Not many mining investors would have known about the resilient Chilean Diaguita Huascoaltino community living in the arid mountains of the Atacames dessert until very recently. When reports about a Chilean court decision arrived in early April ordering Barrick Gold (NYSE:ABX) to suspend all development work on the Chilean portion of the Pascua Lama mine this indigenous people suddenly entered the spot light of international news.
Interestingly, Barrick Gold is not the only large gold mining company that the Diaguita people are taking on. There is another significant development project on their lands, namely the El Morro project which is owned in joint venture by Goldcorp (NYSE:GG) (70%) and New Gold (NYSEMKT:NGD) (30%). And project field work at El Morro had to stop in April 2012 when the Supreme Court of Chile issued a suspension of the environmental permit for this project due to complaints by the Diaguita people populating the Huasco Valley and its catchments. The permit was found invalid on the grounds that Chile's environmental permitting authority had not adequately consulted with the indigenous people affected by the El Morro project. Both Goldcorp and New Gold stated that they were working closely with the local community and Chilean authorities to resolve the situation.
(source: New Gold website)
The El Morro project is located approximately 800km north of Chile's capital Santiago. The project is reported to contain a reserve of 9.6M ounces of gold and almost 7,000Mlbs of copper on top of a resource given as 14M ounces of gold and 9,000Mlbs of copper rendering this deposit world class. The porphyry style mineralisation lends itself to a simple truck-and-shuffle open pit operation and is partitioned into three zones (El Morro, El Negro and La Fortuna). The existing preliminary feasibility study considers only the La Fortuna zone and gives a mine life of 18 years providing work for approximately 800 miners. Planned processing consists of a simple flotation plant with a 90,000 tpd throughput. Due to the scarcity of water in the area a desalination plant on the nearby Pacific coast was considered in the PFS and incorporated in the original environmental impact study submitted to the Chilean Environmental Commission (CONAMA) for the Atacama region. The preliminary capital expenditure for the development of the El Morro mine is pegged at $3.9B to be financed solely by Goldcorp of which $258M had been spent as of December 31 2012. The project was initially jointly developed by Xstrata (OTC:XSRAF) and Metallica Resources who merged with Peak Gold in 2008 to form New Gold as it is still known today. Xstrata attempted to sell their 70% stake in the El Morro project to Barrick Gold in 2009 but this deal was thwarted by New Gold who exercised their right of first refusal and brought in Goldcorp as their JV-partner instead. Barrick proved to be a sore loser and fought Goldcorp and New Gold in court to no avail.
First records of the Diaguita culture date back to the 8th century. Over time Diaguita tribes controlled a substantial piece of land including today's Argentine provinces of Salta, Catamarca, La Rioja and Tucuman plus the Atacama and Coquimbo regions of Chile. Resistance against an Inca invasion in the 15th century was fierce but ultimately the Inca empire was expanded into Diaguita lands until the mountains near modern-day Cordoba. Surviving Diaguitas later came to fame in resisting the Spaniards. Today Diaguita descendents still populate mountainous regions of the Andes mostly practicing agriculture. They are possibly best-known for the invention of the rain stick as pictured below.
Many indigenous rights were created specifically to protect the special relationship between indigenous people and their land. International documents and courts frequently mention the connection indigenous peoples have with particular pieces of land where they have often lived for hundreds or even thousands of years. Land and land rights are central issues for indigenous people around the world due to economical reasons but also due to religious, cultural and spiritual reasons. Land creates identity for many indigenous cultures, be it The First Nation in Canada, Australian Aboriginals or the Sami people in Lapland in Northern Finland to name just three examples. Most Western societies recognize this context and protect the land rights of native minorities. More than 10% of Chilean people consider themselves indigenous according to the 2012 census. Legislation to protect indigenous rights has been developed in very recent times following the democratization of Chile in 1989.
By nature, mining activities are often in conflict with the rights of native people. In the case of the El Morro project the situation was complicated by the fact that the affected land had not been technically recognized as "indigenous land". Moreover, the Diaguita people in the Huasco Valley had not even been acknowledged as an "indigenous community" in Chile until very recently. From their point of view Goldcorp and New Gold were simply unlucky. When the environmental impact study had been prepared (by Xstrata at the time) there was no formal requirement to consult with the Diaguita people. The signs were certainly on the wall, however, with the leadership of the Diaguitas Huascoaltinos commenting Xstrata's intention to sell their share in the El Morro project in no uncertain terms back in 2009.
