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Proven Formula For Success Makes Energem A Clear Standout Among Junior Natural Resource Companies

By Marc Davis, Managing Editor
July, 2004

Energem Resources Inc. (TSX-ENM), formerly known as DiamondWorks Inc., is a rare gem among mining juniors. Not only is the company a successful diamond producer and explorer in Africa but Energem has also strategically and profitably diversified into the energy sector in various oil-rich African nations.

All but bankrupt just a few years ago, the company’s prospects now seem especially bright with resource and logistics interests in a dozen African nations. The change began with the arrival of Tony Teixeira as Chief Executive Officer and a major shareholder in 2001. Since then, Energem (http://www.energem.com/) has made a series of bold moves into the “mid-stream” (distribution) petroleum sector. Energem’s balance sheet is now also benefiting from production at its 40 per cent-owned Koidu Diamond Mine in Sierra Leone. And in terms of “blue sky” potential, Energem offers shrewd speculators an abundance of advanced diamond exploration projects, along with an emerging “up-stream” (exploration) petroleum presence. These compelling factors make the company worthy of special consideration by SmallCapMedia.

Oil product delivery and logistics supply to the oil and mining industries has had an increasingly important impact on the bottom line of Energem over the past two years, beginning when the company acquired an initial 80 per cent interest in Otterbea International Proprietary Ltd. early in 2002. The Otterbea acquisition provided Energem with immediate cash flow that began in the company’s third quarter of 2002 through an exclusive contract to supply petroleum to Zambia. The contribution of Otterbea’s petroleum sales, which exceeded US $30-million for that three-month period, allowed Energem to post earnings of US $3 million for the quarter. Last year, Energem acquired the remaining 20 per cent share of Otterbea.

That was just the beginning of Energem’s turnaround. Revenues swelled to more than US $50 million in the company’s fourth quarter, allowing it to post a profit of US $10.2 million for 2002, with all of it recorded during the last six months of the year. During its 2003 fiscal year, Energem recorded revenues of nearly US $153 million, leading to earnings of US $12.1 million or US $0.19 per share. These results were particularly encouraging. However, the company encountered some problems with its Zambian agreement that significantly curtailed the flow of cash during 2003. The dispute over the Zambian supply agreement still has not been resolved but Energem is currently negotiating a settlement and the company believes a satisfactory conclusion can be achieved. If so, a new deal would provide a shot in the arm for Energem’s revenues.

Even without the lucrative Zambian contribution, Energem still managed to record a profit of nearly US $1.3 million during its first quarter of 2004. Furthermore, Energem’s successful strategy of developing strength through diversification continues to fuel the company’s ascendancy. Most recently, Energem’s petroleum division has made some significant inroads into other African countries that all offer considerable petroleum promise.

Key among the new agreements is a 12-year importation licence covering refined petroleum products to Malawi that was secured in 2003. The Malawi market requirements exceed 20,000 tonnes of product per month and should provide a healthy contribution to Energem’s revenues. The first trial shipments commenced in February of this year and bulk shipments are expected to begin shortly. Energem was also awarded the right to construct and operate a 70,000-cubic-metre storage facility, along with a 600-kilometre pipeline through the Nkala corridor from Malawi to Mozambique, which would replace the current road and rail transportation methods. A bankable feasibility study on the Malawi agreement commenced in April and is still in progress but the economics of the project appear robust.

In mid 2003, Energem added a licence to import crude oil products into Kenya. Initial trial shipments were completed late last year. Those successful trial runs were a major factor in Energem’s decision to acquire a controlling interest in Sceptre International Ltd., a Kenyan company that owns the Kisumu ethanol plant. The plant is expected to have the capacity to supply up to 240,000 litres of fuel additive per day when it achieves full production in late 2005, which will be sufficient to reduce the regional dependence on imported fuel additives in a meaningful way.

Meanwhile, the company has commenced production build-up as of late 2004 with a mandate to achieve daily production of 60,000 litres of ethanol by early 2005. Management views this milestone development as a key source of sustainable long-term earnings for the company. The initial production target is expected to translate into annualized pre-tax earnings of US $6 million. However, this figure is expected to grow significantly once production levels are further expanded, starting in late 2005. Energem is also engaged to be a bitumen importer for the Kenyan government, as well.

To acquire its 55 per cent interest in the Kisumu plant, Energem paid US $2 million and undertook to secure a financing of up to US $8 million more. Meanwhile, an independent valuation and engineering report published in March pegged the value of the plant at US $24 million, making the acquisition another strategically timely move by Mr. Teixeira and Energem. In fact, the company believes that the plant's replacement value may actually be as high as US $90 million.

