In Part 1 of my report, I indicated some of the challenges in valuing the large mining projects that are being developed by junior mining companies. In Part 2, I evaluated Northern Orion’s (NTO) Agua Rica and Novagold’s (NYSEMKT:NG) Galore Creek projects as a potential partner. Now I want to take a look at some other projects. Some of these developments are actually attracting investor interest and some are just interesting comparable deposits.
The well-known acronym for real estate investing is LOCATION, LOCATION, LOCATION. This also applies to the mining business. Large remote deposits can have serious developmental and operational problems. Environmental concerns seem to multiply in the wilderness. Infrastructure, access roads, power lines and ore transport can be very expensive. Construction cost increases and delays seem to be more prevalent in remote locations as Murphy’s Law always prevails.
Novagold will likely spend $300MM just to gain access (roads/pipelines) and bring power to Galore Creek. Northern Orion will spend $210 MM on access and an additional $306MM for the conveyor system to transport the ore and waste.
One of the biggest environmental problems for large open pit mining operations is acid drainage, according to Paul Dowd, Managing Director for Newmont Mining (NYSE:NEM). This is known as Acid Rock Drainage [ARD] and Acid Mine Drainage [AMD]. When rock is mined and exposed to the air, the sulphide deposits acidify. This happens with waste rock, tailings and pit wall surfaces. Subsequent runoff from rains and waterways can wash the acid for hundreds of miles polluting rivers, agricultural land and aquifers. Potential acid generating [PAG] waste is generated two ways at an open pit mine. Tailings, from processing the ore, are often toxic due to the chemicals used to extract the ore. Waste rock, or overburden, may be PAG depending on sulphide content. Waste rock volumes are determined by the “strip ratio”. A 2:1 strip ratio means that for every ton of ore bearing material there are 2 tons of waste rock. Waste storage is a major environmental issue in any mine during pre-stripping, through production and at mine closure/rehab. According to Dowd, 2/3 of Newmont’s closure and rehabilitation costs are managing acid drainage.
The strip ratio at Galore Creek is 1.6:1 over the life of the mine, but 2:1 in early years. About half the waste rock is PAG. The mine plan calls for waste rock to be placed in the valley and flooded. Environmental concerns at GC stem from the fact that the Galore Creek Valley drains into Alaskan waterways. Prime Alaskan fisheries will be on the receiving end of any pollution, while British Columbia and Canada are on the receiving end of all the tax revenue. Galore Creek will generate about 1.3B tons of waste and tailings.
The strip ratio at Agua Rica is 1.89:1 over the life of the mine, but averages about 3.5:1 in early years. The mine plan to transport all the waste/tailings via conveyors and dump it 20km from the mine seems seriously flawed. From the Feasibility Study:
“For the purpose of this report, the tailings and waste rock have not been differentiated since the deposition methodology has yet to be established.”
Agua Rica will generate about 2B tons of waste and tailings. Environmental approval of this plan will be a serious fight with local residents and international agencies.
Before we plunk down a billion for 50% of one these deals, let’s take a look at some of the other copper projects that are attracting partners or gaining investor interest.
Northern Dynasty (NYSEMKT:NAK) is developing their Pebble Mine in southwest Alaska. This deposit dwarfs Galore Creek and Agua Rica. The reserves could easily exceed 20B pounds of copper, 20MM ounces of gold and 1B pounds of molybdenum. NAK was ready to move ahead with permitting and feasibility studies when they discovered a new higher-grade deposit at Pebble East. The project is already seeing strong environmental opposition including US Senator Ted Stevens. Kennecott, the copper division of Rio Tinto (RTO), invested $87.5MM for 9.9% of NAK last July. They can increase their position to 19.9%, pre-emptively, in any additional financings. They also put three of their engineers on the project. Pebble is NAK’s sole project, so the investment basically valued the entire deposit at $875MM. This was an interesting approach. The investment insured that NAK would have the money to advance the project and it is basically a call option for Kennecott.
There are two copper projects in Western British Columbia, near Galore Creek. One is the Red Chris Mine being developed by bcMetals [CVE:C). Red Chris will produce about 1.85B pounds of copper and 1.19MM ounces of gold in its 25-year mine life. So it is about 1/3 the size of AR and GC. However, the deposit is located near existing infrastructure and has a reasonable strip ratio of 1.1:1. The capital cost is only $215MM. It is projected to produce about 100MM pounds of copper and 71,000 ounces of gold annually, although they are now looking at a larger mill. The mine is fully permitted and construction has begun. Like most projects these days, the environmental permit is being challenged. Last July, they did a deal with Jiangxi Copper, of China. Jiangxi will fund all un-financed capital costs (about $110MM), and all cost overruns, for 75% of the project. They will also get to buy the copper at a discount. This will leave bcMetals with a free ride for 25%. So, the Chinese company did a deal for 75MM tons of copper and 53,000 ounces of gold production annually for $110MM. That production would be about 30% of Galore Creek. But 30% of GC would cost about $700MM according to Novagold's numbers ($150MM purchase price and $550 in capital costs). BcMetals is now embroiled in a takeover battle with two suitors, Taseko and Imperial Metals. The current bid is $1.15 per share or about $51MM for the whole company, and 25% of Red Chris.
