David Pathe - President and CEO
Paula Myson - Managing Director, IR
Mark Plamondon - SVP, Ambatovy
Dean Chambers - EVP, Development
Martin Vydra - SVP, Metals
Elvin Saruk - SVP, Oil Gas & Power
Sean McCaughan - SVP, Coal
Nancy Randal - Corporate Controller
SHERRITT INTL COPR R (OTCPK:SHERF) Investor Day September 12, 2013 9:00 AM ET
All right, well good morning everybody. Thanks for coming in and taking time to join us here today. This is our first Investor Day that we have done in I think over five years. So it’s long overdue and we would like to have the opportunity to introduce you some of our people and give you some sense of what we are working on these days.
Many of you I think in the room participated in a bit of survey that we have did leading up to this to get some sense of what the community was looking to hear from us and we have got a lot of great feedback out of that and we are going to play some of that back to you this morning to give you sense of what we have heard from the community and a lot of work has going in structuring the program this morning around trying to invest as many of those concerns that you raised as we can.
This is obviously the first time we have done this in a while and so we have made attempts to do that and we will answer as many of your questions today as we can. I'm sure we won’t answer all of them but as always we are around afterwards and then going forward from here for any further conversations anybody wants to have.
With us today, we have quite a number of people from the management team, Dean Chambers, Brian Tiessen, our CFO and our EVP of Operations are both here as well as the heads of all our business units; Sean McCaughan from Coal, Juanita Montalvo who runs the Corporate Affairs Department, Mark Plamondon is here today from Madagascar, Elvin Saruk who runs Oil and Gas and Power business, Martin Vydra, who runs our metals business in Cuba, and Nancy Rendle, they all are here and we all can be hearing from all of them today. They are going to you take you through some of the key concerns in our businesses. We are going to talk about balance sheet. We are going to talk about where we are in Ambatovy, and Nancy is going to speak to you about some of the peculiarities in the accounting that with our and the impression it creates for ourselves, further the understanding of those sorts of wishes.
So, it’s a busy day, there is a lot to get through but I think we will get through it and we will try answer as many of your questions as we can as well. While I am up here before, I turn it over to Paula to take you through some of the results that came out of the survey to give you sense of how we put this together, there is a number of other names there as well with Lorene and Gretchen, [indiscernible] Stephanie, Amalia [ph], Joe and Andrew, most of them are here this morning as well, though all those people work tirelessly to put this program together and they have done a tremendous job I think. So I want to thank them as well but most of them are here today. So if you have a chance to meet any of them, they have put in a huge effort to try and make this day a success.
Before I turn this over to Paula, you should have you in front of you a set of the slides. You should also have with you a little medallion coin, just to provide actually the conclusive proof that Madagascar is up and running, those that were medallion coins that we have commissioned. They contained Ambatovy nickel. So we put that together this year to commemorate the first nickel production last year at Madagascar. The Royal Canadian Mint actually stamped those coins for us with nickel that we shipped up there from Madagascar.
So, on that note, I'm going to turn it over to Paula to just take you through what we are going to trying to do today and give you some sense of what came out of our survey. Thanks very much.
Thanks David. Good morning everyone and I want to welcome everyone on their webcast as well. If you are joining us by webcast and for those in the room after the presentation, we do have the presentation posted on the website if you want another PDF copy of it is as well.
And so before I begin, I would like to remind everybody that the presentation and the comments that we are making today will include forward-looking statements. So these statements are given as of today and they involve risks and uncertainties and the statements are a product of a number of factors that will change and so the actual results may differ materially from what we say today. So please refer to cautionary language in our filed financial statements and documentation and risk factors in our filings on SEDAR and on our website.
And as Dave said it has been quite a while since we have done in Investor Day. So we wanted to focus today focus today on the topics, there's the warning just so you can see it, focus on the topic you and the investors wanted to hear, maybe a little bit of a collective agenda as a result but that’s where we wanted to spend the time today.
The investment community was very eager to provide us the feedback and suggestions to aid us in directing the day today and we really very much appreciate the time you took to give us that feedback. So part of the feedback was that you wanted to see the results of the survey. So that’s what we will cover in the first couple of minutes here. It did dictate our agenda. So I will finish my comments with going through the agenda, which encapsulate the major issues that you raised during that survey.
So, I won't go into all of the details on these slides but I will hit the highlights. So in this study, we received feedback from 21 investors and analysts that represented about 12% of our stock, our largest fixed income investors and five firms on the sell side and by a large margin the two major issues that you wanted us to talk about today were Ambatovy and corporate structure, corporate strategy, followed closed by liquidity and what our capital discipline was going to be going forward and then valuation issues and operational issues followed there and finally financial reporting. Those themes were reinforced many, many times during the survey and you will see this on slide six.
This is a slide summarizing when we asked you about our communications and it links back to again the major priority that you had in the survey which was strategy. Two-thirds of you stated that we had not been very clear on the strategy and requested we gave greater clarity, particularly now that we are post Ambatovy. We will do that today.
You also articulated your key concerns for the company. Once again, Ambatovy was the top of the list. We saw a little divergence on what concerned people with respect to Ambatovy. For some people it was the timeliness of our commercial production, for others it was operational risk and technical risk particularly during the ramp up and for others it was purely the debt structure and how the cash would flow out of the entity. We'll address all of those issues today. A notable second on your concern was the outlook for the nickel market, now with our Moa joint venture in Ambatovy, a very predominant feature of our company. We will cover that for you today.
And finally a few items that surfaced during the study that were somewhat of a surprise and we call them perceptions or misperceptions and we will like to take the opportunity to address those today. So here is the agenda that results in from that study; quick run through on that, we've divided the morning into two segments. So the first and we'll hold Q&A at the end of each segment. It's a pretty ambitious agenda. So in order to manage the day effectively or the morning effectively, we request that you hold your questions until the end of each segment. We will have extensive period of Q&A. So you will have the opportunity to do it then.
Our first segment we're going to address your top concerns. We've grouped them into the five topic areas that we saw emerge in all of the responses, Ambatovy, liquidity, leverage, strategy, capital allocation. We'll finish the first segment again with the Q&A but before that we want to address a couple of these misperceptions and get them out of the marketplace.
At that point we'll take a short break and when we come back we'll move to an operations review and an overview of our reporting in accounting. When you gave us your responses to the study, the one thing you specifically requested was to hear from our operational team. They're all here today and we're happy to give you the opportunity to hear them in the presentation and have one-on-one conversations with them during the break. We'll conclude again with another question and answer session. One thing you also specifically requested, that this would be a half day event. So we will wrap up what's webcast by noon.
And with that let's get started. Our first topic will be the Ambatovy updates, and for that I’d like to introduce Mark Plamondon our Senior Vice President in Ambatovy who's joined us from Madagascar.
Thank you Paula. Good morning everybody. Thank you for coming. So I'll spend a few minutes giving you an update on Ambatovy. So this first slide here, the graph on the right hand side shows our sellable nickel production since we started, our first test for [indiscernible] out of the back end of the refinery in June 2012 and you can see on that graph coming up to June 2013, we were operating the refinery at just about 50% of nameplate capacity in that month.
And so it's very clear from that curve that we are having progress in the ramp up but it's also showing how it's a jagged curve, it is a saw tooth curve and that's expected in a facility like this and the reason you see saw tooth or a jagged curve is you've got numerous hydro metallurgical process that all operate in series. In of those processes we have redundant parallel equipment but the circuits themselves need to operate in series and so if there's any mechanical reliability issues with any of the equipment in any of those circuits, we then need to conduct maintenance which has an effect on the throughput for the entire circuits and so you see a number of sawtooths on this ramp up curve.
Some examples of some hiccups that we see from a mechanical liability point of view. For example February we had some refractory failures in some of our pressure vessels in the pressure acid leach area and likewise, although unrelated we also have some refractory issues in our asset class in April which affected the throughput of the refinery in May. And so every time we've got a mechanical failure that may affect the process work in series, we take this circuit down and we conduct maintenance and repair activities.
And one of the key components of our operations management program is of course having a reliable backlog, a very clear backlog for maintenance activities, so that when the opportunities arise, when a piece of equipment goes offline we can conduct planned maintenance in other areas so that we can proactively address issues to help us accelerate the ramp up the curve as we move.
So basically since we saw our first forecast [ph] in June 2012 we are seeing progress, we are seeing a rapid curve, but it is jagged, it is sawtooth and we are taking every opportunity we can to conduct maintenance opportunities during periods where some equipment is offline so that we can continue to accelerate the ramp up curve.
So in the first half of 2013 we sold 27.7 million pounds of finished nickel and 2.5 million pounds of finished cobalt. I just want to highlight that, even though we have not hit what's defined as commercial production, remind you what that definition is, we already commercially producing facility, we are producing finished nickel and finished cobalt. It is being successfully sold in the marketplace. We generated sales proceeds of $230 million in the first half of the year.
So it is a facility that is producing finished nickel, finished cobalt and we're successfully moving our product into the marketplace. Now the definition of commercial production, I found a definition is 70% of nameplate capacity over a 30 day period and that's measured as ore throughput through the pressure acid leach [indiscernible]. So that is the point I wish we now are hitting the P&L and we finished capitalizing our costs. And so that is a definition, accounting definition that we put in place of 70%.
We have not hit that yet but it is not mean that we’re not producing finished nickel and cobalt for sale into the marketplace. Now, our expectations, we believe we’re well positioned to hit commercial production in fourth quarter of this year. We’ve just finished a significant amount of opportunistic maintenance in our asset point at one and we’ve done some major maintenance turnaround in a couple of our audit place and we think in the fourth quarter we are well positioned to have more reliable productions so that we can get to that commercial production benchmark, which again is defined as 70% nameplate capacity through the leach plant.
With respect to cash flow neutrality, that’s a little more difficult to predict because of course not only is that a function of a ramp, it’s also a function of commodity prices, nickel and cobalt as well as our input prices and so predicting exactly when we are cash flow neutrality and above which that point we are then a cash generating facility that’s at least given more today with commodity price although with expect that to be in sometime 2015, but that’s obviously more a function of price than anything else and very difficult to predict.
Then financial completion, financial completion is the point at which our debt becomes non-recourse. That at this point is expected in the first quarter of 2015. There is a number of components to financial completion. We have 10 completion certificates that we have to complete and so that is expected to be completing all those in early 2015.
Just to give you some guidance on cost, this graph here that we’re showing on the right-hand side of this slide is giving an indication how our C1 cost, our net direct cash costs are expected to decline as we get up the ramp up curve and approach 100% operating capacity of this facility. So currently when you’re operating facility at half rate, you of course expect hiring the cost because you’ve got of course a lower production volume over fixed asset base or fixed cost base, but as we get up the ramp curve, a couple of things happen; not only do you get more volume of course but by definition, because your equipment is online more often, there is less mechanical repairs, less maintain activities, your maintenance costs come way down and also when your plant is operating in a stated fashion, the metallurgical efficiency optimization, we’re able to do and optimize your process and get that more effectively fine-tuned so that you have more efficient process of all.
So the curve, what we expect is when we were operating around 50% during C1 cost in the $9 to $11 range, but when we get up full capacity at 100% we’d expect to be in threeish and $3 to $5 range for C1 cost again that is a function input commodity price. So it’s not just volume. Volume is part of it but also you really expect because your plant is operating in a more stable fashion to have lower maintenance cost and more efficient input commodities into the process.
Now those key sensitivities to C1 costs are similar to what we see in the Moa Joint Venture, as I said volume throughput levels and then the prices of your main commodities. So Sulfur, so we will expect to consume above 750,000 tonnes of sulfur, over 40 million liters a year of diesel and so the prices of these commodities also have an impact on our unit cost.
And also we generate all of our own electricity on site. We import coal from South Africa and we expect to consume about 500,000 tonnes a year. So the price of coal also is something that needs to be considered in the sensitivities for the unit cost of our operation.
And with respect to capital, what we expect at our facility, we expect our facility to have a sustaining capital requirement similar to what you see at Moa and other facilities adjusted for size and age. Right now certainly over the next four to five years we expect the sustaining capital requirement in the $75 million to $90 million a year range, got a number of projects that need to be executed. We've got some [indiscernible] facility construction to take place in further development of our ore bodies. So the capital required for that over the next few years is guidance to be in the $75 million to $90 million range annually over the next few years.
