Sirius Minerals (SXX)

With our ancient industrial heritage it's easy to forget the substantial mineral exploration and production still taking place right here in the UK. The North Sea is still a hotbed of oil activity, Scotland's first goldmine (Scotgold SGZ) has been given the go-ahead and shale gas deposits are being tested beneath Lancashire.

In the North-East a small company, with big ideas, is assessing data from historical boreholes and one new one. The company in question is Sirius Minerals, its targets are the Potash seams deep below coastal North Yorkshire and out under the North Sea. It also has interests in Australia and the US, but it is the York Potash project that is the most advanced and has caused the share price to take off recently.

Potash is a generic name for a variety of salts containing potassium, and is widely used in fertilisers.

Potash was a target for mining giant BHP Billiton last year when it tried to takeover Potash Corporation of Saskatchewan in a hostile bid. The increasing global population, reduction in arable land and changing diets mean that fertilisers are in demand with potash a main ingredient.

The management team at Sirius Minerals includes highly skilled geologists with local knowledge, plus former directors of Fortescue Metals Group who turned the Australian iron ore miner from a start-up into a US$19bn operator. At the end of October, Sirius Minerals shares leapt on news from the first borehole at its York Potash site. This new data compliments existing historical analysis but has also exceeded the initial exploration target. In essence the results point to more, higher grade Potash than was expected.

Another major plus point is the award of up to £2.8m from the UK government to fund a geosciences centre at the York Potash project.

The two company brokers have recently issued research notes. One broker, Liberium, focuses on the quality of Sirius' Potash (Sulphate of Potash, SOP). This grade is of high quality and has traded at a 45 per cent premium to the standard grade (Muriate of Potash, MOP) over the last eight years. This note was dated 20th September when the shares were around 11p. The 'conceptual scenario' was a share price of 54p.

The downside risks are high. The resource could be un-mineable. Drilling small diameter holes in a National Park takes some negotiation, however drilling a vertical channel tunnel type hole will have its own planning and logistical challenges. On the plus side the project could become the largest single employer in an area which has severe job issues, this helps with the 'national interest' angle that could benefit the project. A lot of short-term traders are attracted by the company's volatility which has mainly been one-way, although there is plenty of scope for interest to tail off and for the share price to retract. In order to bring this resource to fruition Sirius will need a lot of cash which, at the moment it doesn't have. However, it does have the fundraising expertise of the ex-Fortescue directors. Shareholders may at some point have to accept that Sirius can't go it alone and need to bring in a larger company. Three new holes are now being drilled and experience from the first hole will help Sirius to increase its efficiency. There should be results released every six weeks and in the first-quarter of 2012, after the ten hole programme is due to be completed, an official Joint Ore Reserves Committee (JORC) ~ an industry standard ~ resource statement should give further transparency.

Therefore, whilst our view does not constitute a personal recommendation and advice to individual clients would vary according to their personal circumstances and objectives, we rate Sirius Minerals a a speculative buy.

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