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TABLE OF CONTENTS Jan 31 - Feb 6, 2011 Volume 96 Number 50 - 0 comments

Prophecy opens mine, doors in Mongolia

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By: Ian Bickis
2011-01-31

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Tushig, Mongolia - On a cold, clear day last November, Prophecy Resource (PCY-V, PRPCF-O,1P2-F) officially opened its first mine.

The accomplishment came just over a year after John Lee started Prophecy, and roughly nine months after Prophecy and Red Hill Energy signed a definite agreement to merge companies and fast-track development of Ulaan Ovoo, Red Hill's northern Mongolian thermal coal project.

The opening was marked by speeches, traditional music and the cutting of a generously bowed red ribbon to the applause of the scores of employees looking on. 

With the opening of the mine, Prophecy enters a new phase as a producer that has demonstrated an ability to navigate the Mongolian bureaucracy. Despite delays in fully permitting the mine, the company managed to open it in a remarkably short time in a country not known for its efficiency.

"I've never worked as hard as this," says Paul Venter, a director of Prophecy and project manager, who has previously worked on coal projects for BHP Billiton (BHP-N, BLT-L) and Xstrata (XTA-L).

Greg Hall, who helped found the company along with John Lee, and is also a director, echoed Venter's sentiment.

"We really went warp speed," says Hall. While the markets were fairly slow last June and July, Hall notes that they were "just going flat out... we had a very busy summer." 

To push the project through, Lee virtually moved to Mongolia for several months. When he wasn't in the country, Venter was, ensuring a continual push forward. In a testament to his hectic schedule, Lee was unable to make the mine opening because of financing commitments in New York.

The hard work has paid off, however, with the company now on the very short list of Western companies with an operating mine in the highly prospective country, and a second, larger coal project in the pipeline to boot.

"It's a major achievement to have a mining permit in this country," says Venter. He notes that along with the bureaucratic hurdles it needed to jump to receive the permit, Prophecy had to have all infrastructure and equipment in place and the mine fully ready to go; no small feat for a company's first mine.

With Ulaan Ovoo open, Lee has wasted little time in advancing Prophecy to the next stage. Since last November, the company has completed a major financing and restructured to both advance and reap better value from its Mongolian and Canadian assets. Prophecy has also made strides in securing an offtake for Ulaan Ovoo, critical in actually getting the mine in production and the cash flowing. 

Ulaan Ovoo

The Ulaan Ovoo project sits in northern Mongolia roughly 8 km west of the town of Tushig and 17 km south of the currently closed Russian border crossing of Zelter. To reach Ulaanbaatar, one must drive 120 km east on a gravel road to Shaamar, then a further 300 km south on a paved but modest highway. Travel times vary greatly depending on the weather, and the number of animal herds on the road.

Before the mine opening, Prophecy, along with contracted miner Leighton Asia, had already started pre-stripping the open-pit project, with a significant amount of the work accomplished. The company is now only holding out on an offtake agreement before further exposing the coal to avoid oxidation.

On the day of the ceremony, the pit was already covered by a layer of snow as the harsh Mongolian winter was starting to set in. But the still-exposed black pit walls revealed the nature of the operation, and hinted at the potential below.

The most recent prefeasibility study outlined a 2 million-tonne-per-year operation at Ulaan Ovoo, with 1 million tonnes in the first full year. Reserves were pegged at 20.7 million proven tonnes that could sustain a 10.7-year mine life, with a calorific value of 5,040 kcal/kg and 11.3% ash.

Operating costs were estimated at US$10.23 per tonne, while initial capital costs were forecast at US$70 million. Using base-case US$40 per tonne pricing, the after-tax internal rate of return worked out to 25.5% and the after-tax net present value, using a 10% discount, came to US$71 million. Payback on the capital will take four and a half years.

The latest study, however, was significantly constrained, incorporating only 10.7% of the 208.8 million tonnes of measured and indicated resources. 

The reserves and mine plan were limited in part because the Zelter River encroaches on the southern edge of the deposit. To take full advantage of the deposit Prophecy will have to commission further studies, secure additional permits and ultimately divert the river.

The size of the operation was also limited because Prophecy has deferred the use of rail transport envisioned in earlier mine plans in favour of direct truck hauling. The choice significantly reduces initial capital costs, but shipping is maxed at 2 million tonnes per year. 