I think Dean is going to talk to the next slide.
Good morning. So as Mark ramps up in Ambatovy to full production and of course as commodity prices moved down, cash flow will improve significantly. And one of the reasonably complex matters in Ambatovy's financial arrangements with the senior lenders and Sherritt's arrangements with our partners in terms of the partner loans, its how does cash flow waterfall work?
It’s reasonably complex but the principles are actually quite simple. Obviously the first thing that needs to be paid with revenue generated by the project is operating cost. The next thing that needs to be paid, the next priority is payment of senior debt. So here I’m referring to the $2.1 billion senior debt facility, project financing facility that Ambatovy has borrowed to fund its capital construction.
Payment of principal plus interest, we’ve already begun to amortize or Ambatovy has already begun to amortize that debt. So about 60 million semi-annual payments, June and December has been about $60 million this year ramping up to more like $90 million next year, paying principal payments on each of those dates. Currently, the interest rate is LIBOR plus about 140 basis points until financial completion.
Once the debt service is taken care of, you need to keep enough cash in the project in order to fund the maintenance CapEx, sustaining capital that Mark had mentioned, roughly $75 million to $99 million a year. With all that covered, you have cash that can be distributed to the partners.
So, because we own 40% of the project we would get 40% of any distributable cash. However, because of our loans from our partners that we have used to fund our investment in the project, we have an obligation to use 70% of that cash distributed to us to repay the loans from our partners and we would keep 30%. So hypothetically if there is $250 to be distributed, Sherritt would receive $100, 40% of the $250. We would take $70 and payoff our partner loans and we would keep $30.
The other thing that’s sometimes hard to figure out, when you look at it because of the complexity of our financial arrangement with Ambatovy is exactly how much has Sherritt contributed to the project and how did that get funded? So I'm going to walk you through that using numbers that you can find in our public disclosure. So at the end of June, the total project cost was US$6.9 billion on a 100% basis. That is capital cost, working capital interest, foreign exchange, total project costs. Of course fully going down on the $2.1 billion project financing, Ambatovy's fully grown write down, which leaves $4.8 billion that has been contributed by all the partners and our pro rata share of that is $1.9 billion.
So how we funded that $1.9 billion? We borrowed about $700 million from our partners and we have contributed about $1.2 billion of cash from our own balance sheet and our old liquidity. Now if you look at our financial statements and you look at these loans from our partners, it will be significantly higher than $700 million. It's closer to $900 million at the end of June and that's because those loans accumulate interest.
So interest is accumulating on those loans until we have that cash flow and get repaid from that waterfall that I showed you on the earlier slide. But there is no more availability on the partner loans. So that obviously, interest is not being used to fund the project. It’s just accumulated interest that Sherritt has to repay and there is no more availability on our partner loans. So as we go forward and continue to fund the project until it becomes cash flow neutral, then that funding will come from Sherritt’s cash and balance sheet.
This brings us to and a very important matter and that is our cash and our liquidity position. And clearly with the current commodity price environment and Ambatovy ramp-up and not cash flow neutral, it puts a strain on our liquidity position. But this company has always been extremely focused on the strength of its balance sheet, its liquidity position and has not changed.
We will continue to look at our capital allocation priorities in that context and now David will talk about that further. So we are very focused on maintaining strong liquidity position. At the end of June we had roughly $400 million of cash on our balance sheet. I do expect that to decline somewhat to the end of the year as we fund Ambatovy, like I mentioned that on the second quarter call and we have about $600 million of undrawn credit lines.
You see our debt maturity profile, we don’t have a major maturity until 2015 and that is when one of our series of public debentures comes due. It’s in the fall. So it’s roughly two years from now. One thing to mention with respect to our partner loans and we have two types of partner loans, and these are loans that our partners have provided to Sherritt to fund its investment in the project. With one set of loans roughly $98 million outstanding, that does have a maturity date and it’s in 2023. To the extent that cash flows from the project are not sufficient to repay that loan, that it is an obligation of Sherritt to repay any outstanding balance on that date.
The additional partner loans which is the vast majority you can see over $800 million of loans at the end of June has no maturity date. It is serviced by cash flows from the project in that waterfall that I showed you and the maturity will be whenever those cash flows are sufficient to extinguish that debt. It gets extinguished pretty quickly at high nickel prices and that is what we are looking for because we know we will hit that period sometime in the life of the project.
The other thing that is somewhat complex, because of the way the financings have been structured is the leverage on our balance sheet and we look at it in many ways, because you have to understand how the debt is structured to really understand kind of what the risks are inherent in our leverage structure on our balance sheet.
If you just look at our balance sheet at the end of June, you can see we have slightly over $2 billion of debt and in that long-term debt to assets less goodwill is about 33%. But it's not the whole story. If you look at what we call recourse debt, so a lot of our partnered, almost all of our financing arrangements with respect to Ambatovy are not recourse to Sherritt International; they are not recourse to the parent. They are recourse to our interest in the project but not to recourse to Sherritt. So if you take that out and that's primarily the $822 million of partner debt, you get a long term debt to assets plus goodwill of about 20%. The changes are major if you look at it that way.
The other thing I want to mention is the $2.1 billion project that Ambatovy has borrowed is embedded in our net investment in an associate because the equity account for Ambatovy shows up and comes into our balance sheet through the net investment line. But we also look at those loans and they’re fully covered by our partners, the obligations under those loans are fully covered by our partners with respect to any potential guarantees.
So, the project debt is guaranteed by all the partners, and so it passes the completion test that Mark mentioned earlier. Our share of that is $840 million, 40% of the $2.1 billon, but we have cost guarantees and letters of credit from our partners that cover that entire amount as part of the deal when we form the partnership. So part of the price of entry into the partnership if you will from our partners was to provide that coverage on those loans.
So again when we look at those loans, we consider them not recourse to Sherritt International as the parent, recourse only to a project and our interest in the project. There are no financial covenants in our partner loans and it takes only from the Ambatovy cash flow.
If you look at our corporate debt, we do have some bank credit facilities. As you can see we haven’t been utilizing those extensively in the last few periods. They do have financial covenants that could lead to an event of default. But whenever we renew those facilities and we’re actually in the process of doing that right now with one of our corporate facilities, we look at the covenant package and we work with our lenders, our bankers and set up our covenant package that matches our forecast. I’m not particularly worried about covenants in our bank finances.
The important thing is a covenant that’s embedded in our senior unsecured notes in the three series, and there is an indebtedness to total assets covenant of 40%. That's an actually relatively simple calculation. It’s really is a debt on our balance sheet and lease obligations over assets less goodwill.
That is not an event of default. What happens is if we were ever to breach that covenant is that we would be restricted from incurring additional debt. So the biggest risk in that covenant package in my view is, is that if we were to get that level it would impair our ability, it would reduce our debt capacity at that point. So it is not an event of default and doesn’t create any additional consequences for us.
Turning to valuation, the valuation of our businesses. I think we’ve looked at the value of our various businesses in a lot of different ways. This actually shows you how some of you have valued our businesses as we’ve taken some of our analysts data and value of each of our business and our total company overall. What strikes you is the range of values that can be assigned from our businesses.
For example, if you look at the Moa JV you can see a range of $400 million to $1 billion have been put on that particular business and this is one of our long term stable business operations that we have. So it all depends on outlook on commodity price, outlook on the operations and those kind of factors. Also we look at sum of the parts and if you look at NAV calculation that we’ve shown you there, it’s very clear to us that the market is not fully valuing all of our businesses as a whole.
And I think it’s in that context that I’m going to turn this over to David to talk about how we look at moving this company forward.
Okay. So strategy and corporate strategy came as one of the big themes in the Investor Day survey that we did and a few were looking for more insight and direction on that. So I’ve got a couple of slides here but really I’d like to take few minutes and talk to you again about what our strategy has been and where I think that puts us today and where I see us going from here.
Sherritt embarked on the Ambatovy project over six years ago now. It was in June 2007 that Sherritt acquired Dynatec and we’ve been through the process of building and ramping up Ambatovy since that time. Everybody here is well familiar with the history of that project. It’s obviously taken longer and cost more than was anticipated at the time. It’s far and away the biggest project Sherritt’s undertaken in its history and it’s been unquestionably Sherritt’s focus for the last five-six years.
Today though the projects built and you heard it's ramping up. Ramp ups have their challenges but we’re showing solid progress up there and we’re gaining confidence in our ability to get to the full capacity volume of that project every day.
And so I think the question that is becoming more and more prevalent in the market's mind now is as you look at Sherritt and you see the project coming up and you say what does that mean for Sherritt and where is Sherritt going from here? We have four solid and separate state business lines and you’re going to hear more about those later this morning with our metals, our nickel and cobalt business, our oil and gas business primarily in Cuba, our Western Canadian Coal business and the various elements of that, and then the smaller power business in Cuba, all really quite distinct, all have their own attributes that I think make them quite desirable portfolio and collection of assets. But admittedly there is a somewhat eclectic collection of assets that don’t necessarily have a common theme that runs through and I think there are questions out right now which as we put Ambatovy behind us and see Ambatovy ramping to full capacity, where does Sherritt go from here?
To really decide that, you need to look at Sherritt and we have looked at ourselves as hey, what are our core strengths? What make Sherritt or differentiate Sherritt from others in the market, what makes us the logical owner of assets but gives us some better claim to be an operator in asset than something else or somebody else.
I think there is three or four things that really differentiate Sherritt. One is our technology and our expertise in the high pressure acid leach technology for the leaching processes that were developed by Sherritt going back 30, 40, 50 years. They have been actively engaged in Moa for over 20. The Moa facility was originally built in the 60s using Sherritt technology. There is 35 or 40 different facilities around the world using Sherritt technology and processes to process ores into finished metal. That I think is a fundamental strength of Sherritt that truly differentiates Sherritt from many other processor miner in the world.
And we also have unique ability to operate successfully in Cuba that helps us in our metals business but it also makes our oil and gas business quite a unique proposition. Our oil and gas business is overlooked. People are surprised I think when they realize that actually oil and gas business has been the largest contributor of cash flow in this company for the last three four years.
We have a big oil and gas business, 20,000 barrels a day but we have some unique expertise in on-shore drilling, horizontally under the seabed to extract oil. We have all the infrastructure we need in Cuba to be a completely self-sufficient operator there. We've been able to operate that business for close to 20 years. It produces fantastic margins for us on a consistent basis and I think we have the ability to continue that.
So that, I can see that, even if it is not core to us in terms of what our core expertise is, while we have this unique ability to take oil out of ground in Cuba in $12 to $14 a barrel and sell it for $70 to $75 a barrel, that's a business that we would happily be in forever.
A couple other things that I think give us an opportunities is that I think we are very competitive operator, very successful operator in variety of different jurisdictions, a variety of different industries, where we’ve shown our capacity to operator safely and efficiently in different environments, different industries and I think that is a core strength of Sherritt, that has the ability to create value in the future.
Lastly, we conduct almost all of our business across all the different business units for partners. I think we have demonstrated ourselves to be a successful partner. We partner with governments, we partner with industry players, we partner with capital providers. We have a history of doing that successfully to bring it in and I think that gives us the capacity to potentially do new things with partners as sources of financing or sources of expertise and be able to continue to grow the business.
So based on those strengths, where do we see Sherritt’s future? We like base metals. We like nickel. We think we have unique expertise there. We think that expertise is potentially applicable to other base metals and we like that long term story.
Base metals, everybody in the room is familiar is with where the base metal is today. Those challenges could persist for some time yet but we fundamentally believe that the medium to long term story for nickel and other metals is fundamentally strong. Martin will speak to you a little bit later this morning. He's going to give you some views on the nickel market specifically but we like that place and we think we have something unique to offer to that space.
Our oil expertise, as I say in Cuba, our unique ability to operate successfully in Cuba I think creates a future for the oil and gas business and that could be a place we can be long term as well. What that means though I think is we're talking about what we are going to do and perhaps particularly in this environment it is important to talk about what we are not going to do and that’s when some of these slides start to come in.
