At a time when lower commodity prices are fuelling cost-cutting and restructuring plans across the mining sector, Pan American Silver (TSX: PAA; NASDAQ: PAAS) is pushing ahead with expansion projects at two of its three mines in Mexico, and financing both with cash reserves.
“It is somewhat unique under the circumstances,” CEO Geoff Burns says in an interview. “I haven’t read about many new projects starting up, or significant expansion projects of this magnitude in the industry today.”
In May, Pan American’s board of directors approved a US$112.4-million investment to expand the company’s Dolores open-pit mine in the Sierra Madre mountain range of Mexico’s Chihuahua state. The money will be used to add a pulp agglomeration circuit to improve silver and gold recoveries, and develop an underground mine south of the open pit.
The Vancouver-based silver producer is also in the midst of a US$164-million expansion at its La Colorada mine in the state of Zacatecas. The undertaking began in January 2014 and is designed to increase the operation’s annual silver production by 67% to 7.7 million oz. silver by 2018.
The main components of the La Colorada expansion include a 600-metre-deep extraction shaft and hoisting system for ore, personnel, materials and waste of 2,300 tonnes per day; new mining zones; a larger mining fleet; and building up the sulphide treatment plant to 1,500 tonnes per day from 750 tonnes per day. Other work includes enlarging and upgrading the mine’s dewatering and ventilation systems, increasing the tailings storage facilities and building a 115-kilovolt power line connected to the national electricity grid.
Burns says the company has spent US$38.2 million on the La Colorada expansion as of June, with US$125.8 million left to go. At Dolores, US$9.7 million has been spent, with another US$102.7 million left over.
At La Colorada, Pan American has completed the pilot borehole for the 5.1-metre diameter shaft, and in July started full diameter boring. Since then, the company has pulled the 5.1-metre diameter raise bore for 150 metres of the 600-metre shaft length.
Crews are completing the underground development work needed to tie into the new shaft, and working “full tilt” on the sulphide plant, Burns says. The team will likely finish the plant before the power line, but there is a contingency to provide on-site power for a year before the new power line is built.
“There is no issue with the power line, it just takes the amount of time it takes, and we don’t see any issues completing the expansion on time and within the capital budget we’ve announced,” Burns says, noting that Pan American expects to commission the plant in 2017, and reach a run rate of 1,800 tonnes per day by the end of that year.
At Dolores, by the end of June, the company had completed 282 metres of the underground ramp and installed 30% of the power line. Pan American is fine-tuning the process engineering and putting together the construction contracts. Civil works — including clearing the land and excavating down to bedrock for the plant — are also underway. Burns says the company is getting going on the agglomeration plant, but doesn’t expect any problems, as it is a fairly straightforward plant.
“There’s nothing unique or unusual about the plant at all, so I don’t see any reason why we won’t hit this one on schedule and on budget,” he says. “It should be finished at the end of 2016, with commissioning in early 2017.”
Pan American drilled 8,700 metres at La Colorada in the second quarter of this year and expanded mineralization to the east, with high-grade intersects such as 2.9 metres averaging 904 grams silver per tonne, 6.9% lead and 4.5% zinc in the Recompensa zone, and 2 metres grading 1,020 grams silver, 3.6% lead and 22% zinc in the Amolillo vein.
Since 2010, Pan American has more than tripled the reserves at La Colorada. “That was really the backbone of looking at the expansion,” Burns says, adding that the company has yet to reach the bottom of La Colorada’s two main zones — NC2 and Recompensa — which continue down-dip.
“We’ve probably reached the end along strike, but we have indications that they extend at least 200 to 400 metres below the deepest levels of the mine’s reserves today, so there’s a lot more to find,” he says.
Pan American has slowed the pace of drilling at La Colorada for two reasons: it is focused on underground development work, and there is less area to drill from; and it believes there is no rush to find more resources, as it has enough material to feed a bigger mining operation.
“We already have such a large reserve in front of us, it’s not mission-critical to continue to expand it,” he says. “We know there is more than enough material to run that plant for more than ten years and make this expansion plan really pay, so there’s no urgency to keep drilling.”
The big growth areas at Dolores, meanwhile, are where Pan American is moving underground south of the current pit limits, and where it has undertaken drilling. The most effective drilling, however, won’t get underway until the ramp is finished.
“It’s kind of a similar situation at Dolores as it is at La Colorada,” Burns says. “We’ve found so much resource south of the pit that we’re almost to the point that the drilling we need to do is definition rather than exploration, so that we can outline stopes and production schedules.”
La Colorada has proven and probable reserves of 6.8 million tonnes grading 391 grams silver per tonne, 0.35 gram gold per tonne, 2.4% zinc and 1.4% lead, while Dolores has proven and probable reserves of 59.9 million tonnes averaging 33 grams silver and 0.89 gram gold. Both estimates are based on US$18.50 per oz. silver and US$1,250 per oz. gold.