The Diaguitas in the Huasco Valley certainly did not need Greenpeace or any other Western organisation to tell them to protest against the impact of projects by mining giants on their lands as was suggested in this article. They have known fully well about the environmental and social dangers coming their way with the arrival of various mining giants. Access to clean water is essential in the Atacames dessert. The Pascua Lama and El Morro projects are situated on periglacial ground and very close to glaciers. This type of terrain is extremely sensitive to environmental changes and serves as an important regulator for the water supply in lower areas. Damage to such an environment cannot be repaired easily (if at all) and can have devastating consequences for the people depending on the frozen high-grounds as their water resource. A very readable, yet detailed summary of the topic can be found in this report. The illustration below is taken from this report and shows the water ways and glaciers in the catchments of the Huasco Valley clearly indicating that practically all water flowing to the land of the Diaguita Huascoaltino is sourced from glaciers.
The Pascua Lama project is situated immediately next to glaciers and on permanently frozen land and is therefore especially problematic. Roads enabling mine access have already had significant impact on glaciers and dust generated by stripping activities for the open pit have covered large glaciated areas leading to a work stoppage in late 2012.
El Morro is on lower grounds and at a distance from glaciers. Impact on periglacial lands and frozen water resources is still a strong possibility and will certainly be addressed in the ongoing talks with the Diaguita community.
The Pascua Lama development was originally budgeted at $3.3B - $3.6B. After a review in 2011 capex estimates were revised to $4.7B - $5.0B. The latest price tag estimated by Barrick during discussion of Q2/2012 results on July 26 2012 was approaching $8B. In the aftermath of publication of Q2/2012 results Barrick's market capitalisation lost roughly 10% of ground when compared to Goldcorp. The timing of the most recent suspension at Pascua Lama coincided with a historic drop in gold spot price in the first half of April. Barrick's market capitalisation was reduced roughly 15% further than Goldcorp's during this period which we assume was directly attributable to the Pascua Lama suspension order. The chart below illustrates the divergence in market capitalisation between the two companies since the start of 2012.
Goldcorp has recently taken the number one ranking of the largest gold miner by market capitalisation from Barrick Gold. Many would argue that the Pascua Lama disaster was to blame for this shift in positions.
Repeated delays and ongoing court proceedings impact on capital expenditure and cause cost explosions. It was calculated that a further delay of the Pascua Lama project by one year would reduce the NPV of the project by 27% or $1.54 per share. Barrick seems to have adopted a juggernaut approach regarding the concerns of the Diaguita people so far. One cannot help but speculate that more inclusive project planning and management could have spared Barrick some of the costly delays. A recent news item gives rise to speculation of a change in direction. Two highly experienced Chilean mining executives were reportedly hired to advise and assist on the re-activation of the Pascua Lama construction efforts. Hopefully this local talent will bring the necessary negotiation skills to the table to find solutions for all stakeholders in the Pascua Lama project.
The initial capex estimate for the development of El Morro of $3.9B eerily reminds us of the first estimates given for Pascua Lama. The El Morro project development is still at a relatively early stage; however, the carrying amount for this property is listed as $1.4B in Golcorp's latest annual report making it the 5th highest value within Goldcorp's portfolio or 5.8% of the total carrying amount on the books. New Gold states a carrying amount of $423M in their most recent Financial Review for their share of the El Morro project which equates to 13.5% of New Gold's total carrying amount. In other words, both companies already have considerable skin in the game.
At the moment ongoing investments into the El Morro project are restricted to negotiating the reinstatement of the environmental impact study, some engineering design work and onsite security measures. Goldcorp and New Gold are presently keeping mum on proceedings with regards to the El Morro project. Goldcorp's last annual report simply stated that "the Chilean authorities and local communities continue to refine and advance this new consultation process with the Company's support."
A reliable and durable agreement with their neighbors will presumably come at some cost but would go a long way towards taking out a considerable portion of the project execution risk. The Technical Report on the El Morro project includes a sensitivity study for cost inputs related to the project. The base case computes an NPV of $1.025B and an IRR of 7.9% after tax. A 10% increase in Capex would lead to a reduction of the base case NPV to $701M; and a 10% increase in Opex would reduce this NPV to $604M. This would indicate that there is some limited room to move if negotiations lead to an increase in expenditure for the project.
Takeaway for investors
Barrick's Q1/2013 earning call was dominated by the Pascua Lama topic. It is our understanding that for Barrick Gold the fate of this project will have a very strong influence on the share price performance in the foreseeable future. An investment in Barrick Gold at the present point in time has become, to a large degree, a bet on the future of the Pascua Lama project.
For Goldcorp the El Morro project is one of several advanced development projects. The down side is still quite limited, whereas the upside is considerable but will depend on the outcome of ongoing negotiations. A possible development decision will be scrutinised by investors given the example that Barrick has set. Share price performance in the event of such a development decision will depend on the information available at the time and the judgment investors pass on the risks involved with the project.
For New Gold the possible upside at El Morro is immense and the downside is limited. Given the growth ambitions by this up-and-coming gold miner we would expect some anticipation to be baked into share price already. Proceedings at El Morro will quite probably have a fairly strong influence on the share price either way and investors are well advised to monitor developments.