We have opportunities I think to extend the life of oil and gas business and we'll hear more about that later this morning from Elvin. We have opportunities to optimize and take on projects in our existing Moa joint venture in Cuba to get our cost down there, picking up on some other things that were underway when we had an extension that was suspended in 2008, probably beginning with a recommencing the construction of an acid plant that has the potential to reduce our costs on the net direct cash cost basis and oil by 20 odd percent. Martin will be able to tell you more about that later today.
What doesn’t make sense for us this time is taking on Greenfield new expansion projects. Be aware that we have a new venture in Sulawesi in Indonesia, where we are partners there with Rio Tinto and we’re currently working under an earn-in agreement. We've been doing some preliminary drillings and preliminary feasibility study work. The reality is in this commodity price environment, in this market, we don’t see that as the greatest way of creating value at this time. We will be continuing that to the point out the minimum investment it takes the maintaining an option on that ore bed because we continue to believe it is a spectacular oil body that could one day support a world-class large scale nickel and cobalt facility but for the foreseeable few [ph] we did have more elaborate plans into 2014 for more drilling and that would be scaled back to the minimum amount it takes to sustain the option on the asset.
Today, we see the greatest value to be able to drive, continue to ramp up the Ambatovy project to full capacity. That is going to take more investment over the course of next year, particularly as we're now into debt repayment and while the cash facility is not generating sufficient cash revenue to service the debt requirements under 2.1 billion financing, we will have ongoing cash investment into that to get that facility up to full production, but given the recognition that that asset is receiving so far in the market, that asset still has the potential to be in view, we still see that as by far the greatest way of us creating value.
Beyond that what we will be disciplined and focusing on individual projects that are already underway and are achievable and are within our real [indiscernible] that we can optimize and be focused on extending the life of the oil business and driving down our costs in our Moa joint venture where we already have a 25 year reserve life to make the -- continue to be the world-class facility that it has been for us.
When we look out beyond that, when we look at expertise and you look at the state of the world today, I think there are other opportunities to buy assets for less than you can build them. I've spoken about this to some of you in the past and then briefly about this at our annual general meeting in May. Part of the reason that Greenfield projects don’t make at this point in time as you can buy assets, solid world-class assets that are cash flowing today for less than it costs to build them and when you do that, you don’t have to put yourself through the angst and the stress of the construction and ramp up risk that we've all endured in Madagascar for the last few years.
There are opportunities to do that. I think our ability to partner provides opportunities to raise capital for that. I think there is investor appetite over there for the right opportunities that would give us the ability to raise capital and procure partners to do that if we can find the right opportunity.
For us to make any significant equity investment ourselves, it would obviously have to come from cash investments that we would realize from the proceeds, the percentage of sales of some non-core assets which we would entertain in the right circumstances but I think there is partnership [indiscernible] if you do those sorts of things. I think there are assets out there that are desirable. I think what you hear from some of the major companies in terms of them singing songs of focusing on their core business, focusing on their capital, focusing on their balance sheets, you are going to see further assets sales there and I think there are opportunities to buy solid assets at prices that will look quite clever at some point down the road later this decade.
To do that, requires us to have the capital to do it. As I said that could come from sales of non-core assets or it come from partners or some combination of the two. For us to find an asset attractive, obviously we would entertain nickel. I like the idea of more nickel but I wouldn’t shy away from other assets if could find the right kind of asset and more focused on two or three other criteria than I am on what the actual end product is.
For an asset to be attractive to us today, it has to have a long reserve life, it would have to be at the right end of the cost curve, such that you could [indiscernible] operate the asset through the troughs and make a bit of money or not lose your shirt and be well positioned to capitalize when you cash the tarp a couple of cycles further on to the life of the asset and today for us it would have to be cash flowing today. The ideal scenario would be an asset that has potential to be expanded over the time but we would be looking for any asset that would be attractive to us today, would be cash flow and operating today.
All of that of course is conditioned on maintaining our liquidity. That being said, that's always been fundamental to us. We have taken great pride in maintaining the strength of our balance sheet. The only way you survive in this business is making sure that you have got the depth and strength in your balance sheet to see you through the deepest of troughs. We have demands on our balance sheet today to see Ambatovy follow through production.
We have a strong liquidity position, a strong cash position today but we are uncertain as to what the world will hold in the next 12 or 18 months and as been said, they are going to be demands on our balance sheet. So we do have number of specific capital priorities that are both within our existing businesses that we think can make our good business better. We think we have opportunities to better focus our portfolio of assets that we have on where our core strengths are and we have opportunities to expand in areas where we think we have the greatest expertise and we think these market circumstances create opportunities to do that.
All of that though is subject ultimately to us maintain the strength and the liquidity in our balance sheet to know that we can get through the deepest of troughs and know that we can bring back Ambatovy up to full production because that is still unquestionably the way we can create the greatest value in the company.
I think that largely covers what I wanted to talk about on the two slides. I do just want to talk for a couple of moments about a couple of mix that seem to be come through some of the feedback we and then we will open it up to take any of your questions you have on anything you have heard so far this morning before taking a break.
The greatest mix of course come up about with respective to our long history in Cuba. There was always a lot of noise around Cuba because of the Embargo and the Helms–Burton Act and there has always been a perception of risk in Cuba that people don’t have to quantify, they don’t know who can invest in Cuba and you can’t. It is a bit of a murky area because lawyers will never give you straight answers on any kinds of questions that people want to ask. But the reality is that Cuba has been probably the most stable jurisdiction that we have ever invested in.
There is a perception that we don’t have any U.S. shareholders and we don’t actively market in U.S. but the reality is that about quarter of our institutional investment base is U.S. based and we do have a series of the U.S. investors that we speak to on a regular basis. That's something been on stock for quite a long of time. So the fact that it is accessible to U.S. investors is something that I don’t think is not really properly appreciated by the market.
I think there is also still a perception there that Cuba is really all there is to Sherritt and going to 15 - 18 years ago, when Sherritt International was first traded in its present and a corporate form that was really the focus. Sherritt was going to be a Cuba company and other elements of Sherritt's business at the time were spread out into different entities and this entity was created to be all things Cuban and those of you who have known for a long time will have seen that we have been in and out of different business in Cuba, the oil business, the power business. We also took as time into things as diverse in Cuba as hotels and soybeans and cell phones. That is now largely cleaned up. We do have two businesses there are long historically solid business for us in metals in Cuba but we are not CP of the Cuba as it was once expressed 10 to 15 years ago and have no aspirations of being of the CP of Cuba.
When you look at the breakdown there of where our revenue where our assets come from, Cuba's unquestionably a significant piece of our business and will continue to be a significant piece of our business because we see lot of long term opportunity to operate there successfully. But the fact is we are not all about Cuba. A large majority of our revenues and our assets now are located and derived from outside of Cuba.
I'm happy to take any questions now on Cuba specifically and any other questions concerns quite a few have or anything that we've covered so far. We talked about Madagascar and where we are there and we tried to give you an overview of the structure of the balance sheet and then how we see the balance sheet and some insight as to where we are moving to in a challenging and changing world. So we thought we'd do now is another feedback that we've had was lots of opportunity for questions and so we'll take some questions now before we take a break and then get more into the specifics of businesses.
Is Sherritt an asset that is trading below a replacement value and should be part of the corporate strategy or given that you know the asset better than anybody else, does it make sense for, instead of buying a long life asset, does it makes sense to buyback your own stock given its trading so much below replacement value.
I think there is value that's not being recognized in the stock and that's obviously a thesis that the people had for some time. I think there's a few things that are behind that. One is I think, and I think the biggest single factor is that there isn't yet sufficient market confidence in Ambatovy for people to recognize the strength and value that that asset has and will have over the next 25 or 30 years. People waited to see first nickel out of the asset and we’re able to show nickel and people kind of shrugged and said we're going to wait to see more progress in the ramp up in a difficult base and the world people remain skeptical and I can understand that. The only way we overcome that is to continue to the ramp up and demonstrate that this project will be all that we've been telling the world it's going to be for the last few years now.
I think there's also a discount on the stock as a result of our involvement in Cuba and that I think is dissipating as people get more comfortable with Cuba and Cuba becomes less of a lightning rod in kind of a geopolitical sense. I think also as people come to realize while a significant part of our business, it's not all of our business that Cuba discounts, such as it exists, should continue to dissipate. I think it's fair to say also that there's a discount on the stock as a result of call it a conglomerate discount, as it's been billed in the past because of the different nature of our businesses, I foresaw the different business lines that as I say are somewhat eclectic and don't have the common thread running between them.
I think that I where there's opportunity for us to create some value to better demonstrate the value in those assets, better focus Sherritt on the assets where we have our greatest strengths and as we continue to work down that path, I think that would help dissipate the discount as well. Share buybacks does come up every so often. I'm not philosophically opposed to share buybacks. We have recognized the interest in shareholders and they're seeing some element of capital return to shareholders. We've historically done that in the form of a dividend and that the general feedback we get from shareholders is that the dividend is appreciated, particularly in difficult times, commodity times when people are waiting to see more value demonstrated in the stock that people believe is intrinsically there. So at this point in time we'll continue with the dividend.
In the future what do we look at share buy backs, there could be times when that makes sense. At the moment that is not a priority for us. We're really focused on making sure we have the strength and the depth and the balance sheet with the liquidity and at this time I don't see us embarking on a significant share buyback plan at the risk of compromising our liquidity and give us some of the other priorities that we have.
In your capital allocation strategy you had all the priorities for capital allocation and share buybacks, weren't in that category and it just strikes me as…
I think we have a few priorities and in terms of that I think we need to accomplish from a capital perspective and it's a challenging new market right now to ensure you've got the capital to achieve what you need to accomplish. Ultimately we would look at when capital's available to return it to shareholders and that can be done to my mind by way of a dividend or by way of share back or both and as we get Ambatovy up to cash flow positive, and start to see the revenue out of that project we see that that's the time when our capital priorities are more behind us that we could see the possibility of returning potentially a larger portion of capital to shareholders in some forms if it makes sense at that time and at that time we would have the debate at the board level, whether that made sense in the form of a dividend or the share buyback or some combination of the two but and the medium term I don't anticipate us embarking on a significant share buyback program.
Dave, not one word about coal in your whole discussion there. Do you classify it as a non-core business and I mean the Western Canadian utility business I guess?
Yes. Our coal business is, I hadn't spoken too much about coal and we will hear from Sean this afternoon. There are a lot of strengths in our coal business that I think get overlooked in the crowded picture of what Sherritt is overall and we have a $50 million - 55 million a year royalty portfolio, a solid cash flowing business utility like a major producing coal for a western based power utilities for electricity generation and a small export business that produces 3-4 million tons a year coal for the export market.
That's been a business that we've been in. We were partnered and ultimately bought back a 100% of that business in a couple of transactions a few years ago and it's been a solid business for us. I think when you look at our core strength, though; it's not a business that we bring anything unique to. It’s a cash flow positive and it's is a business that we like. I think it's a solid business, but it is not a business that I think we can add a lot to you compared to the opportunities we have in other areas where we have more unique expertise.
Everybody jumping up and down expecting you to just spin it out, sell it, philosophically that’s where you're headed though?
That is certainly a possibility. If I had anything to announce today, you would be the first to know but we’re not announcing anything today.
And just then switch to Mark. Anything that’s going on at Ambatovy that’s a surprise to you? Are there any particular challenges that you’re facing right now that's sought to up and down? Where are on the [indiscernible] up or down?
Thanks for the question. With respect to surprises, we’ve had both positive and some negative surprises. Let’s start with positive surprise. The auto claims [ph] , the leach auto-claim [ph] and stability of those auto claims [ph] when they’re running, it has surprised as how stable they are, how well they operate, how well the metallurgical process is working, and also the amount of metal crews in the auto-claim [ph] is significantly less than we would have anticipated. So we’re very optimistic that in the long run, the overall availability of those auto-claims [ph] is going to be higher than we would have thought initially and therefore giving us an overall capability of achieving nameplate capacity or grater given throughput capability with longer on-stream time of those auto claims [ph]. So that’s been I think a positive surprise.
