Novagold Resources: The Mother Lode or Fool’s Gold?

Mar. 5.07 | About: NovaGold Resources, (NG)

I must politely disagree with Mike Niehuser regarding Novagold Resources (NYSEMKT:NG). Mike wrote two bullish reports on NG in the past week regarding the Galore Creek and Donlin Creek projects. He also lists NG as one of his “top picks” for 2007.

I first reported on Novagold during their takeover fight with Barrick (NYSE:ABX). In the Novagold Empire, I covered some of the major power and logistic problems at Donlin Creek. There is no doubt that Donlin Creek is a world class asset. The problem is that the power does not exist in Western Alaska to develop a 1.4MM ounce/year mine. It will probably be a mine some day, but it will take at least 7 years to permit and build the power generation and transmission. Anyone who believes the tales of windmills and diesel generators to provide the 140MW of power, needed at DC, does not understand the logistics of this site.

Donlin Creek is only accessible by barge up the Kuskokwim River. River barges are then offloaded onto low-draft, 1000 ton barges for the 480 mile round trip journey up Jungjuk Creek to the mine site. Everything except personnel and emergency supplies must make this trip. But, it gets worse, the river is only accessible four months out of the year due to freeze out. Everything needed to build and operate the mine would need to be stored at the site for 8 months of the year. The current plan calls for maximum barge traffic, physically allowable, to make the round trip in 4 months. The additional amount of diesel fuel that would be needed to power the mine could simply NEVER be barged and stored at Donlin Creek.

I went into more detail in my second report, “Promises, Promises”. I spoke with two different engineers at Golden Valley Electric Association, who owns the Anchorage/Fairbanks grid, and provides power to Western Alaska. Barrick/Placer has been studying power options at Donlin Creek for several years and there is currently no solution. When a top GVEA official was asked what it would take to get power to Donlin Creek, he replied: “you simply need to relocate your gold mine”.

The Northern Alaska Environmental Center provides a very good, unbiased overview of Donlin Creek.

Meanwhile, NG and Barrick are fighting it out in court to see who owns what. I believe Barrick will prevail. They will have a feasibility study completed. If necessary they will get one of their banker buddies to agree to financing, subject to permitting. Permitting will take at least 3 years. Barrick spent $52MM last year and will spend $87MM this year. Their “earn-in” for the additional 40% only required a total $32MM investment. Most junior companies, with NO current production, would love to have such a partner and retain a carried 30% interest. If they prevail, NG will have to reimburse Barrick for 40% of expenditures to date. With management fees and interest this will be about $60MM. Meanwhile NG will be saddled with 70% of development costs of what is currently a $2B project, with production years away. Barrick is sure to appeal a negative ruling and tie this up in court for years, making it impossible for NG to find another partner. I think NG management was foolish to not simply extend the JV earn-in, possibly adding a financing commitment, and allow Barrick to carry their 30%. Novagold had a very strong partner; they now have the industry’s most powerful adversary. Make that very foolish.

The fact that Novagold has received BC environmental approvals for Galore Creek is no real milestone. There was never a question that BC and the pampered Tahltans would support the project. It is the State of Alaska that might have the last word. At any rate, the big risk at Galore Creek is in the construction. I have written extensively on this high risk project. Last year, NG management made two promises. First, they promised they would find a JV partner that would pay $250MM for 40% of GC in Q1 2007. Since the Barrick takeover began last summer, NG has had a data room open for this project. At this point, I believe every major company has looked at Galore Creek, and passed. At a reasonable discount rate, the economics of this project are anything but robust. The feasibility study has some gapping budget holes. It uses very aggressive exchange rate assumptions, an unrealistic operating plan (24/365) and there are no allowances for mine closure or cost overruns.

In addition, Barrrick has this project mired in legal battles regarding the Grace claims for tailings disposal.

So, at this point, NG is forced to “go it alone” or mothball Galore Creek. Their second promise was that they would begin construction this year and be in production by 2011. With no partner, and all their cash committed, NG is already “running backwards” on their construction schedule. This is something I have always questioned due to the difficult terrain and short construction season. From the current update:

In the Galore Creek Feasibility Study a total of $375 million (US$303 million) was planned to be expended in 2007, and an additional $50 million was expected to be spent in 2007 by Coast Mountain on power line construction necessary for Galore Creek operations, excluding any bonding costs. The NovaGold construction team has rescheduled and re-estimated costs for 2007 based on a longer development schedule. This rescheduling contemplates a total of $262 with start-up of operations in 2012 rather than 2011.

I don’t believe that this is the last of the construction “rescheduling” or delays at Galore Creek.

NG does not have this $262MM. Their $106MM cash is already committed to other projects and their growing stable of attorneys. In 2008, they will need another $170MM for construction and probably have to start picking up their share of development costs at Donlin. Look for Novagold to make some serious visits to the equity markets in the next couple of years.

So how will Galore Creek be financed? Without a partner, it is more than doubtful any bank will lend Novagold the $1.8B. Even with construction completed, there is still no guarantee that financing can be secured. Novagold management is taking a huge risk by committing $350MM in construction costs at Galore Creek with no partner and no financing in place. This is really unheard of in the mining business, at this level. They call it a “two phased approach” to revalue Novagold shares. In today’s volatile markets, I call it more foolishness.

On a positive note, the Army Corp has reissued the permit for Rock Creek. Start-up is scheduled for this summer, but commercial production will be late this year or next. Rock Creek will produce 100,000 ounces/year. At current gold prices that will be about $40MM annual cash flow. Rock Creek will not finance Galore. Until they really make some progress by securing a JV partner and indicate how they will finance Galore Creek, Novagold stock remains “dead money”.

Novagold’s management is clearly “silver tongued” and their shareholders love them. Also from the recent update, “NovaGold is well positioned to become North America's next mid-tier gold and copper producer”. How is that? Production from Rock Creek will hardly make NG a “mid-tier” gold producer. Galore Creek is not financed and has been pushed back (for the first time) to 2012. Donlin Creek is, at best, is 7 years from production. I can name several companies that will open copper/gold mines and become the “next mid-tier” long before Novagold. As the saying goes, “there is no fool, like a fool in love”.

Note: While I disagree with Mike on NG, I want to thank him for sharing his recent visit (and great pictures) to the Minefinder’s (MFN) Delores development. Minefinders remains undervalued based on 2008 production of 195,000 gold equivalent ounces, a huge reserve base of 5.8MM GOE and a current enterprise value of just $375MM.

The author is long MFN and has no positions in any other company mentioned in this report