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Turquoise Hill sinks on Oyu Tolgoi delay

Turquoise Hill Resources (TSX: TRQ; NYSE: TRQ) plunged nearly 20% after the miner’s parent company Rio Tinto (LSX: RIO; NYSE: RIO) said it has halted underground work at the Oyu Tolgoi mine until the Mongolian parliament approves the...



Turquoise Hill Resources (TSX: TRQ; NYSE: TRQ) plunged nearly 20% after the miner’s parent company Rio Tinto (LSX: RIO; NYSE: RIO) said it has halted underground work at the Oyu Tolgoi mine until the Mongolian parliament approves the project financing.

Turquoise Hill, which owns 66% of the large copper-gold deposit in Mongolia’s South Gobi desert with the state owned firm Erdenes Oyu Tolgoi holding the rest, lost $1.07 per share on the latest delay to end at $4.38.

Earlier this month, Rio, the project owner, and Turquoise Hill started exporting copper concentrate from the US$6.2-billion open pit mine, following the government’s request to delay the first shipment, originally planned for June, as disputes and tensions over the project’s start-up costs, tax payments, ownership structure, management fees and underground expansion lingered.

In April, Rio signed commitment letters with a consortium of global banks to raise roughly US$4 billion to expand the Oyu Tolgoi operation underground, anticipated to cost more than US$5 billion. It submitted the project financing package to the Mongolian government and shareholders for review and approval. However, Turquoise Hill indicates that the package now requires parliamentary approval, something that was not expected before. And with the Mongolian parliament currently on summer recess, it’s uncertain when that will happen.

Due to this and “continued discussions with the government on a range of other issues” Rio said it will stop all underground work “until these matters are concluded and a new timeline has been agreed.”

But it may take some time to reach a consensus. In mid-July Reuters reported that Erdenes Oyu Tolgoi’s executive director Tserenbat Sedvanchig said the Mongolian government still has “22 points of dispute” with Rio. Topping that list was the capital costs for the existing open pit.

Rio says construction of the US$6.2-billion open pit mine was 3% over the initial cost guidance. But government officials argue otherwise, alleging costs have ballooned by at least US$2 billion, the news agency states.

“Capital cost overruns mean that Mongolia’s prospect of receiving dividends from the operation have been pushed back by many years. This has already led to unease in political circles with the demand that Rio pays for the capex overrun,” BMO Capital Markets analyst Tony Robson writes in a note. “Given all equity participants share the risk, Rio, will rightly refuse this, in BMO Research’s view.”

Sedvanchig, before joining the state owned firm, was one of the members of parliament that argued that the Mongolian government should revise its 2009 investment agreement with Rio and Turquoise Hill and increase its stake in Oyu Tolgoi to 51% from the current 34% — a possibility that the government is still discussing.

Despite all the uncertainty, Rio and Turquoise Hill assured their investors that the delayed underground mine will not affect the existing above ground operations, noting they will continue to ramp up the open pit mine and sell concentrates to their customers. The mine, which produced its first concentrate in late January, is expected to churn out between 75,000 and 85,000 tonnes of copper in concentrates this year.

But without the underground portion, BMO’s analyst believes Oyu Tolgoi will not be profitable in the long run.

“The lower grade open cut mining operations is forecast by BMO to provide some cash flow, but very little in the way of profits, out to later this decade. The underground was, and is, vital to provide a real return on equity,” Robson notes.

He forecasts output from the underground mine at Oyu Tolgoi should start in 2018 instead of 2016, pushing out cash flows and profits. He has slashed his price target on Turquoise Hill to $5.50 from $10 and has downgraded the stock to “market perform”.

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