Turquoise Hill lands US$4.4B to go underground at Oyu Tolgoi

A group of 20 lenders have come up with US$4.4 billion in project financing for Turquoise Hill Resources (TSX: TRQ; NYSE: TRQ) to build the underground portion of its Oyu Tolgoi copper and gold mine in southern Mongolia.

The project financing comes at a time the mining industry is suffering one of the worst contractions in its history, and copper prices, at US$2.09 per lb., are at multi-year lows.

Jean-Sébastien Jacques, copper and coal CEO at Rio Tinto (NYSE: RTP; LSE: RIO), which holds a 50.8% stake in Turquoise Hill, described the financing as “significant in the industry,” and “the next important step towards further development” of the world-class Oyu Tolgoi mine, 80 km north of Mongolia’s border with China.

Turquoise Hill’s CEO Jeff Tygesen said in a November conference call that “80% of Oyu Tolgoi’s value resides in its underground reserves,” and that the company would begin underground construction.

The company did a financing in mid-December, updated a feasibility study and revised capital-cost estimates, and plans to restart underground development between April and June 2016.

As far as the industry’s low copper prices and their impact on underground mine development, Tygesen pointed out that the company expects it will take five years to bring the underground online, and another five years to ramp up to full production, so copper prices are barely a factor. “We are a long believer in copper, and we don’t expect prices to remain at these levels forever,” he said.

In a press release announcing the project’s finance agreement, Rio Tinto’s Jacques said that “long-term copper fundamentals remain strong, and Oyu Tolgoi, as a tier-one asset, will be a globally important source of supply, as the market moves back into structural deficit over the next few years.”

Rio Tinto says the underground expansion cost remains somewhere between US$5 billion and US$6 billion, but is reviewing those numbers “because the market conditions have changed dramatically in the last six months,” Jacques said during a conference call from Hong Kong, according to Bloomberg.

Analysts at Investec Securities in the U.K. predict that the projected capex could fall in the revised estimate due to the industry downturn, and lower costs for fuel, steel, concrete and other items.

“Rio Tinto has stated that the capex estimate of US$5 billion to US$6 billion is being re-costed, with better understanding expected early next year,” Investec said in a research note. “Given the lower cost of materials and excess capacity of services now available, we’d expect to see that number come down significantly. It was perhaps fortuitous that work on the underground project stalled in mid-2013.”

In a comment from Cowen and Co., lead analyst Anthony Rizzuto noted that Rio Tinto “continues to deliver impressive progress on the development of Oyu Tolgoi, especially given the difficulties of greenfield project development.”

The project financing comes from a syndicate of 15 commercial banks and five international financial institutions, and export credit agencies representing the governments of Canada, the U.S. and Australia. They include Export Development Canada, the European Bank for Reconstruction and Development, the International Finance Corp., the Export-Import Bank of the United States and the Export Finance and Insurance Corp. of Australia.

Net proceeds of the US$4.4-billion finance facility, after fees and taxes, will be US$4.1 billion. The all-in project finance interest rate for Oyu Tolgoi — including upfront and ongoing fees, as well as the annual completion support undertaking fee — is the London interbank offered rate, plus 6%, Turquoise Hill said in a news release.

In addition, the parties have agreed to a US$6-billion debt capacity for Oyu Tolgoi, providing the option for another US$1.6 billion of supplemental debt in the future.

“It is a significant accomplishment to secure a huge financing package in the current copper-price environment,” Daniel Greenspan and Valeriy Dolgopolov of Macquarie Research said in a client note. “The size of the syndicate … plus the size of the debt package, speak to the quality of the OT underground project.”

The analysts also noted that the debt, combined with Turquoise Resources’ $1.3 billion in cash, is enough to fully fund the first stage of underground development. “We do not expect to see a material change to the $4.9-billion capex estimate released in the 2014 Oyu Tolgoi technical report, when estimates get updated in 2016,” they added.

Oyu Tolgoi is one of four world-class copper assets in Rio Tinto’s asset portfolio. The others are Escondida, Grasberg and Kennecott.