Prophecy wants to hold off on the rail option not only because of the high capital costs, but because there is the possibility of opening the much closer Zelter border crossing. That would allow the company to bring higher volumes of coal over the border either by truck, or even by conveyor, to Russian buyers. The plan requires government cooperation on both sides of the border and there is no guarantee it could be implemented, but it would save considerable cost by eliminating the need for the rail spur.

The current trucking plan calls for a fleet of 90-tonne trucks to haul coal to the Sukhbaatar rail terminal 120 km east. From there, the coal will be loaded onto rail cars and shipped north to have the coal sold at the Naushki Russian border crossing. Prophecy has already made the necessary upgrades to the only road east from the project, including building several bridges.

As is often the case in Mongolia, logistics and infrastructure are the biggest constraints for Ulaan Ovoo.

The mining itself, however, should be fairly simple and straightforward. The main Gol coal seam has a consistent thickness of 30 to 64 metres in the northern half of the deposit, and sits within a coal-bearing basin that forms a 2-km by 1.6-km synclinal fold.

 Venter says that many outside mining experts have commented on the easy access to the coal. 

"Its easy mining," remarks Venter, "there are no stumbling blocks." 

The near-term

Actual mining is on hold, however, until the company secures an offtake agreement. Prophecy is currently experiencing a high burn rate because the mine is commissioned with staff onsite, but offtake agreements haven't been signed, so no coal is being produced.

The securing of an offtake agreement was hampered until Prophecy received the actual mining permits, but now discussions are in full-swing. Venter, who has extensive experience working in the Russian coal sector, brought several contacts with him when he joined Red Hill and continued on with Prophecy. He says various Russian parties have expressed interest, with more stepping forward since the permits were secured.

In the interest of securing the best offtake agreements, however, and to help cut through local barriers in both Russia and Mongolia, Prophecy recently signed a memorandum of understanding with the JUST group of Mongolia. The group is active in the trading, distribution and transportation of energy products in Mongolia and has been ranked the fifth largest company in the country. 

In the proposed three-year deal, JUST will buy a minimum of 1.2 million tonnes of coal from Prophecy to re-sell at the Nauski border crossing at a minimum price of US$35 per tonne, subject to quarterly adjustments. In exchange, JUST will receive a 3% commission on the final coal price, which provides an incentive for JUST to secure higher prices.

Prophecy, with the help of JUST, is also looking at potential rail allocation into Russia and port allocation at the port of Vladivostok, where coal has been selling at over US$80 per tonne.

To help tie it over until it starts selling coal, and to advance other projects, Prophecy recently completed a $42-million financing. The company plans to use the money in part to secure its own mining fleet at Ulaan Ovoo to reduce the significant costs of using its contractors' vehicles.

The financing, of 49.5 million shares at 85¢ each, was bumped up by 14.2 million shares after reporting strong investor demand including significant participation by Mongolian investors. With the financing closed, Prophecy now has 185 million shares outstanding, or 236 million fully diluted.

Chandgana 

The recent financing will also go towards advancing the company's other Mongolian coal project: Chandgana.

That project, sitting roughly 290 km east of Ulaanbaatar, hosts 1.05 billion tonnes of measured and indicated resource in two deposits only 9 km apart with a 2.2-to-1 average strip ratio. The coal at Chandgana, however, comes in at a calorific value 4,379 kcal/kg, making it less economical for shipping.

But, Prophecy has bigger plans for Chandgana. Rather than shipping the coal, the company is planning to build a 6,000-megawatt coal-fired power plant on site, then ship the value of the deposit through the power lines. 

No pipedream, the environmental impact assessment for the power plant has already been approved and permitting and a prefeasibility study are underway.

"We're going to produce electricity here," states Hall simply.

With Mongolia already importing power, and the Chinese border only 350 km south, Prophecy sees no end to demand for power in the area. Future plans call for the company to eventually increase capacity to 4,200 megawatts.

Mongolia

Underlying all these well-considered plans, however, is the fact that the company is operating in Mongolia. Depending on whom you speak to, that either means incredible potential or incredible risk.

Prophecy is firmly in the potential camp.

Venter, who has been coming to Mongolia for six years, sees the country as quite receptive to investment, but also filled with an educated citizenry that wants what's best for the country.

"If your intentions are to truly contribute to the country, you will find your way quite easily," says Venter.

The company is well aware that it has to tread carefully in Mongolia. 