This year Pan American forecasts that its seven mines (Huaron and Morococha in Peru, Manantial Espejo in Argentina, San Vicente in Bolivia and La Colorada, Dolores and Alamo Dorado in Mexico) will churn out between 25.5 million and 26.5 million oz. silver, and between 165,000 and 175,000 oz. gold at cash costs of US$10.80 to $11.80 per oz.
During the first half on a consolidated basis, Pan American produced 12.72 million oz. silver and 81,900 oz. gold at all-in sustaining costs of US$14.35 per oz. and cash costs of US$10.53, net of by-product credits.
In the second quarter, La Colorada produced 1.3 million oz. silver at a cash cost of US$7.85 per oz., and Dolores produced 1.1 million oz. silver and 20,200 oz. gold at cash costs of US$8.34 per oz., despite lower gold prices.
In June, Pan American held US$275 million in cash and short-term investments, US$470-million working capital and US$61.8 million in debt.
The company has negotiated a four-year, US$300-million secured revolving credit line that is available for general corporate purposes, including acquisitions — and Burns isn’t ruling out acquiring a development-stage asset.
“Our preferred domiciles would be Mexico and Peru, so we do spend more time looking in those two locations for opportunities, because we’re trying to lever off the infrastructure we’ve had in place for a number of years,” he says. “In the last six months the gap between how the operating companies are performing share-price wise and some of the juniors, is starting to increase, which then makes things more affordable and value creating.”
says Mexico and Peru have a long history of mining “and are well disposed to provide the industry with everything it needs to operate,” such as having some of the world’s best mining infrastructure, government regulations, security of land tenure, availability of professionals and community understanding of the industry.
While the mining executive acknowledges recent challenges in Mexico with the robbery earlier this year at McEwen Mining’s (TSX: MUX; NYSE: MUX) El Gallo 1 mine in Sinaloa state, and kidnappings in Guerrero state that have affected Torex Gold Resources (TSX: TGX; US-OTC: TORXF) and Goldcorp (TSX: G; NYSE: GG), Pan American isn’t overly concerned.
“Security issues have cycled up and down in the last few years,” he concedes. “Things had seemed to be improving, and then appeared to deteriorate a little bit, but in general, they seem to be manageable from our perspective. Yes, we’ve had to increase our level of security at our sites, but at this stage I would say it hasn’t scared us away from doing the expansions.”
And while Mexico introduced a new mining tax regime last year, which pushed a number of company projects into the uneconomic category, he says, Mexico was simply following the lead of Argentina, Australia, Brazil, Chile, Colombia, Peru, Russia, South Africa and the U.S., among others. “It just means you have to factor the increased taxes into your evaluations,” he says.
Under Mexico’s taxation regime, which went into effect in January 2014, there is a new royalty of 7.5% on earnings before interest, taxes, depreciation and amortization, 60% of which is tax deductible. There is also a 10% withholding tax on dividends paid to non-resident shareholders and a 0.5% environmental erosion fee on precious metals based on gross revenues, which is also tax deductible.
As for weathering the current downturn, the start of which Burns dates to April 2013, the company, like most others, has struggled to re-engineer and retune the business to the reality of market prices. But he says Pan American was lucky because it entered the down cycle with a “strong balance sheet, significant cash balances and essentially no debt,” so it has had “the luxury of taking a methodical and analytical approach on how to strengthen and improve our business, and that has put us in a good spot.”
What differentiates this downturn — or mining cycle — from previous downturns, he notes, is that while commodity prices have marched steadily downwards, cost profiles from the beginning were much higher than they have been in past cycles. “The cost base has gone from US$3 to US$4 per oz. silver to US$12 to US$14 per oz. in an eight-year period, so I’ve not seen a cycle that looked like this before.”
Another aspect of the current downturn is that there is a surplus of almost every commodity, he says. “I don’t recall any time in my career that there was a theoretical surplus of everything, and when I say ‘everything’ let’s review: we have a surplus of oil, potash, nitrogen, potassium, iron ore, copper, gold, silver, zinc and lead. That is just unbelievably strange, and has probably never been seen before.”
Moreover, as monetary policy in the developed world has “exploded” and governments print money (the U.S. has tripled its money supply in the last eight years), the value of tangible assets like gold and silver will rise, he argues.
“In a world where governments are allowed to undermine the original value of their currency by printing more money ad hoc, fundamental commodities will eventually return to their adjusted values and so I’m optimistic that in the medium- to long-term, gold and silver will do incredibly well, as will all commodities,” he forecasts. “As the world gets tired of holding paper, which becomes less and less valuable every day, I’m supremely confident that gold and silver will do very, very well.”
If Burns is correct, Pan American Silver should find itself in a sweet spot.