People forget that from the first exploration hit to appraisal drilling onward to final investment decision to develop an offshore oil or gas find, it may take 7 years to anything up to 10 years or longer. Current oil and gas price is irrelevant to investment in buying a pure MOG exploration play? Who has the clairvoyant vision to forecast oil or gas price that far ahead?
The Best Way Forward?
There seems to be little demonstrated comprehension of the risks factors and nature of MOG business in the local equities market. For this reason, I strongly believe that only those MOG entities with demonstrated positive cash flow from operation before exploration charges for says at least 3 years be listed on the Mainboard on SGX, the rest should be consigned to Catalist listing. Neither SGX nor MAS can reasonably hope and realistically regulate to successfully protect naïve uninformed investors in this new frontier investment horizon. They hardly understand the risks involved and its fair valuation. And neither are those in the securities industry, apparently, in appraising and valuing MOG investments, generally speaking. Without this clear boundary division of Mainboard and Catalist separate listing to underscore the risks inherent in “stronger” and “weaker” MOG investments as warning to trigger-happy punters, SGX would be a fertile ground for more penny stock speculation in MOG entities. Likewise, promoters and powerful controlling shareholders in highly speculative MOG exploration plays can have an ample space to enjoy a lot of fun and “funds harvesting” – not that every MOG entrepreneurs necessarily seeking such exciting adventures as much as they would likely to enjoy of real life actual field exploration activities.
Anyone disagreeing or any interesting thoughts to add?