Seeking Alpha
Research analyst, long/short equity, tech
Profile| Send Message|
( followers)  

Barrick Gold Corporation (NYSE:ABX) operates mines in North America, South America, Australia, and Africa. The company has mainly gold and copper in its portfolio and competes with other mining companies such as Newmont Mining (NYSE:NEM), Goldcorp, Inc. (NYSE:GG), and Freeport-McMoRan Copper (NYSE:FCX).

In this article, we take a closer look at Barrick's Pascua Lama project. It is located on the border of Chile and Argentina, approximately six miles from the company's Veladero mine. Once in operation, Pascua-Lama is expected to be one of the world's largest low-cost mines and is expected to contribute significant free cash flow to Barrick for many years to come. Before that can happen, the company has some major hurdles and challenges to overcome. The project has suffered substantial time and cost overruns due to operational and legal issues forcing Barrick to push back production commencement from the end of 2014 to mid-2016.

We'll take a look at the mine's potential, expected cost of production, significance for Barrick's overall portfolio and future, why it is suffering from time and cost overruns, and its current status.

Pascua Lama's Potential

According to the latest available figures, Pascua Lama has proven and probable reserves of 17.9 million ounces of gold, 676 million ounces of silver contained within the gold reserves, and a mine life of 25 years. Once production begins, Barrick expects to produce 0.80-0.85 million ounces of gold and 35 million ounces of silver annually. The resulting sales will constitute nearly 11% of Barrick's revenues. In 2012, the company had a total gold production of 7.42 million ounces of gold.

Cost Profile

In 2012, Barrick reported an all-in sustaining cash cost of $945 per ounce of gold. In contrast, the all-in sustaining cash cost at Pascua Lama is expected to be $50-$200 per ounce. Including depreciation of capital expenditure incurred in mine construction, the cost is not expected to exceed $550-$700 per ounce.

Barrick estimates that the all-in sustaining cash cost will increase to $900-$975 per ounce in 2013. Hence, when Pascua Lama comes into operation in 2016, we expect this figure to decline.

Problems at the Project

The list of problems and bottlenecks at the Pascua Lama project is rather long. At the end of Q2 2012, Barrick Gold announced a 50%-60% increase in capital costs for the Pascua-Lama gold mine from the top end of the previously announced estimate of $4.7-$5 billion, and delayed first production to mid-2014 from the earlier estimate of mid-2013.

The company attributed increased costs to a combination of high inflation in Argentina and Chile, lower-than-expected contractor productivity, schedule extension and engineering, and planning gaps. Project execution had been tardy due to the challenging physical environment at high altitudes and the company’s decision to use in-house capabilities rather than outsourcing the work to external partners. Management was put under the microscope for not having detected such serious problems earlier.

The real setback, though, came in April 2013 when a Chilean court ordered Barrick to suspend all activities at the under-construction mine. The regulators identified 23 specific steps that Barrick must take to be in compliance with norms. The company was also fined $16 million for the damage caused to the environment. As a result, Barrick announced that the first production from Pascua Lama would have to be delayed to mid-2016 from the end of 2014. This delay, along with the steep correction in gold prices in June, forced the company to take an impairment of $5.1 billion for the project in Q2 2013.

Current Status

As of now, Barrick is going ahead with the Pascua Lama project. There has been no indication so far that it may rethink its commitment to this project despite the continuous setbacks. More than $5 billion has been spent on the project thus far and the expectation of an eventual payoff is too great to turn back now. Among other things, Barrick needs to carry out the construction of canals and drainage systems to divert run-off water away from the Pascua Lama mine. The company is currently engaged in fulfilling the conditions set forth by the Chilean court that passed the adverse ruling.

Since the Pascua Lama project will not commence until mid-2016 and there are no major projects on the anvil right now, Barrick's growth prospects in the medium term don't look very great. While it is emphasizing returns over production, prices are not under Barrick's control so the best it can do is to optimize its portfolio to reduce the average cost of production. This may also necessitate selling off certain mines that don't fit its desired cost profile. Indeed, Barrick has announced that it is reviewing all mines with an average production cost greater than $1,000 per ounce of gold and has already struck a deal to sell its Yilgarn South mines for $300 million.

We have a price estimate for Barrick Gold of $15.

Disclosure: No positions.

Source: A Closer Look At Barrick Gold's Delayed Pascua Lama Mine