Another point, I'm not going to see as surprise but we’re pleased with how well the metallurgy works. The process metallurgy works very well. We’re seeing fantastic separation in nickel and cobalt in the refinery and we’re really making some nice metal products. So those are the good things.
Surprise on the downside is actually the mechanical availability, which is what is giving us a little jagged in sawtooth I think whenever we get a downside and that is a surprise because these are unplanned maintenance activities that mainly take on a basis on failure that we’ve seen in mechanical integrity of the equipment. So that I think each of those downturns in the site, even though you’d expect some jagged part of it, those have been sort of continued surprises on some materials of construction and some of the equipment. It’s hard to give one specific. We’ve got numerous small but numerous mechanical issues that are being dealt with in the normal course of the ramp up.
Ambatovy, what do you estimate the fixed cost at right now in terms of $1 million a year at Ambatovy?
So our overall cost base with Ambatovy again, given where we are in the ramp of curve, give that range in $9 to $11. Fixed cost component of that at this point is over half of that.
Okay and when you’ve mentioned cash flow neutrality maybe by 2015 is that at spot nickel or is that with Sherritt’s forecast nickel price?
That is giving current commodity price outlook we expect sometime in 2015. Pretty much assuming spot through 2013 and 2014
Sure and then maybe last one on the debt. The talk on the partner loan payback, I believe additional partner loans are higher interest. So is the priority paying off the per set of partner loans because they actually have a due date or you target the higher interest rates?
Well actually it is specific. So when I talked about, let’s say $70 out of $100 going to pay our partner loans, $45 would go to pay the additional partner loans and $25 would go to pay the partners.
Mark back you maybe, just want to ask bit of that mechanical availability and you’ve mentioned I think it is important is the mechanical integrity of some equipment that we’ve seen from previous start offs on later rates [ph] is heavy wear on certain piece of equipment and that became very problematic for availability. What are you seeing there and is that something that is solvable by changing the composition of a piece of equipment?
So mechanical availability, all of it solvable and we’re very confident we consolidate. One overarching area is materials of constructions selection in the pilot process. We’ve got some rubber lining that has failed on occasion that we need to repair. All of that is solvable. We have worked through a number of workarounds in areas where we've put in redundant pipelines that are -- for example a redundant pipeline that’s an alloy material that allows you to jump over to that, keep running, repair the rubber and then get back to the rubber lines. So we’re doing a number of things like. And then overtime with sustaining capital program, we will replace the rubber lining, that doesn’t make sense for us. That's just an example but a number of examples of that throughout the entire facility, as you learning you make the appropriate engineering changes, but nothing that we’re seeing right now is something that is an absolute loss for project. Everything is solvable and we’re very confident we will get nameplate capacity in this facility.
Maybe just a question for David. On the acquisition criteria you’ve talked about long ways low on cost for et cetera. Those are attributes that everybody wants and certainly there is fierce competition for those types of assets. You didn’t mention jurisdiction. So maybe you could talk a bit about how you intend to compete those assets and also what jurisdictions you would like and not like?
Sure. Every resource company wants long life low cost assets. The opportunity that exists uniquely though at this point in the cycle is assets that have to come on market when people are rationalizing their portfolios. The competition for those types of assets when commodity prices were strong, it scares them as we see people paying, vastly overpaying for assets in ways that ultimately comes back to haunt them. I think the opportunity just now is that when competition is in step of those assets because companies that aren’t well funded are companies that are retreating in retrenching rather than looking to expand through acquisition. You can better compete for those assets than you can at other points of the cycle.
Jurisdictions, we would look at any jurisdiction, the balance of the risk of that jurisdiction against what we saw as the potential strength of the opportunity. I would think there is benefit to us in having another significant investment in another jurisdiction outside of Cuba and Madagascar, just given the political risk that is perceived in the market in those jurisdictions. I think we can manage political risk by spreading it around as well as all the activities that we undertake on the ground in Madagascar and Cuba to manage community relations and all those sorts of things that I think we've doing quite a good job on.
But yet the political risk is obviously a factor that the reality is some resources are what they are and we will go to where we think we can find an asset that we think we can operate successfully over the longer term. Political climate environment would be one significant factor in that kind of analysis.
A couple of more questions for Mark if I may. First the quality of the nickel and cobalt being sold at this point, are you getting LME grades or what sort of discount are you getting to even the market, see for a reference point?
The quality of the metal is, the metal itself is very nice metal but at this point we are not consistently producing LME specification grade for nickel. We are off on one component and that is a silicon component. It needs to be less than 0.0058%. So we are still slightly above that and we continue to process as we continue to look at that. That has not been a significant problem to help for us to move into nickel into the market. The market, we are able to sell the nickel very successfully, no problem with selling it. But it is not at that LME spec yet and we continue to work towards that but we're actually very encouraged because we're just off spec on that one element on a consistent basis and so we are confident we will get a metallurgical solution to that. And then we are feeling good about all the other components of the nickel.
In order of magnitude what sort of discount does that draw?
It’s in the order of between $400 and $700 a ton.
Okay. Also you referred to cash neutrality on Ambatovy. Are you referring to cash neutrality on an operating basis, if you were to sustain CapEx of your SG&A or including that service? Can you actually define that term for us?
Full cash flow challenges at the point where the partners are no longer sending checks to Madagascar to fund whatever needs to be funded. So that would include every possible expense of the Ambatovy project right up to debt service. It's the debt service actually that’s dragging out the timelines for cash neutrality there more than anything because we are into we making principle and interest repayments on that senior project financing and there is something like $190 million of the principle repayments in 2014. So when we talk about cash neutrality it means covering those into the point where the project can fully sustain itself.
And last question, you were referring to the potential sensitivity of the operating cost to supplies. Can you give us a little feedback on what sort of order or what sort of terms of contracts you have for things like coal and sulfur or what sort of stockpiles would be in place so that we can sense how quickly a price change in the market might result in an operating cost change Ambatovy?
There will be no long term exposure to any of those. There would be more or less at spot prices you might see sort of three and six month changes. I think if you look at the history in the Moa joint venture, you will see pretty similar history of our processes and that going forward at Madagascar. So we won’t be taking any long term positions on any of the input commodities would be more or less at market on that subject to timing lags and shipments and that sort of thing.
Just to pick up what the other gentlemen was asking about your, the discount. What is your commercial strategy for the nickel and cobalt? Assuming it’s on the deliverable, are you signing contracts at LME plus premiums for future production or would you not sign contracts and just deliver it to the LME if you could achieve an LME, at least an LME in price?
It will obviously get marketed similar to the way that we market metal out of at the Moa joint venture now. One of the arrangements amongst our partners at Ambatovy, which is part and parcel of the financing business, the 2.1 million billing of our financing was put in place is that there are commitments to provide 60,000 tons a year of off-take of nickel between consumer total and co-rises, that gave the lenders fundamental comfort that there would a market for the nickel at LME prices. The partners and us market some of the nickel ourselves. They take some of it themselves and use it for purposes of co-rises in the project to procure nickel for the freeing economy. So nickel will be sold at LME subject to whatever premiums and discounts are applicable that baked into the replacements and those sorts of things similar to realization rates as you can see in our Moa joint venture once we’re at full capacity and producing LME grade nickel.
I don’t anticipate we’ll be putting a lot of nickel on the LME itself. If we’ve ever put on LME nickel and deliver nickel to an LME warehouse out of our Moa joint venture, it was many years ago. So we are not anticipating any problem placing product at market and also we have the commitment of our partners to take them.
Your cobalt moving spec, LEM spec?
Close but not [indiscernible] there are on spec
That’s one component of the cobalt is also very, very pleased with cobalt where it's at as well.
So we achieving like 993 gas prices?
Thank you. David, in your chart showing revenue, based on customer locations 24% in Cuba, the way you’ve done the accounting, is any of that 24% in Cuba attributable to Moa revenues?
That is a good question, is that -- so that’s an oil and gas revenue line, so you’re right?
And follow up question was you suggested selling coal is definitely a possibility. How about spinning off nickel division as a separate company?
I guess any plan or direction is always subject to -- and there is not an asset that we have that’s not for sale at a certain price. If somebody comes along and wants if bad enough, and we thought it made sense and delivered more value than we thought we could create there over the long time, we would look at that. But I am not expecting a buyer to come crashing through the door with a big check for the nickel business.
Just following up on that comment about value, looking at the range of valuations to the four analysts that you have in the presentation pack, are there any of those valuation ranges that you take issue with? Are there any of your assets that you think are worth even more or less than those analyst ranges?
I certainly think Ambatovy is worth more than its being attributed to today. I think there is still significant discount being put under Ambatovy to be conservative in estimates in terms of what we’re going to achieve there and I think people are taking pretty conservative views on long term nickel prices that brings down the value of Ambatovy.
Our oil business I don’t think it’s the kind of multiple that an oil business outside of Cuba would get despite the fact we get the cash flow out of that business, that any other oil business would produce. So yes I think there is value in those businesses. But what it is depends on what you, again as Dean said is driven largely by your long term assumptions on nickel prices, but I think we do suffer discounts and the drove value [ph] attributable assets because of their stage of development or their geographic locations that are in excess of what it certainly warranted.
May be just one other on oil and gas. On a capital sustained world, would you be spending a lot more on Cuba in oil and gas?
Can I ask you to wait on that because Elvin is going to speak this afternoon about what we see and some of the potential there and what some of the potential and capital would be if we can achieve some of the things we’d like to do in Cuba and oil and gas. So if you just still got that question in an hour come and ask me again.
All right, well, why don’t we take a little break now then, give everybody a chance to get a coffee and stretch their legs and we’ll come back in say 10 minutes to 15 minutes. So say we'd be back about 25 after 10 then we’ll head into our second phase and introduce you to some of our business leaders.
All right, why don’t we get going here again? As Paula mentioned at the outset, a couple of other themes that came through the survey was that you wanted an operations overview and so exposure to the people that run our business units and you wanted a bit of analysis and insight to some of them with a more complicated bits of the accounting of some of our businesses.
So to try and address those concerns, we’ve changed the phases at the front. The second phase here. I am going to introduce first Martin Vydra who is our Senior Vice President of Metals. He is based in Fort Saskatchewan and he runs our Moa joint venture. So he is going to talk a little bit about the Moa joint venture and give you a bit of insight into how we are looking at the nickel market today.
Thanks David. Good morning, everybody. So I’m just going to give you guys a little bit of overview of our metals operation in Fort Saskatchewan. We have a mine in a Moa. We ship the mix all the way up to For Saskatchewan where we refine it. Within a stable operations is the formation of joint venture in 1996 and the Moa mine is been operating since 1959.
So we are, as David said, a very stable operation, generating good cash. Our focus over the next 12 and 18 months in this nickel environment is how are we going to protect our margin and how are we going to improve our productivity? Through the life of the joint venture we’ve been very profitable and our costs have always been underneath the price. Some of things that we’re doing to improve our margins as you will see is we are going to be looking at bringing online another asset plant at the Moa joint venture. We continue to explore that opportunity with our Cuban partner and as the economic benefits of that become more evident, it shows us that that is one way to improve our margin.
The risks that we have at our operation to achieving our goals are very limited. Really be biggest risk that we are facing right now is the ability to secure good labor both in Alberta and in Cuba. Alberta has become one of the hottest hot beds of labor in the country and the Fort Saskatchewan site is one of the most industrialized areas in Canada. So, for us in order to secure labor has been quite a bit of challenge.
Opportunities within our businesses as I said is the completion of our asset plant. At Moa we believe this will reduce our NDCC by approximately 20% and I will show you a slide showing our NDCC makeup. The other thing is as we continually evaluate the completion of our assets that were partially constructed as one of our expansion, this will allow us to bring on different grades of ore bodies that are located in the area and it will also allow us to treat these ore bodies economically thereby reducing our cost.
So, what you see here is our C1 cost structure for the last four years at the Moa joint venture. Now, C1 cost is, the NDCC is our Net Direct Cash Cost, dollars per pound of nickels produced. So, C1 cash cost is a trademark named coined to help evaluate the production cost of various nickel producers but when we make our comparisons we know that not all C1 costs are comparable because there is no set criteria on what you have to report.
