Turquoise Hill eyes legal clarity for Oyu Tolgoi expansion

In November, Turquoise Hill Resources (TSX: TRQ; NYSE: TRQ) reported that a lawsuit previously lodged by a Mongolian non-governmental organization (NGO) group was apparently upheld by the country’s Administrative Court.

The challenge, brought by NGO group Darkhan Mongol Nogoon Negdel, alleges due process was not properly followed in 2015 when the Government of Mongolia finalized the Oyu Tolgoi underground mine development and financing plan (UDP) with partners Turquoise Hill and Rio Tinto (NYSE: RIO; LON: RIO), both of whom refute any suggestion that the UDP or any of its underlying agreements are illegal.

Rio Tinto is operator at the Oyu Tolgoi copper mine in southern Mongolia, and a majority shareholder of Turquoise Hill, holding a 50.8% interest. The Mongolian government owns 34% of the large copper operation through its state-owned Erdenes Oyu Tolgoi LLC, and Turquoise Hill owns 66%.

The reported ruling in favour of the NGO is the latest in a series of challenges faced by Turquoise Hill and its parent company Rio Tinto in the plan to expand underground mine development at the major copper and gold operation. The UDP envisions a phased ramp-up of underground production and has seen US$3.2 billion spent to date on the initiative.

However, according to the Financial Times, some optimism has emerged. Mongolia’s Minister of Mining and Heavy Industry Dolgorsurengiin Sumyaabazar confirmed in a Nov. 26 speech at the recent Mines & Money conference in London that Oyu Tolgoi’s underground expansion program will “not be stopped” and “would proceed directly forward.”

The Minister said Mongolia’s National Security Council had accepted a parliamentary resolution calling for the government to improve the UDP, but did not elaborate on what that would entail.

Turquoise Hill did not respond to a request for comment before press time.

The massive Oyu Tolgoi copper-gold operation in Mongolia. Credit: Rio Tinto.

Oyu Tolgoi began production in early 2013 as a major open-pit operation on the Oyut deposit, and is forecast to produce 125,000 to 155,000 tonnes copper and 240,000 oz. gold in 2019. In its recent third-quarter results report, Turquoise Hill said annual C1 cost guidance is expected to come in at the US$1.50 to US$1.70 per lb. copper range — lower than the previous guidance of US$1.75 to US$1.90.

Third-quarter metal output from open-pit operations dropped quarter-over-quarter in 2019, as the mine sequences through lower-grade ore, with third-quarter production of 28,400 tonnes copper and 35,400 oz. gold — a drop of 28% and 64% from the preceding second quarter. Average mill feed grade for the third quarter was 0.37% copper versus 0.46% copper in the second quarter, and 0.57% copper in the first quarter.

Average mill throughput of 109,000 tonnes per day in the latest quarter was above the concentrator’s nameplate 100,000-tonne-per-day capacity. However, recoveries slipped to 75%, down from 80% and 84% in the first quarter and second quarter, reflecting dropping feed grades.

The company posted third-quarter net income of US$45.1 million on revenues of US$209.2 million, with a metal value split of 73% copper, 25% gold and 2% silver. C1 cash costs for the third quarter came in at US$2.14 per lb. copper, and all-in sustaining costs were US$2.84 per lb. copper.

Turquoise Hill recently completed and is commissioning the second of five major planned shafts for Oyu Tolgoi underground operations. Shaft 2 sports the world’s largest production hoist motor, with the ability to lift 35,000 tonnes of material to the surface daily at maximum capacity. The company says the 10-metre-diameter, 1.3 km deep Shaft 2 service hoist could move 300 people per cage cycle, versus 60 people per cage cycle through its Shaft 1.

In mid-year, Turquoise Hill provided a preliminary status update on its phase-two underground program at Oyu Tolgoi that tabled projected cost overruns and delays to initial production due to geotechnical issues and ground conditions at the planned block-caving operation on the Hugo North (Lift 1) deposit. The company flagged that development capital expenses for the project could increase US$1.2 billion to US$1.9 billion over the previously estimated US$5.3 billion, and initial production delayed 16 to 30 months to between mid-2022 and mid-2023.

A rendering of the recently completed Shaft 2 at Turquoise Hill Resources’ Oyu Tolgoi copper mine in Mongolia. Credit: Turquoise Hill Resources.

Market reaction to the cost escalation and forecast production delay was harsh, with Turquoise Hill shares shedding as much as 45% of their value to close at 79¢ on July 16 after the news. Investors were spooked by the capex overrun and its implications on the company’s liquidity and ability to fully fund the phase-two underground development program.

In his Nov. 12 research note, Scotiabank base metals analyst Orest Wowkodaw reiterated liquidity concerns for the company with its stated US$2.7 billion of available liquidity, commenting: “Based on the recent project delay, the company believes it currently has sufficient liquidity until first-quarter 2021. Given the significant medium-term funding uncertainty, our estimates continue to assume $3 billion of additional financing in 2021, comprising $1.5 billion of new debt and $1.5 billion of new equity.”

In its third-quarter results presentation, the company acknowledges financing will be needed beyond its existing liquidity to sustain underground and power development funding at Oyu Tolgoi. A mine optimization study is in progress to provide greater clarity on the additional funding requirements, and Turquoise Hill has provided a proposal to its major shareholder Rio Tinto regarding funding sources.

Based on current development plans, Turquoise Hill says that Oyu Tolgoi will be the world’s third-largest copper producer at peak metal production in 2025, and expects average annual production from 2025 to 2030 to be more than 550,000 tonnes copper and over 450,000 oz. gold from the combined open-pit and underground operation. The mine is one of the largest contributors to Mongolia’s economy and has a 14,500-person workforce — 92% of which are Mongolian.

Turquoise Hill shares closed at 59¢ at press time, near the bottom of its 52-week trading range of 53¢ to $2.84, and at historic lows, giving the company a $1.2-billion market capitalization.