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Friday, July 28, 2006 7:38:16 AM
*** Will Cerro Casale Backfire for Bema? (BGO) ***
Will Cerro Casale Backfire for Bema?
By Ben Abelson
27 Jul 2006 at 01:30 PM EDT
NEW YORK (ResourceInvestor.com) -- Shares of Bema Gold [TSX:BGO; NYSE:BGO] spiked higher this week as the company released an appraisal for its highly awaited Cerro Casale project in Chile. But while the news was good enough for an approximately 15% gain in Bema’s stock over just a few days, investors appear to have overlooked just how extremely price sensitive the project’s fundamentals are.
Bema has long been known for taking risks on untapped projects in far-flung corners of the globe. Some, like Julietta and Refugio, have turned out quite nicely for the company. Others, like the much-maligned Petrex project in South Africa, have been unmitigated disasters. Although Cerro Casale could provide decent returns for Bema, the projects economics, including a planned initial capital investment of about $2 billion, are nothing short of mind boggling.
While Bema is an undisputed leader at exploration, the company’s operational history is much rockier. In mining, operations that look great on paper have a way of turning into serious problems – a situation that Bema is well acquainted with. With Bema well into its second decade of annual losses, it may be time for investors to stop looking at the ounces in the ground and ask a tough question: when will Bema actually become a profitable mining concern, and will Cerro Casale help it get there?
Cerro Casale: A Large-Scale, Marginal Operation?
Located in Northern Chile, Cerro Casale is unquestionably one of the largest undeveloped copper and gold deposits – with proven and probable resources of 23 million ounces of gold and 6 billion pounds of copper. The project’s life has been estimated at a whopping 17 years, with average annual production of nearly 1 million ounces of gold and 294 million pounds of copper. With $500 per ounce gold and $1.25/pound copper, the mine will have very cheap cash costs (net of by products) of $166 per ounce.
So what’s the problem? Well, using that same base case scenario, Cerro Casale is only slated to have a 12.8% internal rate of return. For a long-life project likely to see many extreme metal price fluctuations over its 17 years of operations, that doesn’t seem like an entirely comfortable margin. Additionally, capital expenditures are now slated at a mammoth $2 billion – up from Bema’s previous estimate of $1.65 billion. Two years ago, that figure was at $1.43 billion. Considering that Bema operates in an industry that gets hit with cost increases every time a rocket is launched in the Middle East, investors should be asking whether capital expenditures won’t creep upwards even further before Cerro Casale becomes operational. That, of course, would reduce the company’s rate of return even further.
As the chart above shows, Cerro Casale’s fundamentals are extremely price sensitive – especially to copper. If metal prices stay high throughout the mine’s operational life, Bema could make out a like a bandit. With $600/ounce gold and $3/pound copper, Bema’s rate of return would be a healthy 33.1%, while cash costs net of by-products would be negative $245 per ounce. Of course, any investor predicting copper prices holding above $3 per pound for the next two decades might be interested in a bridge that I’ve got for sale in Brooklyn.
The final kicker for Cerro Casale: Bema and Arizona Star [TSXv:AZS; AMEX:AZS] will need help from a major in securing financing. With Barrick [TSX:ABX; NYSE:ABX] solidly out of the picture, there aren’t that many big names remaining who could successfully obtain the $1.5 billion plus in financing that Bema’s probably looking for.
Whatever your opinion of the majors’ sometimes hardball tactics with their JV partners, there is ultimately a solid operational reason that Placer Dome (and later Barrick Gold) opted to not develop Cerro Casale. If Barrick actually thought the project had a chance of blockbuster success, you can bet the company wouldn’t have sold their stake to Bema and Arizona Star for as little as $70 million.
When it first decided to not pursue development of Cerro Casale, Placer Dome cited the aggressive price assumptions required to make the project feasible over the long term. Bema fired back by accusing Placer of using stall tactics, and calling the company to conservative – a charge that was echoed by many Bema shareholders.
But, the investors who drove up Bema’s price this week seem to have forgotten that mining is a highly cyclical industry, prone to long periods of boom and bust. In order to remain a going concern, it’s crucial that miners use conservative historical estimates when planning for long-term operations. Companies that don’t follow this “hope for the best, plan for the worst” mentality are those most likely to get blown out of the water when the first price declines hit.
Using historically conservative estimates, Cerro Casale looks like a first-class boondoggle. At $1/pound copper and $400/ounce gold, the mine has a paltry rate of return of 2.8%, a net present value of negative $297 million at a 5% discount, and a payback period of over 14 years. That isn’t to say that I expect $400/ounce gold anytime soon – but isn’t it foolish to not set your base case using pricing below what one could reasonably expect over the life of a mine?
Many Bema investors are probably aware of this. What’s most disconcerting is that they don’t seem to care. In their hunt to jump onto the biggest momentum players with the best story and the most leverage to metals prices, investors have forgotten the two things that have created successful, long-term mining operations: fiscal conservation and a goal of long-term profitability.
Conclusion
If gold spikes into the four digit range – as it very well might at some point over the next 5 years – I’m sure these concerns over Cerro Casale will fall even farther to the backburner. But 17 years is a long period time – and chances seem good that there will a point where some Bema investors are caught at the punchbowl long after the party’s died. That’s the curse of chasing the crowd instead of investing in a company whose projects are actually designed for long-term operational success.
http://www.resourceinvestor.com/pebble.asp?relid=22009
Will Cerro Casale Backfire for Bema?