You are supposed to report basically what it costs you to bring the nickel to market. When we make our adjustments accordingly and look across the market, we are consistently in the lowest 40% of producers, nickel producers, primary nickel producers when it comes to cash cost. Currently, we believe that 50% of primary nickel producers in the world are under water or cash neutral when it comes to looking at your C1 cost versus the nickel price.
A third asset class at Moa which you will see will reduce our C1 cost, what we believe is 20%. And if you look here, this portion here represents sulfur and this portion represents sulfuric acid. At Moa and at Ambatovy, we use sulfuric acid in our HPAL process to dissolve the metals and bring them as a solution.
When Moa was originally constructed, two acid plants were sufficient to meet capacity. We’ve been able through efficiencies to increase Moa’s capacity to as of yesterday 38,000 tons per year. We do not have enough asset plant capacity. So we are forced to purchase less economic sulfuric acid.
Once we are able to come to some sort of agreement and complete another asset plant of Moa, we will be able to eliminate this section of the graph, which is sulfuric acid and we will also be able to erode some of our fuel costs, because a byproduct of sulfuric acid production is you generate steam and energy. So you reduce your fuel consumption. And market Ambatovy has the benefit is that he’s not purchasing any acid; he is generating all of his acid through sulfur purchases.
So on the capital profile we have at the Moa joint venture is, it has been very stable. We typically are spending about $9 million a quarter in sustaining capital. You will see that in Q4 usually there is ramp up and that’s typically cycled with maintenance activities beginning in the first half of the year. Capital spending and payment for capital usually takes place in the fourth quarter. With an improvement in commodity prices we would expect to see our capital increase about $10 million to $15 million a year on sustaining activities but however in a lower price environment we have been taking a very hard look at all of our capital, scrutinizing what is required, what can be deferred and making sure that remain cash positive under all price environments.
As I said earlier, the acid plant is probably the most compelling capital project that we have that we are exploring. We project that it would take between 18 and 20 months to complete after we have received all approvals and agreements on funding and estimated capital cost on 100% basis right now is about $65 million to $75 million.
So I’m going to take a little bit of time to talk about the nickel market. There were some questions earlier about nickel market and I’d like to talk to you about primary nickel and secondary nickel or Class I and Class II nickel. Sherritt, through both of its joint ventures Moa and Ambatovy is a Class I nickel producer and it is an LME deliverable nickel producer. Not many nickel producers are LME deliverable and Ambatovy actually is the only projects since Merin-Merin [ph] that is providing LME deliverable material.
So, we are always able to place our material on the LME and achieve the highest pricing available in the market. Class I nickel receives LME pricing. Class II nickel which is you ferro-nickel or nickel oxide or nickel sinter or NPI will never achieve LME pricing. It will always be at discount. Under the current market conditions where you hear that there is an excess supply, there are some producers out there that are taking deep discounts in order to be able to place their material and LME producers such as Sherritt never has that issue. We are always able to place the material on the LME.
As Dave said, we are not in a position where we have to place our material on the LME. The product produced by the Moa JV and of course we being approached by Ambatovy is such high purity, customers are actually quite demanding it. We are sold out. Every year we have no trouble selling our nickel and cobalt production. Cash flow is guarantee for us.
Just to give you an idea of the uses of nickel, class I nickel can be used anywhere. The biggest consumer of nickel is stainless steel. Nickel pig iron, ferro-nickel, Class II nickel can be used in that. However outside of stainless steel, class I nickel is the only one that can be used in the super alloys and special chemicals, things like that. So if you are only making Class II nickel, you are very limited. You have got access to about 66% to 70% of the market. If you are making Class I nickel you have got access to a 100% of the market at the top price. So that’s where Sherritt’s focus is as we make Class I nickel and we have access to all other markets out there.
Just to give you a little bit on the global nickel market, currently global nickel consumption is about 1.8 million tonnes of nickel. Global production, refined nickel is about 1.85 million tonnes. So there is slight oversupply currently in the market and that’s seems to be effecting the short term pricing. If you look at it, that 0.5, that represents a very small proportion of supply-demand balance and if I was asked I would say well nickel supply-demand situation is actually running right on the line. You are on either side of the supply-demand balance. The swing capacity seems to be coming from the up crop of nickel pig iron in China. Nickel pig iron is generally, its low grade ferro-nickel. That’s all it is. It started out as a replacement for stainless steel scrap, technology improvements, improve that product and now it's really a low grade ferro-nickel and it’s classed as a Class II nickel product.
There is an upper amount, upper limit to the substitution or the use of the Class II nickel in stainless steel and other products because ultimately when you are using a ferro-nickel or a Class II nickel in the production of stainless steel or high purity products, you will be getting impurities. So you will need Class I nickel. We feel that the current supply-demand balance, eventually at one point in time somewhere down in the road there is going to be a shortage of Class I nickel and Ambatovy-Sherritt, we are going to be well positioned to take advantage of that because as I said there are no new projects that have come on line in the last 10 years aside from Ambatovy that are producing Class I nickel and I don’t believe if you look at any other literature, there are any Class I projects there are in the pipeline currently.
If you look at the LME stocks that sit about 200,000 tonnes, that is a very small amount compared to the global demand of 1.8 million tonnes a year. So that, if there was shortage of class I nickel or demand for class I nickel increased, I think you would see those stocks come down drastically over time.
Finally, just a little bit about nickel pig iron, because I know everybody is always talking about Nickel Pig Iron. That’s next best thing in nickel. As I said, nickel pig iron really is just another form of ferro-nickel and over the time has evolved to a higher grade of ferro-nickel. Most, if not all nickel pig iron is produced in China and approximately the numbers are unknown to the industry but really right now everybody believes that there is about 400,000 tonnes of nickel units coming out of China in nickel pig iron.
One of the downsides of ferro-nickel and nickel pig iron is that it’s quite energy intensive. If you look at the production of nickel from various feed sources, ferro-nickel and nickel pig iron is one of the highest energy consumers to make pound of nickel from it. Over time, they have reduced their energy consumption from about 19 gigajoules per ton of nickel to now 10, the most efficient Rotary Kiln - Electric Furnace, they use about 10 gigajoules per ton of nickel.
If you like to add it in comparison, nickel from an HPAL process such as the Moa joint venture of Ambatovy, we're between 5 to 8 gigajoules per ton range and then sulfide nickel such as the Sudbury basin and [indiscernible] operation because they have sulfur bearing a 4 or less gigajoule per ton basis. So if you look at that, that tells you about the cost structure of ferro-nickel, nickel pig iron that needs to come down in order to be competitive in this price environment. That’s all I have.
So, next I would like to introduce Elvin Saruk. Elvin is a long-term Sherritt employee. Over the years Elvin has built power plants and developed oil and gas businesses in Cuba. He also spent a couple of years in Madagascar during the construction phase overseeing construction. He came back from Madagascar in early 2012 I believe and went back into running oil and gas businesses. Elvin is going to come down and give you a sense of what we are doing in Cuba in oil and gas.
Thank you, David. Good morning to everyone and greetings from Cuba since I spend most of my time in Cuba. So this morning, I take a bit of time to give you an oversight of our business in Cuba and the opportunities we have in our business there.
So currently we operate two PSCs, Production Sharing Contracts and they are called Varadero West and Yumuri PE and they are shown in page five in our annex. I will be referring for these by name. So I thought I'd introduce them at the outset.
Exciting times for our business right now. We have robust pricing. We also have good cash flow and we are in the final stages of negotiating two additional business opportunities with our partners in Cuba. The first business opportunity will be to have an extension to our PE Yumuri contract and the second opportunity is to, we're in the final negotiations for four explorations blocks in Cuba. One of those blocks is adjacent to our existing production [indiscernible] two are just on the West side of Havana, and one is in the central part of Cuba.
As David said, I've been involved in the business for quite some time and I was, Mike you and I were the first ones on the ground 20 years ago when Sherritt started to own gas business in Cuba, so in the past 20 years Sherritt has developed and implemented a strategy, a strategy which has resulted in the growth of a successful oil and gas business, and I'd like to just outline a few of those key components of why this strategy has been successful. Firstly we are an integrated own gas company in Cuba, we have, we own and operate two drilling rigs we have all our own equipment to service the wells, we do our own pipeline facility construction and all our own maintenance, secondly is, we have developed highly skilled and experienced technical personnel which have become experts on the geological complexities of Cuba and Cuba is indeed a very complex geological region.
Our people continuously model the reservoirs and as we drill wells each well is incorporated into the model and the most current production is incorporated into the model and that model does change regularly and frequently, and we are thankful for the sophisticated technology we use because it has given us a lot of insight into the oil and gas business in Cuba over the last number of years which I'll show you on the next graph. We have developed and we continue to nurture a relationship with our partner the National Oil Company that benefits both parties, we have a highly skilled and qualified operating staff in Cuba that we have developed over the last 20 years.
And lastly is it we have developed and trained local people to take on key supervisory positions in the past few years. Our gross working interest in Cuba is in the order of 20,000 barrels and has been at that level for some time, our net production which is also shown in the slide has been quite stable at about 11,000 barrels. The convergent from gross to net is a fairly complex formula but there are two components to it, one is that all the money we get invested we get returned to us through oil and then what is remaining from the gross amount that's not utilized to recover our costs is shared between us and our partner and it's provided in more detail in Nancy's presentation.
But what's intriguing about Cuba, its thrust and fold complex geological setting, this is a highly fractured reservoir, it contains heavy oil, our API gravity is just in double digits, 10,11, 12. Just to give you a sense Alberta tar sands is about 8, 7, 8, so we're not far different from quality and these type of reservoirs whether in Cuba or anywhere else in the world have a natural reservoir decline of anywhere from 15-25%. With our drilling success and recompletion of existing wells that we have already drilled, we have been successful over the last few years to arrest that decline to show that we are relatively flat in production, and you'll see that right there on this curve here and we did have an anomaly as is noted on point number three that we had to relinquish in a non-operated walk in 2009, so taking that away we actually have had stable production for the past ten years.
So the important measuring element in your own gas business is RLI, reserve life index, and everybody would like to see that number as high as possible, as you can see from our graph our reserved life index is in the magnitude of 2-5, averaging 3. So why is the reserve life index as low as it is, the reserve life index is virtually a replacement of production, so it's reserves over production, so anything you produce you have to replace to maintain your reserve life index so by us maintaining flat, reserve life index indicates that the capital we invested on an annual basis is sufficient to maintain our reserve base year after year. This capital is in the order of $50-60 million and it’s utilized to operate one rig, it's utilized for money to be spent on wells to be recompleted for additional production, any pipelines that are required with the new additional wells and financing any upgrading to maintain our production facilities at an optimal level.
Unidentified Company Representative
I’d like to speak about operating costs now, so our operating costs are fairly stable and mostly effect because we’re an integrated oil and gas company in Cuba. You see the classifications of the various categories on this graph but as importantly you’ll notice that there was increase in operating cost from 2010 to 2011 and that’s strictly due to reclassification that increased our costs from $8 to $12, but in reality their costs were stable throughout those years that with just a matter of reclassifying them to reflect a higher unit operating cost. What are the risks of the operating cost as David had mentioned we’ve operated at certain level about $12 to $13 an operating barrel and selling the price at about $65 to $70, so we’re operating nice margin, so what are the risks of those operating cost going up. Those operating costs are not at risk of going up at all on an absolute basis. They are stable and fixed. Most of our material and service based cost comes out of Canada, so there is an inflationary element into our operating costs and as our operating cost denominator is net working interest production. If our net production drops then our unit operating costs go up, but on absolute basis the dollar amount will stay the same.
New opportunities; give you a little bit of information on our new opportunities that we are pursuing with our partners. The first opportunity as I had mentioned previously was the expansion of our existing production sharing contract called [indiscernible]. We are in the final negotiations of this expansion and what it would provide is an expansion to the year 2028 and we are negotiating certain commitments that we would be obligated to undertake on this PSC and this would entail us to having to start off our second rig which is currently ideally in Cuba. Our exploration opportunities would entail us having to shoot seismic for the next two years mainly 2014, 2015 at cost of about $10 million per year.