As L. Bolormaa, editor of the Mongolian Mining Journal explains, everyone in the country is talking about mining. Added to that, the country is small, and the Canadian mining sector's involvement in the country has not gone entirely smoothly so far.

Bolormaa says that the deal reached with Centerra Gold (CG-T), which was the first western mining agreement in the country, was seen by some locals as a bad deal that left a bad impression; Khan Resources (KRI-T) has engaged in a verbal and legal battle with the country over uranium licences; and Ivanhoe Mines (IVN-T, INV-N), while poised to help create great wealth for the country, came close to alienating Mongolia. Bolormaa adds there are still grumblings in parliament today about the recently reached Oyu Tolgoi deal. 

Prophecy has created some local goodwill by selling about 40,000 tonnes of coal from Ulaan Ovoo at a loss to the city of Darkhan for its coal-fired power plant. The company has also worked to secure high-level partnerships, such as the deal with the JUST Group, as well as commercial ties with Monnis International, another Mongolian conglomerate.

 Chuluunbaatar Baz, president and CEO of Monnis, explains in an interview that while the country presents challenges, it is improving, and still holds incredible promise.

"Mongolia's legal environment is reforming to become more suitable for investors and compatible with international standards," says Chuluunbaatar.

"Mongolia's land is like a treasure island with so many assets," he adds, "the investors who come in first will benefit more than the latecomers."

Much like the obstacles faced at Ulaan Ovoo, Chuluunbaatar says the lack of infrastructure was one of the biggest challenges to operating in the country.

The government, meanwhile, has been trying to balance growth with stability. A proposed "super-tax" was abandoned, but the government has clamped down on issuing new licences, and revoked hundreds of exploration licences that went against restrictions on exploration in water basins and woodlands.

To secure more value from its resources and to make the most of existing infrastructure, the government is planning a huge industrial complex called Sainshand. The plan is to route the resources coming from its many large-scale mines like the Oyu Tolgoi gold-copper project and the Tavan Tolgoi coal project to Sainshand for further processing and then ship the resources farther on a centralized rail system.  

For Prophecy, a stable and growing Mongolia will be beneficial, both in terms of power and coal demands, and in terms of generally making it a more straightforward place to operate.

Prophecy looks ahead

To better focus the company during its rapid growth, Lee recently announced plans to split Prophecy Resources into Prophecy Coal, with the company's Mongolian assets, and Prophecy Platinum, with the company's other assets.

Lee stated that "this transaction unlocks the intrinsic value of Prophecy's assets. Investors will have a choice to own Prophecy Coal for 1.4-billion-tonne coal exposure, or own Prophecy Platinum for unique and significant nickel PGM exposure."

The split also involves Pacific Coast Nickel (NKL-V), which, under a binding letter of agreement, will acquire Prophecy's nickel and platinum group metals projects. The deal is actually a reverse takeover, with Pacific Coast issuing 550 million shares to Prophecy in exchange for the properties and changing its name to Prophecy Platinum. Prophecy will then own roughly 90% of Pacific Coast.

When the deal goes through, Prophecy Platinum will control the Lynn Lake nickel project in Manitoba, the Wellgreen polymetallic project in the Yukon, and potentially the Las Aguilas project in Argentina. 

The deal is just the latest for Lee, with no sign of letting up. Having started the company in October 2009 with a $500,000 market capitalization, Lee highlighted in a 2010 year-end letter that Prophecy's market capitalization now exceeds $170 million. 

Prophecy's share price has gone from starting at less than 10¢ to a high of $1.27 in November 2010, and recently closing at $1.04.

Greg Hall says that while everyone at the company is working hard, it is Lee's drive and vision that has kept the company going at the pace it has.

"There are no roadblocks with John (Lee)," says Hall, adding that Lee is often underestimated. 

Hall says that when Lee first started Prophecy, the general response they heard was: "What makes you think you could run a mining company?"

Today, with one mine open, another project at an advanced stage and exploration active at others, perhaps fewer people are asking that question.



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Photos

Prophecy Resource management, employees and Mongolian dignitaries gathered for the Ulaan Ovoo coal mine's opening ceremony in northern Mongolia. Photo by Ian Bickis
Prophecy Resource management, employees and Mongolian d...
The mine camp at Prophecy Resource's Ulaan Ovoo thermal coal project in northern Mongolia. Photo by Ian Bickis
The mine camp at Prophecy Resource's Ulaan Ovoo thermal...


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