Donlin Creek costs hit US$4.5 billion

Vancouver – NovaGold Resources (NG-T, NG-X) has been hit with another massive capital cost increase: an updated feasibility study for the Donlin Creek gold project in Alaska pegged development costs at US$4.5 billion, more than double the estimate from 2006.

Donlin Creek is a 50-50 joint venture between NovaGold and Barrick Gold (ABX-T, ABX-N). The project hosts one of the largest untapped gold deposits in the world – with the new study proven and probable reserves stand at 383.8 million tonnes averaging 2.37 grams gold per tonne for 29.3 million oz. gold.

But the gold is not easily had. The open-pit operation would bear a 5.7 to 1 strip ratio and therefore need a massive tailings facility. The mine is no where near a power grid. Supplies would have to be barged in along the Kuskokwin River. So it is no great surprise that the study estimated an operating cost of US$440 per oz. gold produced.

If the partners could cobble together US$4.5 billion to build the mine, though, they would be rewarded with 21 years of operation. Chewing through 53,500 tonnes of ore each day, the mill would produce 1.6 million oz. gold annually for the first five years and 1.25 million on average over the life of mine.

Ore would be processed by conventional crushing and milling followed by flotation, pressure oxidation, and carbon-in-leach recovery. With gold recovery expected to come in at almost 90%, the operation would produce an impressive 26.2 million oz. gold over its lifetime.

Donlin Creek is in west-central Alaska, some 150 km northeast of Bethel or 500 km west of Anchorage. Grid power is not even remotely close so a mine at Donlin Creek would need its own power plant. The mine is expected to draw 127 megawatts; the partners plan to produce that power from a combination of on-site combined cycle gas turbine generators and fourteen wind turbine generators. The wind co-generator would contribute roughly 7.5% of the energy requirement.

Along with essentially building a small power plant, to develop Donlin Creek the partners would also have to build a port on the Kuskokwin River as well as a road connecting the port to the mine site. Mine supplies would then be barged in from the commercial port already in operation some 12 km downstream. An airstrip is also included in development plans.

There are few mines in the world that produce more than 1 million oz. gold annually. Given its challenges – power, access, and strip ratio are the biggest – a Donlin Creek mine unfortunately has trouble turning that high production level into serious cash flow. Using a gold price of US$725 per oz., the project’s after tax internal rate of return (IRR) is just 2.3%, which means it would take 15 years to pay back the US$4.5-billion investment. Its after tax net present value (NPV), using a 5% discount rate, is significantly in the red: negative US$733 million.

At a gold price of US$1,000 per oz., the picture gets a bit better: the after tax IRR rises to 10.2%, payback falls to 5 years, and the after tax NPV comes in at US$1.7 billion.

In addition, the partners note that the costs of construction inputs such as steel, concrete, diesel, and labour have fallen considerably of late. They plan to review the capital cost inputs and may release an updated economic study later in the year. In the meantime, NovaGold and Barrick included in the current feasibility study a table showing how key parameters change with a 15% reduction in capital costs.

At US$750-per-oz. gold and a 15% decrease in costs, the after tax IRR reaches to 4.4% and after tax NPV almost climbs out of the red, hitting negative US$138 million. At US$1,000-per-oz. gold, the after tax IRR rises to 10.2% and the NPV to US$2.3 billion.

NovaGold and Barrick are some ways away from even considering a production decision at Donlin Creek as they still have significant permitting hurdles to clear. And they say that will be the focus of their work this year. As the partners describe it, given its scale and access route Donlin will require “a considerable number of permits and authorizations from both federal and state agencies.”

The partners are well advanced with environmental baseline studies at Donlin Creek, having started basic studies as far back as 1996. The companies have also made good progress in terms of social relations and so far enjoy reasonable support for the project.

Even if they achieve all the permits needed, the biggest challenge in developing Donlin Creek will be the cost. NovaGold has $78.8 million in the bank; Barrick just learned from partner Kinross Gold that its Cerro Casale project in Chile is now expected to cost US$3.6 billion. A US$4.5-billion price tag for Donlin Creek may be too much for either to handle.

In other NovaGold news, the company recently advised investors that it does not plan tp restart operations at Rock Creek this year. NovaGold built a 7,000-tonne-per-day open pit mine at Rock Creek in northwest Alaska and started commissioning the operation in late 2008. Only two months later the company was forced to put the brand new mine on care and maintenance because of mechanical issues with the crusher combined with rising costs and upheaval in the financial markets.

The company recently increased the resource count at Rock Creek by 24%, bringing total project resources to almost 3 million oz. gold.

NovaGold’s other major project is Galore Creek, in northwest British Columbia. Galore Creek is a 50-50 joint venture with Teck Resources (TCK.B-T); the partners started construction in 2007 but halted work in 2008 when an updated feasibility study pegged capital costs at $5 billion.

The partners recently signed an amended partnership agreement for Galore, stemming from the fact that both are short on cash. Teck will now finance 100% of costs at Galore until it has contributed $60 million to the project, including payments already made. Both companies will continue to hold 50% interests but while Teck is acting as sole financier it also holds a casting vote on the project’s management committee with respect to the timing and nature of expenditures.

And NovaGold is in safer waters, financially, after a private company out of New York City paid US$60 million for a 28% stake in the company. The investment from Electrum Strategic Resources comprised the lion’s share of a US$75-million financing that NovaGold closed in January. The company also converted a US$20-million bridge loan into 15.8 million shares and sold its stake in Alexco Resources (AXR-T) for $3.8 million. The company now has sufficient cash on hand to meet its commitments for the rest of the year.

NovaGold’s share price rose consistently during the latter part of April, gaining 55¢ to reach $3.29. The company has a 52-week trading range of 47.5¢ to $10 and has 182 million shares outstanding, 251 million fully diluted.