At the end of that seismic campaign, we’re hoping that we’ll see positive results which would see us drill an exploration well or two at the end of 2015. So our exploration opportunities are similar geologically and similar in structure and sizes to what we’re currently producing in or existing fields. So based on success we could see anyone at these exploration wells develop into a field that could give us an additional production level of anywhere from 5 to 10,000 barrels of gross production per day, of course, this is always predicated on being successful in our exploration program.
Even though I didn’t have [indiscernible] there is a question from the floor so maybe I’ll just talk about it. The question was on capital in regards to the opportunities, the development opportunities that we have talked about would we have made a final commitment but it would see our second rig start off so there would be definitely additional capital would be required when we finalize the negotiation on the development opportunity.
So in summary under our current operating strategy, our current PSCs are providing solid economic returns and the results will continue with Sherritt implementing the same operating strategy for the development and exploration opportunities.
Unidentified Company Representative
All right, thank you Elvin. Next, I would like to introduce you Sean McCaughan. Sean is another long terms Sherritt’s employee, held a variety of roles both in the corporate office and he moved out to Edmonton and joined our coal business a few years ago and about 18 months ago when Mark Plamondon moved to Madagascar. Sean took over as our Senior Vice President of Coal, so like to have Sean everywhere.
Good morning. Thank you, David. So as David mentioned I am from our coal division from Edmonton and my goal here this morning is to shed a little bit of light on our coal business particularly on the key things that came out of the study that being our operating costs and capital profile outlay. So where I would like to begin is to walk to through this -- sorry I am going to go over to this slide the coal side, this slide on our focus and challenges in the near term.
Before I do that I think most of you are familiar with our business there is some details in the appendix about our business in a nutshell we are Canada’s largest thermal coal producer. When we report our results we tend to report our business in two segments prairie and mountain easy way to look at that is prairie is essentially our domestic business it’s the bulk of our production and sales we also have a mountain division that is purely focused on export to Asia.
So I am going to start with our key focus which is really two key topics for the next 12 to 18 months that being cost control initiatives that we are focusing on in prairie and mountain I will speak to that in a little bit more detail on the following slide. And the second key factor that we are working hard on over the next 12 to 18 months our renewals of coal supply agreements. And that would be in our prairie division. Our prairie division is what we call mine multi operation our mines are located next to our utility customers and when we set up these arrangements we set up long term coal supplier agreements between the mine and the neighboring power plant from time to time these long term coal supplier agreements come up for renewal.
We are working through some renewals we have had some success over the past years on renewing some contracts in our [indiscernible] mines and other mines right now an example of a contract that we will be working on and are working on actively is SAS Power in Saskatchewan at the Boundary Dam line which is located in Estevan. Outside of coal supply agreements we have other smaller contracts that we are also renewing such as our chart sales, one of our chart plans in Estevan as well.
Some of the risks that we are monitoring that could affect our business plan in the short term period we have listed up here the first certainly being international thermal coal prices we have seen thermal coal prices trend downwards since March 2011 and we feel that they have certainly come down quite a ways we continue to watch the risk of that how it impacts our mountain business.
Other risks that we are actively watching our important rail congestions so moving our coal to the West Coast in our mountain division and a further risk is permitting and regulatory issues, from time to time we either expand our mines or we actually need mine license approvals for in pit activities.
We've seen some delay at times on achieving those pit licenses, we manage around that to the best we can but there have been instances in our last 24 months where we had not received a license on time which has caused us to mine outside of our preferred mine plan for the time being. The next point on this slide that I wanted to mention was opportunities when I look at opportunities I think what we are doing up above that I mentioned on focusing on cost control renewing key contracts is our big opportunities that we are working on right now. But I did want to put an example of other opportunities outside of that on this slide.
One such opportunity is with SAS Power a key utility customer of ours is doing in Southern Saskatchewan SAS Power is nearing completion and starting commissioning soon of a life extension of its unit three at its Boundary Dam Power Station. This is quite significant it is significant life extension I think what makes this more interesting and more significant is SAS Power’s commitment and SAS Power provinces to Saskatchewan’s commitment to invest in a carbon capture and sequestration. This will be the first of its kind in Canada it’s a large CO project all signs are looking like that project will be up and running Q1, Q2 of next year and we eagerly wait for the results of that project as we supply coal to that Power Station.
So I am going to transition on to the next slide which is a slide on operating costs. And we have we got a series of charts on the right hand side which shows you the cost per ton of our various businesses between prairie and mountain over the last five years. I won’t go through all of that categorization of the costs largely the makeup of our costs the segments of our cost between the two businesses are similar. Probably the key differentiating factor between the two is in the non-business you have which is x my cost such as larger transportation for costs that part in addition to your mine costs.
I am going to try to focus on two points on this slide for you, the first being drivers of our operating costs and the second being cost controlling issues that we are working on. So I will begin with the cost drivers. In the mining business in the surface mining business the cost drivers for us that we manage and plan for in the annual sense when we do budgets and forecasted logs from a long term are such thing that changes in my conditions and we see that as we proceed through our mining sequences we see changes in strip ratios we see changes in geology all those things can affect either the amount of manpower you need or the amount of equipment that you need on-site to execute your plan. Examples of which we’ve seen at some of our Prairie mines would be some strip ratio increases. An example there would be our Pencrude [ph] mine where we’ve seen strip ratio increases we’ve had a great amount of additional mobile equipment which is the pre-strip fleet specifically.
In the Mountain business over time we’ve perceived into newer pits that has come with some increased haul distances in the Mountain business which is an example of the change in mining condition for us. I’d also like to touch on changes in these costs overtime. We have inflationary pressure that we’ve seen over the last five years. certainly mine inflation has been I think larger than your standard CPI in some cases. There are components that have stood out to us over the past five years that are -- is embedded in this profile one of which I’d like to highlight is certainly diesel pricing which is probably not a surprise frankly in this room. We’ve seen diesel pricing in our operations over this period almost double in our operations and we certainly work to do whatever we can to mitigate that price increase.
So let me transition over to what we’re focusing on for cost control in our company right now. Here in Prairie a lot of what we’re doing is capitalizing on efficiencies that we’ve seen at some of our mines and sharing those best practices with other sites. To give you an example would be technology investment. We’ve seen some fantastic benefits coming out of implementing equipment dragline technology it’s really GPS monitoring technology on our draglines. We use draglines at all of our mines as our primary earthmover so that is the key piece of equipment for us to maintain our low cost profile. Anything we can do incrementally saves us money and we’ve invested in various monitoring programs on some draglines and now are in the process of purchasing that program for other draglines at other sites where we haven’t done so.
Moving onto Mountain with respect to cost control, a key focus for us has been lowering our cost per ton in Mountain. You all seen some steps we’ve taken over the past few years. Last year we suspended the higher cost Obed mine certainly during this tough time of pricing that we’re in apparently. And our focus this year and right now is certainly on coal value given where pricing is at so what are doing at full value. We are adjusting our mining sequence focusing on a production level if that make sense during this time period. For this year I think we’ve given guidance that we’re guiding to be lower than previous years in production and sales of [indiscernible] production. And we’re going to continue to manage that as we go through this point in the cycle. We’re focusing on coal [clean] and the pit what can we do to get higher recoveries out of the pit which will translate into higher yields for us once we put the coal through the wash plant.
We are driving increased availabilities how we’re doing that we’re spending a fair amount of time on our maintenance practices. We’ve brought in an additional third party to assist us in driving better maintenance practices at full value. That so far has already resulted in [idling] some equipment, which is lowering our cost profile we will -- I’ll speak to equipment on the next slide as well. Contracted usage reductions has happened [virtually] at site we have almost removed all contractors so far. We have also looked at work force reductions which are unfortunate things to talk about but in this environment it is reality and it certainly has happened as we’ve changed our production profile at full value going forward to a lower rate. And lastly G&A cost. This would apply to full value but it would also apply to our Prairie operations. We’ve looked for synergies across our complex of mines in some regions where we have mines in similar geography we are capitalizing on sharing resources going forward. We are looking at G&A in our corporate office as well as say G&A and we found opportunities already this year.
So with that I propose we move on to the next slide, which is our capital profile, so let me begin with Prairie. Our capital profile or our ability to make up over capital in the coal mine business I'd boil it down to three key areas: one being dragline investments as that is our primary piece of equipment to move earth. Those investments in dragline can vary from our routine annual maintenance expenditures that we need to do on the dragline to keep up our availabilities and productivities. But we also have what I would characterize is more infrequent capital jobs in draglines that can happen every 5, 10, 15 years on dragline such as tub investments and bloom investments and that can at times show up as some variability in Prairie’s capital.
We also invest in mobile equipment. We use a fair amount of mobile equipment in our industry. That piece of sustaining capital instance is quite routine, we typically capital lease, our mobile equipment historically which helps smooth our capital spending in financing of that capital spend.
And lastly infrastructure investments which would be construction of hollows into new pits, extension of power lines, expansion of wash face et cetera.
With respect to capital efficiency, we’ve reduced our capital enquiry over the past few years. Our guidance for 2013 right now is 58 million which we feel based on latest forecast is where we’ll be targeting. Going forward I think that’s in the range of sustaining capital number for Prairie, probably the range is 560 million to 575 million depending on those the currencies of those one time drag in our investments, as I mentioned earlier.
We are deploying either equipment both in Prairie and mountain that we have or across each division whether it sort of equipment that we’ve realized that in the mountain division from producing production or in some of our Prairie sites we’ve increased our availabilities or utilization such that we have – those are at one side that’s become free that I can move to another site and capitalize on that opportunity. I’ll just touch mountain quickly about our capital.
[indiscernible] similar to Prairie with the addition of a wash plant that we run a core value to process the coal that would comprise our capital makeup, we see when we look at capital of Mountain, it take higher degree of availability on an annual basis going forward in Prairie even our production can get a little bit more and we are certainly working with how we manage our margin and our cash flow during different times of placing in the amount of business there for we and period like are actively looking that we can do on capital. Some of the initially I spoke to you earlier driving are driving capital numbers lower, this year our guidance for capital at mountain is approximately 48 million and I think this the range of the sustaining CapEx number for mountain for us is probably in this period 30 million to 50 million and we are doing a lot on site to target lower capital members going forward in to next year and confidence that some of the measures we are taking, we’re raising benefits of [indiscernible] equipment will resolve not being able to manage that number quite well.
With that I would like to turn it back over to you Dean.
Thank you Dean. Our power business is Cuba is a stable utility business. Currently, we operate two power generation facilities, one facility is located in [indiscernible] and has a capacity of 175 megawatts to operate it about 60% capacity. At Boco we have capacity of 150 megawatts currently operating about 65% capacity. in addition at Boco we are currently in the final stages of construction of our combined cycle or phase eight as some of you had know it by that would add another 150 megawatts of capacity.
The shortage of gas supplies prevents us from operating at base load or at 100% capacity. So, this is the challenge that we as management are facing this business and on that lines we are currently undertaking to address this situation by negotiating with the Cubans an opportunity that our technical team has identified as gas potential in our PE and New Marie production sharing contract. So with the modeling that we have done, we have identified a couple of gas zones in this area that we are going to upon completion of our agreement with our partners go in and evaluate the potential that these two zones would have in these two areas that are under one projection sharing contract that supports the [indiscernible] area.
We are encouraged from what we see from what we see from log analysis and modeling and this could prove out to be a significant increase in gas production from us if these work overs and drilling ventures are successful.
The other option we’re pursing to get our Boca power generation facility to capacity is alternate fuels. This is a little more complex of course and logistically and more construction infrastructure be required but it is something that we also are looking at and pursuing as a second alternate to the gas opportunity.
Our operating cost is unique for utility because we do not pay anything for the gas. The gas is contributed by one our partners at no cost to us. So our operating cost revolve around the three items that you see on this graph and they are virtually fixed and they are stable. We have the same situation that we has in oil and gas, we have some reclassification of our cost that has given us an increase in unit cost from 2010 to 2011.