Energem has also expanded its mid-stream business into oil-rich Nigeria with plans to construct a deep water berth and storage facility to handle refined petroleum products for the Nigerian market. Engineering studies and project planning activities have already commenced for what will be the only privately owned facility of its type in the country. The berth is expected to be able to handle vessels of up to 30,000 tonnes. Moreover, the storage facility is being designed to allow a throughput capacity of about 120,000 tonnes per month. This would make Energem the likely primary supplier of refined petroleum products for the Nigerian market.

The company’s aggressive expansion into Africa continues to gather momentum. Energem has expanded its mid-stream business further with the signing of an agreement early this year with the government of Sao Tome, a nation consisting of a series of islands just off the coast of Gabon. The joint venture partnership will manage oil allocations granted to the Sao Tome government by other African oil producing nations. Accordingly, Energem will receive 70 per cent of the profits derived primarily from the marketing and trading of crude oil and crude oil products. As well, Energem is developing logistical, distribution and supply opportunities in Angola.

Energem also has an emerging up-stream presence in the African petroleum industry through its acquisition of a 51 per cent controlling interest in Gulf of Guinea Petroleum Inc. The junior company was recently awarded the East Oravinyari Oil Field off the coast of Gabon – a prolific oil resource that has been drilled and outlined by Marathon Oil. Gulf of Guinea has a development plan in place to achieve commercial production from this expansive oil field, along with a production sharing agreement with the government of Gabon. The acquisition is a good match with Energem’s strategy of acquiring producing or near-producing marginal fields with proven reserves. As well, the company is pursuing a number of untapped petroleum related projects in several West African countries.

Another major coup for Energem’s savvy management was the signing of a joint venture agreement with a major Chinese oil company, PetroChina International Ltd in April of this year. The arrangement covers oil field projects in a number of African nations with an ultimate goal of jointly sourcing crude oil for the energy-hungry Chinese market.

Although nearly all of Energem’s revenues have to date been earned by its petroleum businesses, the company’s 40 per cent-owned Koidu Diamond Mine in Sierra Leone is soon expected to begin to make a significant contribution. The mining of the No. 1 and No. 2 kimberlite pipes started earlier this year as part of a large bulk sampling program that is expected to help determine the best long-term mine plan at Koidu.

The No. 1 pipe at Koidu is estimated to contain about 1.6 million tonnes of ore with a grade of about 0.67 carat per tonne, while the No. 2 pipe holds an estimated 3.1 million tonnes of ore with a grade of about 0.40 carat per tonne. All told, the two main Koidu pipes contain about 2.3 million carats of diamonds. As well, there are four dike zones at Koidu that could add to the diamond resource.

Significantly, the Koidu diamonds are of high quality and display a robust size and Energem’s production has commanded a premium price as a result. The company has sold over 31,000 carats in three sales earlier this year at an average price of US $220 per carat. This has provided the company US $6.9 million in additional revenues. The value of the diamonds from the No. 1 pipe was just over US $220 per carat, which was well in line with expectations. However, the No. 2 gems significantly surpassed expectations, selling for US $202 per carat. At those lofty prices, the two key Koidu pipes contain a gross diamond value estimated at nearly US $500 million.

Extraordinarily, the company believes that this half billion dollar evaluation could even be topped by another emerging diamond project in Sierra Leone. Earlier this year, Energem was awarded the rights to the Tongo project that had previously been held by Rex Diamond Mining Ltd. The project had been put on hold in 1997 due to a civil war in Sierra Leone but financial difficulties made Rex unable to resume work once peace was restored. The government opened the Tongo project for bids and Energem was selected. This fortuitous development was primarily attributed to the company’s expertise in getting the Koidu Mine back in operation in an efficient and timely manner.

The Lando diamond dike is key to the Tongo diamond fields project. The fissure can be traced for about six kilometres. However, its length could ultimately exceed that mark by a significant margin, according to Rex’s exploration findings. Notably, the grade of Lando is approximately three carats per tonne (a very high value) in the upper portions, and although the diamond content decreases with depth, the feature appears to be a major source of quality diamonds.

Lando, like all of the Tongo fissures, is narrow, and waste rock would also have to be mined to achieve a minimum mining width of about one metre. Nevertheless, the diluted grade of the Lando dike should be about 0.8 carat per tonne, which would be more than enough to support a profitable operation.

