Why Did Silver Wheaton Hold On To Its Pascua Lama Streaming Agreement?
Jan. 15, 2015 3:32 PM ET
Trading NRG - Seeking Alpha
"What is holding Silver Wheaton back from canceling its agreement with Barrick Gold’s Pascua Lama Project?
This is a major project that could provide a hefty return for Silver Wheaton’s investment.
In the current silver price environment, Silver Wheaton is likely to find it harder to find new projects to finance. As such, keeping this deal is important for Silver Wheaton.
The recent announcement regarding leading silver streaming company Silver Wheaton (NYSE:SLW) pushing up the deadline for the completion of the Pascua Lama mine to June 2020 may have raised a particular question for Silver Wheaton investors. Why is the company still holding on to this deal and not terminating it with Barrick Gold (NYSE:ABX)? I'll try to offer a few answers to this question.
Barrick Gold is still attempting to resume construction on the mine, which came to a halt in the last quarter of 2013 due to legal and environmental issues. So it's still unclear if this mine will actually open, and for now Barrick Gold only accumulates additional costs related to this mine. Last year, the mining company incurred $300 million in environmental costs.
Silver Wheaton entered this agreement back in 2009, and for the Pascua Lama mine and a few other smaller mines in South America it paid a total of $625 million. In the original contract, Silver Wheaton was to receive 25% of the silver produced in the Pascua Lama project for the life of the mine. Moreover, the company initially projected to receive 9 million ounces of silver in the first five years of the mine's operations. If Barrick Gold doesn't complete construction of the Pascua Lama mine until June 2020, then Silver Wheaton can choose to void the streaming deal and receive its original investment -- after subtracting the pay it has already received from Barrick Gold.
So, why is Silver Wheaton still hanging on to this deal, even though the mine's future development remains uncertain?
For one, it's always good practice to keep a good relationship with your partners, and Barrick Gold is still one of the leading gold producers worldwide. Silver Wheaton has contracts with Barrick Gold for several other mines, including Lagunas Norte Pierina and Veladero under this original contract.
Even though the deadline for the Pascua Lama mine was pushed forward a couple of times, Silver Wheaton is still receiving, as agreed, silver streaming from Barrick Gold's other mines. Up to the third quarter of 2014, Silver Wheaton received 12 million ounces of silver from Barrick Gold. This comes to a total operating cash flow of $275 million, roughly 44% of Silver Wheaton's initial investment.
Thus, it isn't very risky for Silver Wheaton with regard to getting back its initial investment. The main risk will remain the default of Barrick Gold, which is always a risk that a company such as Silver Wheaton has to account for with any of its streaming contracts. There's also the possible cancellation of construction or the sale of Pascua Lama sometime in the future. By then, however, Silver Wheaton is likely to have already retrieved its initial investment.
Here is another point to consider: In a world where gold producers slash their capex, this means fewer new gold and silver mines will be developed in the coming years. Barrick Gold cut its capex in 2014 from $5 billion in 2013 to $2.35 billion in 2014; Goldcorp (NYSE:GG) announced it will reduce its 2015 capex to $1.3 billion. Last year, the capex was around $2.4 billion. Therefore, the future opportunities for Silver Wheaton to invest in new projects are likely to be fewer than in previous years.
Also, Silver Wheaton didn't enter into new streaming contracts in the past year. The last big deal it struck was back in early 2013. So holding on to the Pascua Lama project will allow the silver streaming company to increase its operations in the coming years, assuming of course the project will eventually become operational.
Let's look at the valuation of this mine based on the initial investment of $625 million, and assume a price of silver of $15 for the life of the mine.
This is another assumption that the mine will deliver 9 million ounces of silver per annum for most of the life of the mine. The starting point is supposed to be June 2020, but until then Barrick will keep delivering silver from its other mines. So far, Silver Wheaton cashed in $275 million. The discount rate is set at 5%, and the price of silver starts at $4 with 1% inflation. Based on this crude calculation and assumptions, Silver Wheaton's ROI is positive with an NPV of a little over $1 billion.
If we were to shave off a few years or assume Silver Wheaton will receive less silver in the next few years until the mine opens, it will reduce the valuation of this mine. But the streaming company will still show a hefty return on its investment.
I think this is the most important factor to consider -- the chance of making a high return on an investment with relatively little risk. This doesn't negate the uncertainty of Pascua Lama's future. But for a company such as Silver Wheaton, which hasn't made any big streaming deals in a while, canceling this agreement could reduce its revenue in the coming years."