On a long term base, our operating cost are stable as I indicated but there are cyclic over a six year period and the reason is our gas turbines and steam turbines have a six year maintenance cycle to them so every two years we do a certain amount of maintenance but in the six year when the major maintenance has to be done with these machines which could be in the order of $4 million per machine. Although these machines are staggered and there are sequence of maintenance now but you will see form the graph here for example in 2011 and 2013 a significant increase in that maintenance category that’s the reason for that increase in maintenance so we are going to see a reduction in the next couple of years and then will see another bump up in maintenance in probably two years from now.
Unit operating cost would be reflective of what I just described, plus the gas available. Gas available generates a power to unit cost, this cost divided by amount of megawatt we generate. Now, there are two variables that we have in the unit operating cost.
Our capital is stable well, relatively significant $8 million to $10 million per year and this is required to ensure that we operate our facilities in an integral basis. This would be a number of small projects that would be used to financing small projects for either slide upgrades or replacement on the equipments to maintain integrity of our operating asset.
So on the power of business side; we have a robust utility business with the successful startup of Boca to combine cycle our capacity will be at 475 megawatts. We have approximately 190 megawatts of capacity that we have to find gas for or an alternatively fuel for. As I described our main focus is indeed that. We are looking investigating the additional gas supplies on one of our existing PSEs in the own gas sector and looking at all the fields.
The management stated that we committed to this challenge of finding fuel to get back to get our Boca power generating facility to capacity so that is our main focus and an endeavor at this point.
Thanks, Elvin. So that completes a relatively, completely high level overview of each of our four businesses but our intention there was to try and give you a sense of where our focus and attention is in each of those businesses today in this environment.
We will have to take your questions on all that before we do there is one other topic we want to cover. Coming out the survey and we do get a lot of question on a fair regular basis on some of the financial presentation issues that come up in our financial statements. Those of your called us for a while will have seen our statements evolve as we move from Canadian GAAP to IFRS and some more recent changes as IRFS as evolved in the last couple of years so our structures and investments and joint ventures as the complexity accounted under IFRS, and so we probably went for spending few minutes trying to help people to understand how those work and how those have changed over the last few years so you can be making comparisons on the consistent basis.
So here today to that we have Nancy Randal who is our corporate controller who has been in for last years in the front office and Nancy has been with Sherritt with six odd years now Nancy? Five. Nancy is going to [indiscernible] some of the bigger presentation issues in our financial statements and give you some of those questions and concerns that we see pretty regularly.
Thank you very much David and good morning everyone. I have been asked to explain some of our reporting as we understand obviously from the investor survey that our users may find some of our disclosures a bit complex and we understand feedback are accounting can be quite complex. So today, my goal is to provide a high level overview of the complexities in our reporting throughout some of our business units and to provide you with our conciliation in more complex disclosures, which you can use for future reference.
So, in my mind, the biggest driver of complexity in our reporting is the change in accounting standards to IFRS-International Financial Reporting Standards. The accounting standards are require us to report in a manner that not always as intuitive as we would like but it’s the nature of our business arrangements that drive the accounting policies that were required to follow.
So this slide demonstrates the significant impact of IFRS, particularly with the accounting for joint ventures. The change for Ambatovy from full consolidation under Canadian GAAP to equity accounting in 2011, reduce our total assets by over $2 billion. The change in accounting for the Moa Joint Venture from proportionate consolidation to equity accounting earlier this year, had a very significant impact on our revenues reducing them by almost $400 million annually, so by far these are the two most significant areas in my mind.
So let's move on to the metal segment, one reason our metals reporting has become more complex is the multiple operations included in the metals segment that we report and it consists of four operations which is outlined in this diagram. It includes the Ambatovy and Moa joint ventures and two smaller businesses that support these joint ventures and these are referred to in our disclosures as the fourth site which is Sherritt's fertilizer operation and metals marketing which does nickel from the Ambatovy projects. So slide 22, it's very busy but it provides you a reconciliation of the operations in the consolidated metals segment and this can be used as a reference tool for those of you interested in reconciling our disclosures in the future, one point I did want to highlight on this slide is that once we reach commercial production for Ambatovy the metal segment revenue will include an additional column for those Ambatovy sales so that's something to watch out for in the future, so as we mentioned the second area of complexity at metals is the change to equity accounting for our joint ventures, the tables in slide 23 can be used again for future reference to reconcile the investment note back to the Safe Harbor statement.
But to sum it up as the most important change resulting from equity accounting is that the net assets and the net earnings of the joint ventures are now collapsed and presented as a single line item on the face of our statements and because of this we've been required to add additional note disclosure in our financial statements, so this of course is not a preferred presentation and we like proportionate accounting but we are constraining the [indiscernible] standards.
Moving on to Ambatovy the term commercial production is mentioned a great deal in our disclosure, we wanted to note again that it's not a business milestone but it's an accounting term that's only relevant in that it describes the changeover from project accounting wherein net costs are capitalized to our balance sheet to operational accounting where Ambatovy's earnings will flow through Sherritt's income at 40%, so it's important to note that there will be losses from Ambatovy following commercial production as its cost which include financing and depreciation costs will exceed our total revenues in the near time, and even once the project reaches breakeven cash flow there will still be losses for some time as we approach full designed capacity and that again is due to the significant depreciation expense that we will be reporting.
So I'll move on to the oil and gas business and again the accounting that we use here for revenues add another example of complexity and it's due to cost recovery accounting. Now the reason we use cost recovery accounting is because of the profit sharing contracts we have in place with our Cuban partners, the contracts allocate a certain portion of barrels of oil to Sherritt as reimbursement for our capital and operating costs and these are known as cost recovery barrels.
So this slide provides an example and it can be a bit of an extreme example of how our oil barrels could be allocated between cost recovery and profit oil barrels simply depending on the size of the cost recovery pool. As you can see it's advantageous to have cost recovery barrels as we get those back at a 100% versus profit oil barrels which we only get 45%.
So I’ll move on to our coal business, a significant portion of capital purchases that coal are done through leases in fact this year's been over 50% and that's been the trend over the past couple of years. In our disclosures and our ND&A we disclose total capital spending, whether that's cash or lease capital, this could cause some confusion when you look at a disclosure in our cash flow and our segmented notes because there we only reflect the cash spending as per the accounting guidelines.
A further complexity of coal is in the accounting that we use for our capital assets due again to the structure of some of our contracts, IFRS requires the business to classify some of the capital assets as finance lease receivables, and this is due to the fact that similar to lease arrangement, shared effectively grants controls of certain of its assets to the power generation plant.
So in this table you can see that this change in accounting from Canadian GAAP to IFRS had a significant impact, moving almost $240 million of PPNE to finance lease receivable on transition. The coal operation also has significant goodwill in the balance sheet that we must regularly monitor for impairment indicators, we've outlined for you some of the critical inputs and management assumptions that impacts our estimation of the fair value, we do want to highlight that any changes in these mentioned assumptions could have material impact on the valuation as well, and moving onto our power operation. There are two points that I wanted to highlight with respect to our power revenues. The first has to do with the fixed price lease contracts. These are from leases in Madagascar, our Madagascar power plants, and we wanted to point out that due delay and collection of that revenue expected this quarter we’ll stop recognizing that revenue obviously it’s not a material amount but we did want you to be aware of that. And also the construction activity revenue relates entirely to the construction of our Boca project. We expect that to be completed towards end of 2013 and again once the construction is complete, we will no longer be reporting the revenue or the offsetting expense that you see come through in our disclosures.
The next slide deals with the Ambatovy Call Option and it’s really refers to Sherritt’s option acquired half of SNC’s interest in Ambatovy. The accounting requires the option to be revalued every quarter and any change in that value will flow to our financing income on our income statement and that does create some volatility in our earnings as you are aware and the graph here actually maps out changes over certain period of time and you can see that there are periods of volatility in the option value and it tends from the different input that we put into the black shells model to value that option.
One point I wanted to highlight, as a result of the extension of the deadline for the Ambatovy completion test from 2013 to 2015, that means that Call Option value will also in terms of expiry will also be pushed out for two years and as this is one of the inputs in the value of the option, we will expect to see a gain or an increase in the value of that option in this coming quarter that could be in the magnitude of over $10 million, so we wanted to highlight that for you and of course as with any option over the life of the option overtime that value will decrease and the losses will flow through our earnings as well. Again, these are all non-cash adjustments to our earnings.
So we’ve just included a couple of slides to speak to non-GAAP measures. The first is operating cash flow metric with measures our ability to generate cash. We just wanted to point out that again due to new IFRS standards this year, our cash will no longer include cash in Moa Joint Venture, so that has reduced our cash liquid share, and in the second table in the slide you can see the impact of excluding the Moa Joint Venture.
And finally in 2013, we amended our definition of adjusted EBITDA, to include the results of our equity accounted investments, the reason we did this is that we wanted to ensure that our EBITDA continues to include the results of Moa Joint Venture so that that measure is comfortable over prior years and so that again is just something that we wanted to highlight for you. So that concludes the accounting portion of the presentation. Hopefully, I have been able to clarify some of the complexity surrounding our disclosures and if you have any further questions, we understand there is a lot of materials here and please feel free to forward those questions to Investor Relations and we’ll be happy to respond to your questions. Thank you very much.
Unidentified Company Representative
Thank you, Nancy. Well that concludes the formal part of what we wanted to present and introduce you today. Before we head through and have some lunch so we’re obviously welcome any questions if you have for any of us up here again.
Unidentified Company Representative
At this point and we’re well advanced in the discussions with our partners, the arrangements haven't been finalized yet but at this point we’re anticipating that we should be able to go through both of the opportunities that I have been talking about in terms of the extension of one of the existing PSCs and the new block should be on economic terms that are comparable to what we have now.
Good morning, just a quick question on the coal business, you’ve spent a lot of time highlighting the details in the operational side, kind of skipped over the potash and coal royalty streams. Just wondered if you could address either an asset class that's something used to in the raise fund or just how do you see it fluctuating going forward?
Unidentified Company Representative
Yes, I will tell you a little bit about that. That is reported as part of our [indiscernible] segment is the royalty stream that in the neighborhood of $50 million to $55 million a year about three quarters of that is derived from thermal coal sales and the other 25% is potash based. the coal royalties are pretty consistent because they are almost entirely just volume based royalties you see a little more variability in the potash royalties because of addition to volume some of the royalties are scaled to market pricing as well. It is a pure financial asset the revenue that comes through that are close to almost entirely to EBITDA it’s essentially a coupon cutting exercise so that really has no expenses affiliated with it. I think it is overlooked by the market somewhat because it is affiliate with our coal business. There is some potential for growth in the royalty portfolio and potash side overtime as develop potash reserves and we do enter into incremental potash royalty agreements from time to time and it is with the producers you expect it to be it is Mosaic’s and [indiscernible] of the world.
But yes we really look at that as part of our coal business the coal business really has three distinct elements to it between royalties, prairie and mountain to my mind that can be parceled or separated in any way that make sense.
Unidentified Company Representative
Yes a significant portion of the coal royalties are derived from our mines where reproduce coal and sell it to the utilities. In some cases it’s all covered in the contract with the utility and in some cases there are separate royalties that are payable and the royalties vary a little bit just depending on what the long term mining time looks like in terms of some royals and coheirs are subject to royalties in some art but it is the saying utility customers in Alberta and Saskatchewan that are paying off to those royalties.
Unidentified Company Representative
Yes there would be some structuring that would have to be done so it is paid out in the cash flows but there is reason that couldn’t be a change.
Unidentified Company Representative
Sorry what was that?
From 152 million of EBITDA for the last 12 months of coal does that include the royalties?
Unidentified Company Representative
So after axing out the royalties CapEx and revenue is the same or EBITDA is the same. It would not be much in the way CapEx attributed the royalties that you are looking of what the EBITDA out of royalties is that should be heard from the same as the revenue number.
And is that because of the lumpiness of the drag lines maintenance or replacements?
Unidentified Company Representative
That's what drives the variability in the capital number now, so am I understanding your question?
Yes. I guess my point is other than the royalties how do we get our money back from coal operations priority?
Unidentified Company Representative
There is the royalties and there is and balance across all of the portfolio, there is some positive margins on the sale of coal. The coal costs average of about $13, $14 a ton and realized pricings $17, $18. And then out of that you take your sustaining CapEx.
