Xstrata Coal, a subsidiary of diversified miner Xstrata (XTA-L), is looking to sell its 75% stake in the Donkin coal project in Atlantic Canada.
Erdene Resource Development (ERD-T) owns the remaining 25% of the project, which sits on tidewater off Nova Scotia’s Cape Breton Island within 30 km of a deepwater harbour for 160,000-tonne Capesize vessels. Erdene and Xstrata took over the project in late 2005, more than a decade after the Canadian government invested $100 million in 1992 to complete two 2.2-km tunnels beneath the ocean floor to access Donkin’s coal seams.
A technical report completed in June 2011 concluded that the project was worth US$1.06 billion on a net present value basis using an 8% discount rate, and has a 36% internal rate of return.
Erdene has a 60-day right of first refusal on selling Xstrata’s operating stake in the project, which is forecast to produce 2.75 million tonnes per year of washed, high-energy thermal coal and metallurgical-grade coal to markets in Brazil, and across Europe and Asia.
Peter Freyberg, Xstrata Coal’s CEO, said in a statement that the company’s evolution and business strategy has revolved around big mining complexes.
“Xstrata has stated that their decision is based not on the technical merits of the project, but rather on how the company has evolved, and that their priorities have become focused on larger-volume projects,” Peter Akerley, Erdene’s president and CEO, explained to analysts and investors on a conference call.
“When you look at the future of a Glencore-Xstrata, you can understand that a 2.75-million-tonne-per-year production has little impact on a US$90-billion company. But for many, that 36% IRR and an earnings before interest, taxes, depreciation and amortization — in excess of US$200 million a year at full production — will prove very attractive.”
Akerley noted Xstrata’s decision did not come as a great surprise. “We’ve recognized for quite some time having worked with Xstrata since 2005 that this company was headed in a different direction,” he explained. “A Glencore-Xstrata is expected to become the fourth or fifth largest mining entity in the world . . . so we have recognized that Donkin was falling lower down the priority list, and for that reason we believe that this decision brings clarity and resolution to the project and sets it on a more certain and timely course leading to production in 2014.”
When asked in a subsequent email whether Donkin’s underwater coal seams could deter prospective buyers, Akerley said no, explaining that by the time the Second World War had ended, subsea miners were working 5 km offshore from Cape Breton.
“These mining efforts evolved to the point where millions of tonnes were being mined annually by the federal government using modern longwall and continuous miner practices right through until closure in 2001,” he elaborated. “The idea that you are subsea seems very foreign to many outside the industry, but the Donkin project is little different from other underground coal mines. You need to understand your roof and floor conditions, meet your ventilation requirements and control groundwater.”
Under its joint-venture agreement Xstrata is committed to pay the first $10 million of Erdene’s development-funding requirement. It has promised to bring forward up to $1 million of this to cover Erdene’s expenditure share on the project during the sales process, which it hopes will be completed before year-end.
“Our company has little in the way of funding requirements until 2014, unless we pursue a greater interest, which would only be done if it were deemed to be of value to our shareholders,” Akerley explained on the conference call.
He also emphasized that project timelines will be maintained during the sales process. These include completing an environmental assessment and getting approval to begin an underground exploration phase.
Coal production is forecast to begin in 2014 and move to full production in 2017–2018.
“With the right operating team, and particularly one that has the technical and financial ability to operate an underground mine . . . we’re very confident we’ll see Donkin through its production phase,” Akerley said, adding that he believes Donkin coal can be loaded onto capesize vessels coming in at less than US$60 per tonne, which puts the project well ahead of Appalachian or West Coast producers.
“There’s a strong demand for thermal and coking coal projects, especially those that have access to seaborne markets, and there are very few of these in the world,” he continued. “Donkin is a project that ranks very highly in the economic development of Nova Scotia. We see the province of Nova Scotia working closely with us to ensure the right partner is brought in.”
When asked what the ideal partner might look like — a producer, trader or steelmaker — Akerley said he was sure there would be no shortage of potential partners.
“I don’t think there is any issue with regards to finding financial backers for this project, whether it’s offtake or traders,” he elaborated. “The real question is who fits the bill from an operator perspective. Our job will be to find the right one that fits the bill.”
“I wouldn’t say we have a tremendous amount of influence,” he added, “but we’ll be there with the province making sure the applicant meets the criteria that was initially in place.”
“Would we look at building it ourselves? Not completely. Could we bring in a few people and align ourselves . . . that is something we have to look at.”
Akerley also emphasized the importance to the government of Nova Scotia of keeping the project moving forward on schedule.
“The province issued a tender to successful bidders to develop this project. They own the underlying resource and have leased it to Xstrata. They don’t want to see this drag out. If the transition is to take place, it has to take place rapidly. Final bids are to be submitted by September and a decision made in November, so I expect the province will take a firm hand in this to ensure the transaction is brought to completion, so long as there are applicants in place.”
In other remarks, Akerley pointed out that it is an “opportune time for Donkin to be seeking a new 75% partner.” He said that almost every major coal deposit in North America has been subject to mergers and acquisitions activity in the last few years, and that in this year’s first quarter alone, there have been over US$6 billion in coal industry deals.
“We’re 25% owners of the last big coal deposit approaching 500 million tonnes sitting at the bottom of two twin tunnels that have been dewatered, that have some of the thickest seams and highest quality coal ever to be defined in Eastern Canada,” he noted. “This is a very thick seam, particularly when you look at it in comparison to Appalachian mines. The seam ranges from two to almost five metres in thickness, and it’s been marketed to domestic power utilities, but perhaps more importantly to steel manufacturers globally. The harbour seam has found its way to German, Brazilian, Korean and Japanese steel manufacturers.”
Akerley also noted that local utilities import more than 2.5 million tonnes of coal a year and purchase another half a million tonnes from Nova Scotia’s domestic producers, so there is a ready market opportunity for the portion that will be sold as thermal coal in the province. And that thermal coal component provides energy content that is 30% higher than almost any Atlantic basin coal, he said. Donkin coal or harbour seam coal typically comes in just over 14,000 British thermal units.
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