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Harry Koza

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Peat power

Harry Koza

TORONTO (GlobeinvestorGOLD) It's summer, time for Trade by Numbers' annual road trip looking for new investment ideas. This year we're going to the Lakehead, to T'under Bay home of Nanabijou, the Sleeping Giant.

It's a great drive, whether you take the northern route up highway 11 all the way to Cochrane and then head west, or go up highway 400 through Parry Sound to Sudbury and then Hwy 17 through the Soo to Wawa and along the lake. Fabulous country and great bush both routes, miles of white sand beaches along Lake Superior (Put your thumb and index finger an inch apart. That's how cold the water is). Both roads meet at Nipigon, and it's an easy drive southwest along the lake from there to Thunder Bay.

Great town, and I recommend hoisting a frosty pint of Kakabeka Cream Lager at the Neebing Road House and raising a toast to the old Neebing Hotel.

Back in the 1870's, a couple of Liberal Party bagmen named Adam Oliver and Joseph Davidson built the Neebing Hotel, and quickly sold it to the federal government's new railway for $8,500, a princely sum in those days. The idea was that the building would be used by the railway for office space, but it was so rickety and badly built that it was never fully occupied. To make matters worse, the useless building had been constructed in Fort William, and the good burghers of Port Arthur, jealous that the railway terminus was in the neighbouring town instead of their own, raised a howl, claiming that the sale was an egregious example of government patronage and corruption. The resulting kerfuffle in the Commons contributed to the eventual fall of Alexander MacKenzie's government (the Dominion of Canada's first Liberal government, 1873-1878). A hundred and thirty years later, Liberal Prime Ministers are still fooling around with dodgy hoteliers, but I digress.

We've still got some distance to travel, so I can't, alas, spend more time listing the delights of Lake Superior Country though I recommend them heartily but before we hit the road again, there's time to pop into Kangas' Sauna for a restorative schvitz and a tasty Finnish snack. Refreshed by our visit to this Lakehead landmark (it's easy to find, just follow the voices shouting, "Aarvo, more steam!"), we head West to Shabaqua Corners, then turn north on the Trans-Canada to Upsala.

There's no need for you to say for the umpteenth time, "Are we there yet?", because we have finally arrived at our destination.

We're here to look at a peat bog. Northern Ontario is covered with them, and Canada has the world's largest peat resources the equivalent of 14 billion tonnes of coal in fuel-grade peat. But first, a little scientific interlude.

Back in 1916, a young scientist named Lennart von Post stunned a Swedish scientific academy with his research into pollen found in peat bogs. He was able to reconstruct thousands of years of vegetation and climate change in the life cycle of the forest, from post-glaciation pioneering plants through forest successions to the climax forests of spruce and pine. His techniques enabled archeologists to study the original settlement of North America by humans, and much of our knowledge of that period stems from his work.

Spending his time mucking about in peat bogs also prompted von Post to develop the aptly named Lennart von Post Humification scale. It ranges from H-1 (completely undecomposed material that yields only clear water when squeezed) through H-10 (completely decomposed matter with no visible growth structures). Peat with a humification rating of H-1 to H-3 is peat moss, handy in your garden. Peat rated H-4 through H-10 can be burned as fuel.

In Ireland and Scandinavia, they've been burning peat to generate electricity for years. Higher humification grades of peat contain, with some variance, about 8500 BTU per pound of heat energy, as much or more than coal, and especially much more than the lignite (1.4 million tonnes a year) burned by Ontario Power Generation at its plants in Atikokan (230 MW) and Thunder Bay (326 MW). It is also, unlike coal, very low in ash, sulphur and mercury. Ontario spends a billion dollars a year to import coal for power plants, mostly (about 80 per cent of it) from the U.S. By the way, there are some 220 million tonnes of coal (in 2000) burned to make electricity every year in the Great Lakes basin, of which Ontario uses about 10 per cent, so while eliminating Ontario's coal generators may be a good start, it won't stop the smog blowing across the Lakes from the U.S.

A junior mining company, Peat Resources Ltd. has exploration licenses for peat bogs covering roughly 200,000 hectares around the Upsala area, containing an estimated preliminary resource of 45 million tonnes (at 50 per cent moisture content) of fuel-grade peat. The company believes that there are enough resources to support a 1-million-tonne per-year mining operation for 20 years.

The idea is to mine, dry (to 10 per cent moisture), and pelletize the peat and sell it to OPG to fuel the generators at Atikokan and Thunder Bay instead of coal, the use of which the Ontario government wants to eliminate anyway.

It's a neat idea. The coal-fired generators can easily be adapted to run on clean-burning peat, or peat mixed with other fuels, like propane, and OPG has conducted combustion tests on the fuel. It stacks up well as a fuel: less moisture, clean burning, higher heat content per pound. Peat is also cheaper than coal: $1.80 per million BTU versus $2.60 per million BTU for coal (Ontario 2003 average price).

Over the years, the government has spent a lot of money cataloguing and mapping the province's peat resources. Maybe it's about time they put some of that knowledge to work.

Now, about the stock. It's a penny stock, and the company has a lot of work yet to do on the project: environmental studies, developing appropriate mining methods, and running the regulatory gauntlet to get mining licenses and a contract to supply fuel to OPG, so it's early days yet.

On the one hand, it seems obvious to try to adapt the Atikokan and Thunder Bay plants to burn peat. Those plants cost a lot of taxpayer money to build, and would still have long useful operating lives ahead of them if they didn't burn coal.

On the other hand, I'd want pretty steep odds before making a bet on the likelihood of the Ontario government doing anything logical on the electric power front.

So I'll watch PET with interest and wish them well, and hope they get their plant built. Even then, the unfortunate truth is that industrial mineral producers generally are not well-valued by the stock market. Still, while a viable peat mining operation may not garner a high market multiple, it would likely make for quite an interesting income trust, and I would hazard a guess that that will be the ultimate outcome if, as, and when the project comes to fruition.

I refer the interested reader to the company website where you can read, among other things, an independent engineering study of the project. PET has assembled a team of geologists and technical advisors with considerable expertise in peat and its use as an electricity source, so they have the necessary human resources. What they need is capital. I note that the company is currently looking to raise money for the next phase of exploration, hopefully leading to a bankable feasibility study. Given the current level of interest in infrastructure projects (especially power projects) shown by the big pension funds, I reckon that if the venture can be advanced to that stage, then arranging project finance debt to build the mine and processing plant should not be a problem.

Would I buy the stock? Likely not at the moment, as it's still a bit sporty for my taste. But I will be watching it with interest, and will definitely take another look when Phase 2 of the exploration plan is completed. In the meantime, if you're somewhat more risk-tolerant than I am, and you're looking for an unusual punt in the electricity sector, you may find it of interest. Just remember Harry's First Rule of Speculative Stocks: Don't bet the mortgage money.

OK, back in the truck, everybody, we've got a long drive ahead of us. We'll go back by the opposite route to the one we took to get here. Anybody ever been to Beardmore? Nakina? Well, buckle up, then you're in for a treat!

Harry Koza is Senior Analyst in Canadian markets for Thomson Financial/IFR. At various times in his career, Mr. Koza has been a prospector, metallurgist, project manager, engineer, as well as an institutional bond salesman for 15 years. His current area of expertise is in high-yield distressed securities and corporate bonds in general.

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