Another Galore Creek neighbor is the Schaft Creek project being developed by Copper Fox [CVE:CUU]. Schaft Creek is only 36km from Galore Creek, but it is on the BC side of the mountains, thus no tunnel or Alaskan environmentalists. The deposit is every bit as big as GC and they have a top notch CEO. The life of mine strip ratio is a much cleaner 0.7:1. The gold grades are higher and it also has molybdenum. The 2004 capital costs were $600MM. While the cost is sure to increase it will still be much less than GC. Copper Fox optioned the property from Teck Cominco in 2002, but Teck retained a back in right for up to 75%. Teck would have to contribute 4 times all prior expenditures and arrange financing after CUU delivers the feasibility study. A preliminary feasibility study and an updated resource estimate were ordered last month. At $2 copper and $500 gold the NPV is $1.2B discounted at 8%. So CUU has arguably a better project and a strong partner already in place. They will undoubtedly have to dilute shareholders to complete the FS, but then they get four times their expenditures to help pay for their 25% of capital costs. The entire market cap of Copper Fox is currently about $40MM. Twenty five percent of Galore Creek would run about $600MM.
Now let’s look at a couple of South American neighbors to Agua Rica.
Northern Peru Copper [TSE:NOC] is fast tracking their Galeno project in the famed Yanacocha Mining District of Northern Peru. Galeno is another world-class deposit and a project that will undoubtedly be developed. It is located near existing infrastructure and is in moderate terrain. The ore body and production is similar in size to Agua Rica/Galore Creek, albeit with less gold. Production and environmental risk is extremely low as the deposit has a very clean strip ratio of 0.2:1, meaning essentially no waste. Capital cost in December 2006 dollars is $852MM. At $2 copper the NPV is $1.64B, the IRR is 34.3% and payback is 1.1 years. The pre-feasibility study is very complete and IRR calculations include $258MM in sustaining capital (vs. a scant $122MM at Galore Creek), $115MM in owner costs (vs. $56MM at GC) and $50MM for mine closure (omitted at GC). In addition, the project includes a gold discovery at Hilorico that has an inferred resource of 1MM ounces with just 30 holes drilled. The property is clearly in “elephant country” lying 16km east of Newmont’s Yancocha mine, 5km south of Newmont’s Conga project and 5km north of Peru’s Michiquillay copper deposit.
Gold Fields (NYSE:GFI) is also developing their Cerro Corona 35km to the north. Yanacocha is the largest gold mine in South America. NOC also has another promising prospect in Pashpap. Ross Beaty, who founded Pan American Silver, is behind the wheel at NOC. He has indicated he wants to advance this project, possibly with a partner. Nowever, everything Beaty is involved in is “for sale”. The total market cap at NOC is currently about $160MM and they will admittedly have to do a financing this spring. I look for a NAK/Kennecott type of deal with a major partner becoming involved. But, for about $1.2B you could probably buyout NOC, develop Galena and own 100%. The same $1.2B would buy less than 50% of Galore Creek.
The last project I am going to review is Xstrata’s (XTA) El Morro development in Chile. Metallica Resources (MRB) optioned this project to Noranda/Falconbridge/Xstrata in 2002. El Morro should prove to be as large as AR and GC, but with more gold. This project is one of the top three developments in Chile according to the Chilean Copper Commission. Under the agreement, Xstrata must continue to pay for all development and complete a feasibility study, by September 2007, to earn their 70%. The agreement also calls for Xstrata to finance 70% of MRB capital costs, if requested. Xstrata already owns 8.9% of MRB.
Metallica has another very promising development in Chile at Rio Figueroa and a JV with Full Metal Minerals [FMM, TSE-V] in Alaska. In addition, they own 100% of the Cerro San Pedro gold/silver mine in Mexico. The first ore was just delivered to the leach pad and first pour will be this spring. Cerro San Pedro will produce 115,000 gold equivalent ounces annually. This production is un-hedged and MRB has no debt. The entire market cap of MRB is currently $350MM. This is about the value of the 2MM ounces of gold equivalent at their Mexican mine. El Morro is not really being factored into today’s stock price. Meanwhile, development of El Morro is a “free ride” on Xstrata, a very strong partner. Again, 30% of Galore Creek would cost me $700MM.
The search goes on at NG and NTO for partners with deep pockets. Unfortunately, recent industry consolidations have already filled the project pipelines at several companies. The more projects I look at, the more I dislike Galore Creek and Agua Rica. Both projects have enormous budgets with gaping holes in their assumptions for owner’s costs, sustaining capital and mine closure. Both projects have huge development, production and environmental risk. With copper prices declining, I think that potential partners will pass on both projects.
I have gotten a few emails asking why I am long Northern Orion, while being so critical of Agua Rica. NTO also owns 12.5% of the very lucrative Alumbera Mine, operated by Xstrata. Their share of Alumbera is about 50MM pounds of copper and about 60,000 ounces of gold annually. They also have about $180MM in cash. I bought my current position, near current levels, this fall, in anticipation of a positive feasibility study. I feel the current stock price is supported by their income and cash flow from Alumbera. The FS was not filed until December 15th, the last day allowed by the SEC. After fully reviewing the study, I now have my doubts that Agua Rica will ever be developed. I am currently swapping my NTO for MRB and NOC.
Disclosure: The author is long NTO, MRB, NOC, GFI and has no positions in any other stocks mentioned in this report.