By Ben Abelson
27 Jul 2006 at 01:30 PM EDT
NEW YORK (ResourceInvestor.com) -- Shares of Bema Gold [TSX:BGO; NYSE:BGO] spiked higher this week as the company released an appraisal for its highly awaited Cerro Casale project in Chile. But while the news was good enough for an approximately 15% gain in Bema’s stock over just a few days, investors appear to have overlooked just how extremely price sensitive the project’s fundamentals are.
Bema has long been known for taking risks on untapped projects in far-flung corners of the globe. Some, like Julietta and Refugio, have turned out quite nicely for the company. Others, like the much-maligned Petrex project in South Africa, have been unmitigated disasters. Although Cerro Casale could provide decent returns for Bema, the projects economics, including a planned initial capital investment of about $2 billion, are nothing short of mind boggling.
While Bema is an undisputed leader at exploration, the company’s operational history is much rockier. In mining, operations that look great on paper have a way of turning into serious problems – a situation that Bema is well acquainted with. With Bema well into its second decade of annual losses, it may be time for investors to stop looking at the ounces in the ground and ask a tough question: when will Bema actually become a profitable mining concern, and will Cerro Casale help it get there?
Cerro Casale: A Large-Scale, Marginal Operation?
Located in Northern Chile, Cerro Casale is unquestionably one of the largest undeveloped copper and gold deposits – with proven and probable resources of 23 million ounces of gold and 6 billion pounds of copper. The project’s life has been estimated at a whopping 17 years, with average annual production of nearly 1 million ounces of gold and 294 million pounds of copper. With $500 per ounce gold and $1.25/pound copper, the mine will have very cheap cash costs (net of by products) of $166 per ounce.
So what’s the problem? Well, using that same base case scenario, Cerro Casale is only slated to have a 12.8% internal rate of return. For a long-life project likely to see many extreme metal price fluctuations over its 17 years of operations, that doesn’t seem like an entirely comfortable margin. Additionally, capital expenditures are now slated at a mammoth $2 billion – up from Bema’s previous estimate of $1.65 billion. Two years ago, that figure was at $1.43 billion. Considering that Bema operates in an industry that gets hit with cost increases every time a rocket is launched in the Middle East, investors should be asking whether capital expenditures won’t creep upwards even further before Cerro Casale becomes operational. That, of course, would reduce the company’s rate of return even further.
As the chart above shows, Cerro Casale’s fundamentals are extremely price sensitive – especially to copper. If metal prices stay high throughout the mine’s operational life, Bema could make out a like a bandit. With $600/ounce gold and $3/pound copper, Bema’s rate of return would be a healthy 33.1%, while cash costs net of by-products would be negative $245 per ounce. Of course, any investor predicting copper prices holding above $3 per pound for the next two decades might be interested in a bridge that I’ve got for sale in Brooklyn.
The final kicker for Cerro Casale: Bema and Arizona Star [TSXv:AZS; AMEX:AZS] will need help from a major in securing financing. With Barrick [TSX:ABX; NYSE:ABX] solidly out of the picture, there aren’t that many big names remaining who could successfully obtain the $1.5 billion plus in financing that Bema’s probably looking for.
Whatever your opinion of the majors’ sometimes hardball tactics with their JV partners, there is ultimately a solid operational reason that Placer Dome (and later Barrick Gold) opted to not develop Cerro Casale. If Barrick actually thought the project had a chance of blockbuster success, you can bet the company wouldn’t have sold their stake to Bema and Arizona Star for as little as $70 million.
When it first decided to not pursue development of Cerro Casale, Placer Dome cited the aggressive price assumptions required to make the project feasible over the long term. Bema fired back by accusing Placer of using stall tactics, and calling the company to conservative – a charge that was echoed by many Bema shareholders.
But, the investors who drove up Bema’s price this week seem to have forgotten that mining is a highly cyclical industry, prone to long periods of boom and bust. In order to remain a going concern, it’s crucial that miners use conservative historical estimates when planning for long-term operations. Companies that don’t follow this “hope for the best, plan for the worst” mentality are those most likely to get blown out of the water when the first price declines hit.
Using historically conservative estimates, Cerro Casale looks like a first-class boondoggle. At $1/pound copper and $400/ounce gold, the mine has a paltry rate of return of 2.8%, a net present value of negative $297 million at a 5% discount, and a payback period of over 14 years. That isn’t to say that I expect $400/ounce gold anytime soon – but isn’t it foolish to not set your base case using pricing below what one could reasonably expect over the life of a mine?
Many Bema investors are probably aware of this. What’s most disconcerting is that they don’t seem to care. In their hunt to jump onto the biggest momentum players with the best story and the most leverage to metals prices, investors have forgotten the two things that have created successful, long-term mining operations: fiscal conservation and a goal of long-term profitability.
Conclusion
If gold spikes into the four digit range – as it very well might at some point over the next 5 years – I’m sure these concerns over Cerro Casale will fall even farther to the backburner. But 17 years is a long period time – and chances seem good that there will a point where some Bema investors are caught at the punchbowl long after the party’s died. That’s the curse of chasing the crowd instead of investing in a company whose projects are actually designed for long-term operational success.
http://www.resourceinvestor.com/pebble.asp?relid=22009
Dan 
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