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Prophecy Coal: An Update

|Includes:Prophecy Development Corp. (PRPCF)

Prophecy Coal Update (OTCPK:PRPCF)

Just want to give an update following a few of the more recent news releases. On May 24th, the company signed an agreement with a DRI (direct reduced iron) manufacturing company in Mongolia. The agreement is for 22,100 tonnes of coal this year, but the DRI company stated that it would like to eventually increase its supply from Prophecy up to 300,000 tonnes on an annual basis. The Ulaan Ovoo mine has a targeted production of 300,000 tonnes this year with most of the tonnage set for delivery to local Mongolian companies. Prophecy believes that this increased demand from the DRI manufacturer could come on line within the next two years, but if that is the case production at Ulaan Ovoo will have to be ramped up significantly. Prophecy is experiencing the potential for demand increases on all sides, this new DRI company, other Mongolian companies or government organizations, and the Russians via the Zeltura border crossing. If we assume, conservatively, that the Mongolian company demand stays relatively flat, but that the DRI company begins requesting 300,000 tonnes a year and the Zeltura border is opened up then the production levels must be much higher to meet demand. This is a good thing for Prophecy because it will allow the mine to become much more profitable. After talking with the Investor Relations department they appear to be making significant progress with the border crossing. While the Russians want the crossing open, work remains to be done on the Mongolian side. Prophecy must put certain infrastructure in place (including roads, border post, and a gate), though the hope is that this will be a short-term initiative. Once the border is open the saleable market grows significantly and the company will be able to ramp up production to meet both domestic and international demands.

Also of note was the covenant that Prophecy entered into with the Energy Authority on May 28th. While this unfortunately did not include the PPA it does show positive progress. The government has now agreed on the terms that will outline the upcoming PPA. In my opinion this greatly derisks the PPA because the primary risk for this step was the government uncertainty. Now that the government has agreed to terms you can infer that they are behind the project and all that is left to determine is the actual dollars and cents. The one discouraging thing to note from this agreement is the statement regarding the initial power supply. The document lists the date as Q1 2016 (for 100MW), this pushes it back from the original estimate of Q4 2015. I don't see this as too much of an issue and feel that their signed agreement is an offsetting force. Something else to watch for when the plant actually comes online in 2016 is the potential for excess production. The agreement allows for an incremental increase of 100MW twice a year (in line with the 150MW module completion dates). However, this is only 66% of potential capacity so the question must be asked if either Prophecy plans to run the plant at well under capacity? The state will have an option for increased purchasing potentially built into the PPA? Or maybe Prophecy will be able to sell their excess capacity to either a private corporation (another mining company perhaps) or they will look to sell to China? I think the most likely scenario is that the government wants to hedge itself because it cannot foresee how the economy will continue to grow over the next 4-5 years, and subsequently how energy demand will continue to expand. I am very confident that there will be a market for the energy given the country's economic growth. I don't believe that the price discrepancy would be significant if Prophecy sold the energy to a non-government customer. I think that this is a very positive development and the IR team at Prophecy says this helps to show government commitment, a good indicator for the PPA completion.

Continue to watch for the PPA announcement and following that the finalization of the financing. The IR team also says that it appears the debt/equity financing split is likely to come in closer to 75/25. This is slightly lower than expected, but is still subject to shift either way with the ever changing global capital markets. Something to watch for.

Disclosure: I am long OTCPK:PRPCF.

Stocks: PRPCF