VANCOUVER — Copper isn’t turning out to be the growth avenue Barrick Gold (ABX-T, ABX-N) hoped it would be.
The gold major jumped into the copper scene in 2011 with the $7.3-billion acquisition of Equinox Minerals, owner of the Lumwana copper mine in Zambia. At the time copper was selling for more than US$4.50 per lb. amidst booming demand from China.
Two years later, Barrick has found out Lumwana isn’t quite the mine it was chalked up to be — or at least, it isn’t an operation that works at today’s lower copper prices. A new life-of-mine model for the operation shows higher-than-expected operating and sustaining costs, which means lower-than-expected production and profitability.
As a result, Barrick just recorded an after-tax asset impairment charge of US$3 billion for Lumwana, plus a goodwill impairment charge of US$800 million for its copper business unit, which also includes the Zaldivar mine in Chile.
Taking a US$3.8-billion writedown on a fairly recent $7.3-billion investment means something went seriously awry. For Barrick, that something was pursuing production growth at any cost.
Aaron Regent, Barrick’s previous CEO and an architect of the Lumwana deal on behalf of the directors, certainly pursued that goal. Unfortunately, that narrow focus on production growth got him fired when it became clear that adding ounces and pounds was not necessarily adding net dollars to Barrick’s balance sheet. The model also wasn’t doing any good for Barrick’s share price, which had dipped to a post-recession low of $32 when Regent was shown the door.
A big part of the problem was that Barrick assumed copper prices would stay strong and rise. Instead, copper prices have slipped about 25% since the acquisition.
Barrick has since reinforced the company’s focus on stricter, more disciplined capital allocation in announcing its latest results, including the writedown.
“Rising costs, poor capital allocation and the pursuit of production growth at any cost in the industry have led to declining equity valuations across the sector,” said Barrick’s current CEO Jamie Sokalsky, who replaced Regent in mid-2012. “The message is clear: the industry must chart a new path forward . . . we are increasingly taking strong action and refocusing our business based on the principle that returns will drive production — production will not drive returns.”
Since his appointment, Sokalsky has made it clear that he is focused on rates of return, not production growth. In his six months at the helm he has already deferred some $4 billion in previously budgeted capital spending and shelved plans to build new mines. In fact, Barrick has no plans to build any new mines, a point it made several times in its earnings release.
Sliding copper prices were not the sole culprit at Lumwana. In the latter part of 2012, Barrick completed an exploration and infill drill program at the project aimed at better defining the limits of mineralization. The results were apparently not impressive.
“After this drilling was completed, the orebody did not meet economic expectations,” Barrick states. “While the drilling increased reserves and defined significant amounts of additional mineralization, some at higher grades, much of it was deep and would require a significant amount of waste stripping, which makes it uneconomic, based on expected operating costs and current market copper prices.”
In 2012 Lumwana produced 468 million lb. copper, with each pound costing US$2.97 to produce. For 2013 Barrick plans to produce only half as much from the Zambian mine, and those pounds will come at higher cost: guidance calls for output of 210 million to 250 million lb., at an average, fully allocated cost of US$3.20 to US$3.60 per lb.
The company has also shelved earlier plans to expand Lumwana, reinforcing the idea that it “will not invest capital simply to increase production.”
Sokalsky tried to put a silver lining on the dark Lumwana cloud, ending his discussion of the $3.8-billion writedown by suggesting that higher copper prices in the future would restore immense value to the mine.
“When we bought Equinox, our view was that Lumwana was a long-life mine, with exceptional resource potential in the Chimiwungo area,” Sokalsky writes. “Our view of the resource potential has been validated by the results of our exploration program — Lumwana has an enormous mineral inventory and tremendous leverage to higher copper prices. As copper becomes more difficult to find and demand increases, we stand to benefit substantially from having this asset in our portfolio.”
Barrick also had more positive news. Despite the huge copper writedown, the company brought in adjusted net earnings of US$3.8 million for the year, the second highest in the company’s history.
The company has also contained the capital-cost overruns at its construction-stage Pascua-Lama gold project, which is expected to cost US$8 billion to US$8.5 billion. Pascua-Lama is a world-class resource, with nearly 18 million proven-and-probable oz. gold, as well as 676 million oz. silver. The mine is expected to produce 800,000 oz. gold and 35 million oz. silver annually for 25 years, with initial production expected in mid-2014.
Barrick’s share price gained 72¢ on all the news to close at $32.44. The company has a 52-week trading range of $31.18 to $49.93, and has just over 1 billion shares outstanding.
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