Another key part of the Tongo project is the Kondo dike, which should be capable of supporting a mining grade of about 0.4 carats per tonne. Two other fissures appear capable of supporting diluted mining grades of about one-quarter of a carat per tonne, although the actual diamond grade of the kimberlite rock is much higher, at about one carat per tonne.

Rex claimed that the gross value of the Tongo diamonds was about US $3.3 billion. To its credit, Energem makes no such promotional claims, choosing instead to investigate the kimberlite fissures in a systematic fashion that will allow the company to produce a realistic mining plan for the project. With Koidu and its 50-tonne-per-hour processing plant just 50 kilometres away, there appears to be a natural synergy between the two projects. Therefore, the Tongo project should be a key part of Energem’s plans.

Elsewhere, the company also has a series of alluvial diamond projects in the Central African Republic that are scheduled to be developed in the next several years. Energem also holds the mining and exploration rights to the Yetwene and Luo diamond deposits in Angola. These were the company’s key exploration and development projects in the late 1990s until a rebel attack on Yetwene halted work. With so much riding on these two Angolan ventures, the company’s future was bleak in the aftermath of that attack but Energem’s current management team has performed an extraordinary job over the past few years, bringing in new investors and developing the profitable new strategy.

Tony Teixeira, now president and chief executive officer of Energem, has been very instrumental in the company’s turnaround. It began with an initial cash infusion that he facilitated and continued with the various diversified acquisitions that have built so much intrinsic value into Energem’s business model. By way of his background, Mr. Teixeira is a successful entrepreneur who built up several businesses in the transportation logistics, trading and petroleum sectors, which are now among Energem’s primary business ventures.

Brian Mennell, the Executive Chairman of Energem, has an extensive background in mining and diamonds. He worked for De Beers for nearly a decade but left in the mid 1990s to return to his family business, Anglovaal Mining Ltd., which is a diversified mining company with interests in base metals and precious metals in South Africa and Zambia. The Mennell family sold their interest in Anglovaal a few years ago and Energem’s diamond division is now a high priority for Mr. Mennell. Energem also appointed Rob Rainey to be its Chief Financial Officer last year. Mr. Rainey had previously served the company in this role but he left in 2001 to assume a similar position with SouthernEra Resources Ltd., which has platinum and diamond mining interests in South Africa. In addition to his career as a chartered accountant, Mr. Rainey has a wealth of experience in directing and managing public companies.

As of late 2004, the company's senior management was strengthened with the appointment of Mr. Brett Thompson as chief operating officer of mining. Mr. Thompson is an accomplished mining engineer who brings to the company over 20 years of experience in the international mining industry, with specific experience in diamonds, gold and base metals, as well as relevant country experience in Southern Africa, South America, West Africa and Australia. He has filled operational, technical and corporate positions and in recent years and has held senior management roles in Anglo American, Anglogold-Ashanti and, most recently, De Beers.

Indeed, the company dynamic management team continues to impresses SmallCapMedia and investors, alike, with its sophisticated and enterprising approach to capitalizing on lucrative market niches. Among the company’s most significant and recent initiatives is the acquisition of a 60 per cent interest in the Swiss commodities trading house, Republic House AG in April of this year. Republic House boasts a turnover exceeding US $200 million per annum and a profitable history of commodities trading in copper, cobalt and precious metals in Africa. Its commodities trading skills will compliment Energem’s existing business model and will become the oil trading “back-room” arm of Energem. Furthermore, Republic House’s existing relationships with the African mining industry -- through its ongoing trade -- offers considerable synergy for the future.

On a technical note, Energem has approximately 102.7 million shares outstanding (about 124 million fully diluted.) However, many of these shares are tightly-held by insiders and institutional investors. For instance, a company controlled by Tony Teixeira, Lyndhurst Ltd., has a 41 per cent stake in Energem, giving Mr. Teixeira ample incentive to continue to build value into the company. Also among the company’s notable shareholders is the venerable investment house JP Morgan Fleming.

Accordingly, SmallCapMedia believes that Energem is quite undervalued at this time as the company’s share price is clearly in a consolidation phase during the cyclically lacklustre summer months. After more than doubling in value to around $3.60 during the first few weeks of 2004, the share price has drifted back towards a soft technical support level in the $2.20 to $2.30 range.

However, the “big picture” looks very promising for this shrewdly diversified mining junior, especially with the emergence of a solidly profitable business model. Also, the likelihood of the near-term resumption of the company’s Zambian petroleum refining and delivery business promises to fuel exponential revenues growth for years to come. And with the production of high-grade diamonds and an attractive portfolio of exploration projects in many mineral-rich African nations, Energem has all the right dynamics to be a strong performer during the next 12 months and beyond.