Barrick Gold And The Pascua-Lama Disaster

| About: Barrick Gold (ABX)

Editorial Note: The following article is based on my discussion with a Chilean government official who wished to remain anonymous. I contacted this official through one of my colleagues who is Chilean and formerly held a high ranking position in the finance ministry in Chile.

Barrick Gold's (NYSE:ABX) most important future gold mine is a project named Pascua-Lama located on the border between Argentina and Chile. While Barrick has a lot of other mines, Pascua Lama is significant because when and if it is completed, the mine is supposed to be one of the cheapest mines in the world to produce gold from with a cost per oz. of less than $100.

Normally, this mine would be enticing shareholders to buy into the company left and right, but the mine is already over budget, and behind schedule. It was supposed to cost $3 billion to build as of 2009, but the construction estimate has spiraled to $8.5 billion today. Similarly, Pascua-Lama was previously expected to come online in mid-2013, but now the company is estimating the start-up will be delayed at least one year to mid-2014 at the earliest.

Then, further heaping injury on the firm, this week the company was forced to stop construction of the Pascua-Lama mine after a Chilean Regional Appeals court said the firm needed to do more to placate local indigenous Indians who are concerned about the mine's effect on the environment. While the company has suggested that it can continue work on the mine on the Argentinean side of the border, in practice this won't help because the mine can't be opened until all work on the Chilean side is completed also.

In an effort to get a feel for how much of a problem this court order is, and what it will take to get the project back on track, I reached out to a high-ranking Chilean official through a friend and fellow finance professor who is Chilean and worked for the Chilean government until recently.

From what I've been told, apparently, Barrick has been having problems with the Chileans for a while related to the mine and the environment around it. The best analogy for U.S. citizens seems to the long stalled oil pipeline that TransCanada proposed to build through the Midwest to Texas, in order to export oil from Alberta. The pipeline would be good for the economy, but environmentalists have been all over it because of the concerns about oil spills and such. Barrick's chances of getting the mine completed at all, whether in two years or 20 years, went down some today according to the official I talked with. However, he also said that if the company begins cooperating with officials and being extremely serious about environmental concerns, the mine should still end up being built. My translation: Barrick is going to have to spend a pile of money on environmental controls to get the local Indians and the government officials on board.

Chile's economy is extremely dependent on gold and copper mining. It's a small country that has a reasonable level of economic development and unlike Venezuela, the Chileans aren't constantly looking for ways to nationalize every asset they can and steal from shareholders. So Barrick should be able to do business in Chile successfully - a lot of other miners do - but the company is going to have to spend more money to get the gold mine operating. Frankly, this will erode some of the low-cost value of the mine, but it's the company's only real option. If it walks away from the half finished mine at this point, it will take an enormous bath when trying to sell it.

Specifically, the most important thing Barrick is going to have to do, or so I'm told, is to monitor three glaciers (Toro 1, Toro 2 and Esperanza), and the water supplies around the mine site to watch for chemical and sediment runoff from the mine during construction and after the mine begins operations. In addition, the firm will probably end up having to negotiate with the locals to get them on board the project, something the official told me the company had done little of to date.

All told, the official I talked with suggested that Barrick might need to spend an additional $500 million to $1 billion in costs to get the problems taken care of including costs from the work stoppage. In addition, I suspect the company will need to effectively bribe the locals with more jobs in order to get the project pushed through. The company has an outside shot of getting the whole disaster reversed on an appeal of the appeals court decision, but I'm told that the chances of the decision being reversed are slim. The appeal would go before the Chilean Supreme Court, which has supported mining in past decisions, but the firm will have to abide by a fairly standard set of six technical environmental criteria that regulates most mining activity in Chile.

Barrick officials have previously said that the cost overruns facing the mine are the result of the extreme elevation of the mine (basically it's on top of a huge mountain range) and the inhospitable conditions. Add to this the fact that the mine is on the border of two countries, one of which is the perpetually fiscally untrustworthy Argentina, and the fact that the mine is near several glaciers, which has environmentalists all over the world fired up, and the project has become a money pit very quickly. The Chilean official I spoke with also said that the other problem Barrick has faced (in his opinion) is the company has mostly been trying to build the mine "in-house." While Barrick did hire construction firm Fluor to oversee the mine last July, up until then outside management of the construction process had been minimal.

So, long story short, it looks like Barrick is going to have to open up its checkbook again to get the Chileans to stop harassing it. The costs of this are significant, but not unbearable for ABX, and mainly the issues will take time to get straightened out. Unfortunately time is perhaps the most important commodity for Barrick on this project, as this setback just adds to the long line of continuing delays and cost setbacks the company already faced.

Perhaps most importantly, the Chilean Official I spoke with was optimistic that the mine will eventually get completed. He further said that Chile has far more stringent regulations vs. Argentina, so once Barrick gets past the Chilean environmental regulators, the project should proceed more smoothly. Hopefully, the expertise of Fluor should help in this regard.

Now Pascua-Lama isn't a make or break operation for ABX; the firm will still be around if it walks away from the mine. The company has three other mines in South America alone with two in Peru and one in Argentina. And while ABX has other promising future mine projects such as the Pueblo Viejo mine in the Dominican Republic, Pascua-Lama is still a very important piece of the company's future.

The result of this work stoppage order was an 8.36% fall in Barrick's stock price on Wednesday, which took the already depressed price down to the lowest levels since the height of the financial crisis in mid-2009. As recently as the start of the year, the firm was trading 50% higher than its closing price on Wednesday which probably reflects a combination of falling gold (NYSEARCA:GLD) prices, perpetually increasing mining costs which have also afflicted other miners like Newmont (NYSE:NEM) and Yamana (NYSE:AUY), and a shift by investors out of the precious metals sector into equities, real estate, fixed income, and perhaps even Bitcoins (see my article here).

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in ABX over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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