Just wanted to understand Kelvin the CapEx in the oil and gas business for the next couple of years it’s 50 million to 60 million sustaining capital plus 10 million a year at least for the next two years precisely plus the reactivation of the Southern drill is that going on top of all those members and what is that CapEx for the reactivation of that drill or the cost?
There will be some variability in that depending on what the drilling program looks like it hasn’t really been fully finalized yet and until we get the, 10s of millions of dollars or yes 10s low 10s, low 10s, okay. And secondly on the nickel business margin you said sustaining CapEx I think I don’t have the number in front of me right now but it’s what right now in the nickel business a lower.
Unidentified Company Representative
Actually about $9 million for…
Right and in a better nickel price environment that would double?
Unidentified Company Representative
No, no that wouldn’t double.
Unidentified Company Representative
For an average year sustaining CapEx for the Mosaic is probably I call it $100 million on a 100% basis.
Throughout the year on the 100% basis?
Unidentified Company Representative
Yes 50 Moa on average.
Maybe a question for Martin just on the Moa nickel business specifically the SAS plant it is my understanding in the next I don’t know how many years you are going to move away from some more to the saprolite stuff more into the [indiscernible] where you are getting more acid consuming type of rock anyway is that the reason for the acid plant that you are getting a cost benefit now but as you move into the [indiscernible] is it going to be net neutral with the benefit of the acid plant how is that going to play out?
Unidentified Company Representative
We are not moving into higher saprolite in the saprolite we have saprolite available with our concessions and we economically choose how much of that to blend in but we have belemnite feed for the next 20 years.
Right size when you are moving up towards the hill if you move in that direction you would be getting to not saprolite but little bit more mix of pebbles and that is not the case?
Unidentified Company Representative
Depending on whatever the drill program brings up right now we have not seen any changes really in our ore grade over the last 5 years we are still averaging the same nickel and cobalt content. We do mix in a little bit of saprolite that is around the plant that makes it economical by doing that as we have moved it to concessions we have a consistent fee going in there?
It is in the coal quick in that, given that strip ratios is making [indiscernible] on the cost and I know on a modeling bases you don’t really have any visibility on the strip ratios. Is there [thought] to providing some guidance to the analyst on that front?
Unidentified Company Representative
I suggest we haven’t done it, we can give you some sense going forward I think of what operating expenses are going to be as we get further into our disclosure into next year and you’ll see that reflected but we haven’t to be honest we can consider giving you any guidance on strip ratios but we can [indiscernible] that.
Actually two questions, one within the Power block you get operating cost there is almost $9 megawatt hour freight, can you outline what exactly the freight charges?
Unidentified Company Representative
[indiscernible] I can’t talk -- top of my head and I wouldn’t [indiscernible]…
Well, the category there is freight and other, so there is a host of other costs in there. Our freight does fluctuate because we have quite a large expense we were into these major overhauls because we have to bring all our parts and all our supplies out of Middle East as for our contractors that provides all the services for the gas and [scheme] for buying overhauls.
So that freight has in fact the large part of the maintenance that you block [opposite]…
Unidentified Company Representative
Well oil and gas I mean we do [indiscernible] freight and other but it’s associated with good part of the maintenance.
Okay, second question relates to the coal business. Obviously with natural gas becoming virtually abundant in North America and the [indiscernible] gained worse power prices will affect they will likely to be under pressure in Alberta. How do you guys think about that and how do you manage the business long term on the basis that you unlikely to see your consumer being compressed and therefore having your prices compressed?
Unidentified Company Representative
Certainly it’s a [competitive] of electricity industry right now in Alberta and Saskatchewan and then the utility providers of gen electricity generators out there are struggling with their revenue models, so margins are [attended] as a high volume in margin business. We’ve done [indiscernible] at prevailing gas prices coal is still economic [indiscernible] and the economic benefit new coal if you have to ship in any distance but these mine mouth operations where you have the [symbiotic] relationship with the power plant built right next to the coal pit are still economic even if prevailing gas prices you may see as increasing demand in Alberta and Saskatchewan and are still anticipating significant increases in demand and the electricity requirements for the next five or 10 years with the growth that’s going on there. You may see more of that being satisfied with incremental addition of the natural gas production rather than the new coal fire production. But at the levels of coal production that are in the province now and the contribution they’re making to the base load in Alberta and Saskatchewan we still don’t have -- we have a hard time frankly seeing how there is going to be any significant production in coal consumption in the provinces in the short term.
Saskatchewan in particular was committed to coal as the fundamental part of their base flow program that’s why they’ve invested 100s of millions of dollars in their carbon capture project that Sean and [indiscernible] a couple of months ago. So gas substitution has been a big issue and has been a big issue in the U.S. but in lot of that cases in the U.S. that moving coal from mine sites and by rail to power plants and that adds the significant chunk of cost to it which makes it much more difficult to compete with gas.
[How does] change in accounting policy has quite materially alter the carrying value of some of your assets. And I wonder how does the debt covenant get adjusted to reflect that carrying value?
Unidentified Company Representative
Well, our ability to adjust to debt covenant we’ve been with our credit facilities we’ve worked with our lenders in those facilities renew annually and we can have quite reasonable conversations with the bankers on what actually make sense and they’re willing to take views in terms of what has actually changed in the business and what hasn’t. On the indenture however we don’t have quite that same question [indiscernible] in the indentures and that funded indebtedness ratio that the Dean spoke up in our first session this morning is a 40% funded indebtedness in total assets covenants from total assets on that is whatever assets are in accordance with GAAP which is now IFRS as it may evolve over time. So to the extent we see assets coming off the balance sheet we’ve generally had viabilities come off the balance sheet the same time that have resulted in those ratios not changing dramatically but no question that the assets coming down or changes in the asset level does change the new [greater] for that 40% number to [indiscernible] for that indenture covenant. Matt?
Matt Murphy - UBS Securities Canada Inc.
I’ll just have a follow up question on that coal EBITDA because I think I understand where the question is coming [from] to build your chart and the appendix and I think what you are after, you’re kind of saying your EBITDA in the coal business is up to 150, 160 million. If you were to take out the royalty stream and you have an EBITDA of 100 million and your base CapEx is about 120 million round figures. So if you were to [indiscernible] off the royalty stream, how do you expect the coal business just from coal production to be a sustaining business long term? Is there room to increase cost or what are we going to drive there in terms of that business taking money outside of the royalty stream?
Unidentified Company Representative
You’re right if you’re reading to dense side of the royalty stream the remaining cash to margin [indiscernible] business at the moment is not there is -- there will be some variability and there is two things that will drive it there is variability in the capital number and the capital number should come down as we get through couple more significant one time capital items like dragline bucket replacements. And we are looking to see when we renew some of these contracts we should be able to renew some contracts get back to work historical norms with respect to margin. But you’re correct in your perception that the margins and the net cash flow in the coal business [indiscernible] is not a significant number.
Just on the acid plans that Moa, could you set me straight, my interpretation was initially under construction was going forward and end up getting held up as a Cuban government finances. How are they looking at it in this kind of nickel price environment? And secondly, if it doesn’t go forward considering sulphuric acid is a such a big cost for portion is there any way to lower cost by scaling back of it and minimizing your sulphuric acid consumption that way.
Unidentified Company Representative
The sulphuric acid – you’re right, was under construction as part of the broader extension program that was under way in 2008 for those of you have around for a while although that we had extension underway that first took Moa from 33,000 tons a year to 37,000 tons and that was completed in 2008 and now we produce between 37,000 to 38,000 tons facility. There was a second phase of construction that was underway that was going to take the operation from 37,000 tons to 46,000 tons and construction was halted on that in October 2008 because first Cubans were able to keep up their half of their funding and that point sometime we know to continue with our share of funding.
We’ve had various discussions with our partners over the last few years and how that phase II project might be resurrected given where nickel prices have been in the last couple of years, the conclusions that come with lot of work and our [indiscernible] with our partners is best done in modules and in terms of individuals components so that [indiscernible] one that makes the most sense on incremental basis is completing the acid plant that was under way.
The biggest [indiscernible] in the acid plant is it it’s not the return on that incremental, it finish the acid plant which is not actually particularly depended on the propelling nickel price, rather than nickel prices the return on the acid plant investment is actually realized on the input substitution moving from sulphuric acid to just consuming sulphur. So you’ll see that reduction in that operating cost, producers find the nickel regardless to what you selling nickel regardless to what relatively the cost of the input commodity is out because it that substitution from sulphuric acid to sulphur that differentiate the same things.
In terms of why they are not making commitment, we are I think getting conference everyday on the ability of find a way forward to financing this with our partners, the Cuban partner is very keen on it because of economics and incremental benefit. The economics of this is well understood and so I’ve got a pretty high level conference [indiscernible] pretty positive announcement on that hopefully before the end of the year.
In terms of going ahead with respect to what we do at in terms of acid consumption and the amount of sulphuric acid we actually consider market say a couple of things and I see [indiscernible]. One is just pointing to the history of the Moa joint venture and our cost are going up and down there but we are regardless that where we are in the cycle we’ve always been able to have that get that operation to a point where it’s cash go positive, when nickel prices fell dramatically in 2008 I think we had one quarter, we were cash fund mutual and then after that our cost came down in the input commodities such that we are back to at least small net cash margin in that business.
The other thing we give from an operational perspective is we adjust the amount of acid that we put into the auto crises restriction purposes based on the nickel price obviously the marginal return in terms of incremental for nickel extraction whatever additional limit of acid that you add goes down but in terms of high nickel prices is worth pumping in those extra units of acids to get those ever decreasing incremental extractions of nickel because that it does smaller increments of nickel are still worth more than incremental cost of the acid so when [indiscernible] operating history slightly lower nickel extraction levels because we do adjust the level of acid when we inserting the process based on the relative cost of the unit of acid against the relative revenue that comes from an incremental unit of nickel.
That I think is just partially done and those calculations have done at daily weekly monthly kind of basis but ultimately our primary focus is on making sure that we’re offering on the cost level where we can maintain that positive cash margin regardless of what we’re getting from nickel price.
[indiscernible] material extension to nickel reserve life at Moa.
Unidentified Company Representative
When we added a few new blocks there in the concessions in the last 12 or 18 months actually the range with our partners and there is that operation to have 25 [indiscernible] life at completion of these successive level of extension and by the discussions we’ve been having with our partner over the last couple of years is been contemplated resumption construction on acid plants and other activities related to phase II is how that requirement of having sufficient reserves for 25 years reserve life with the size wise. So there had been a number of initial concessions we entered now to the Moa joint venture. Beside that we are now confident this 25 years with the board there, it doesn’t yet show up in the public disclosure with those new concessions have not been [indiscernible] off sufficiently yet to reach the levels of the information we need to be class as reserve in the reserve report but we will see disclosure next year in terms of the additional concession has been granted. I think we currently show 14 or 15 years with the reserve life in the AIF disclosure at the moment but we are confident that there is 25 years and more
So, if there was a guarantee of 25 years of reserve.
Unidentified company Representative
That was part of the arrangement that was agreed to when expansion to the 37,000 and ultimately 46,000 tonnes was originally agreed in 2005 and 2006 that was part of the agreement with our partner yes.
Since 25 years from 2005 or from today?
Unidentified company Representative
I believe its 25 years from the time that the expansion was undertaken. So that might be something less than that now when we have the fully drilled up [indiscernible] but we are confident that there at current levels of production I think was 25 years with their ultimately but I can’t say that would have [indiscernible] drilled out by our experts [indiscernible] standard.
Unidentified company Representative
Well thank you very much again for taking the time to join us. I am well aware of how busy everybody is these days on the demands of your time and so asking for a significant time [indiscernible] and I am pleased somebody have took the time to join us here today. I believe that wraps up our formal part of our investor day as I said this is the first time that we have done this in five years so I promise you that I won’t let another client go by before we do it again and in the meantime if you have other questions or comments, Paula is always available and any of us are available to help you understand and appreciate some of the things we are trying to do here.
So with that I believe we can sign off to the people that have joined us on the webcast and those of who in the room we would like to come through and join us for lunch. Thank you very much.
Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.
THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.
If you have any additional questions about our online transcripts, please contact us at: firstname.lastname@example.org. Thank you!