Underground work delayed at Oyu Tolgoi

Shares in Turquoise Hill Resources (TSX: TRQ; NYSE: TRQ) plunged nearly 20% after the miner’s parent company Rio Tinto (NYSE: RIO; LSE: RIO) halted underground work at the Oyu Tolgoi mine until the Mongolian parliament approves the project financing.

Turquoise Hill, which owns 66% of the large copper-gold project in Mongolia’s South Gobi desert, with the state-owned firm Erdenes Oyu Tolgoi holding the rest, lost $1.07 per share on the latest delay to end at $4.38.

Rio and Turquoise Hill began exporting copper concentrate in early July from the US$6.2-billion open-pit mine, following the government’s request to delay a first shipment originally planned for June, as disputes and tensions over the project’s start-up costs, tax payments, ownership structure, management fees and underground expansion lingered.

In April, Rio signed commitment letters with a consortium of global banks to raise US$4 billion to expand the Oyu Tolgoi operation underground, anticipated to cost more than US$5 billion. It submitted the project financing package to the Mongolian government and shareholders for review and approval. However, Turquoise Hill indicates that the package now requires parliamentary approval, which was not expected before. And with the Mongolian parliament on summer recess, it isn’t certain when this will happen.

Along with “continued discussions with the government on a range of other issues,” Rio said it would stop all underground work “until these matters are concluded and a new timeline has been agreed.”

But it may take some time to reach a consensus. In July, Reu-ters quoted Erdenes Oyu Tolgoi’s executive director Tserenbat Sedvanchig as saying the Mongolian government still has “22 points of dispute” with Rio. Topping that list is the capital cost for the existing open pit.

Rio says building the US$6.2-billion open-pit mine was 3% over the initial cost guidance. But government officials argue otherwise, alleging costs have ballooned by at least US$2 billion, the news agency states.

“Capital-cost overruns mean that Mongolia’s prospect of receiving dividends from the operation have been pushed back by many years. This has already led to unease in political circles, with the demand that Rio pays for the capex overrun,” BMO Capital Markets analyst Tony Robson writes in a note. “Given all equity participants share the risk, Rio will rightly refuse this, in BMO Research’s view.”

Before joining the state-owned firm, Sedvanchig was a member of parliament who argued that the Mongolian government should revise its 2009 investment agreement with Rio and Turquoise Hill, and increase its stake in Oyu Tolgoi to 51% from the current 34% — a possibility that the government is still discussing.

Despite all the uncertainty, Rio and Turquoise Hill assured their investors that the delayed underground mine would not affect the existing above-ground operations, noting they would ramp-up the open-pit mine and sell concentrates to their customers. The mine, which produced its first concentrate in late January, is expected to churn out between 75,000 and 85,000 tonnes of copper in concentrates this year.

But without the underground portion, the BMO analyst says that “the lower-grade, open-cut mining operations is forecast by BMO to provide some cash flow, but very little in the way of profits, out to later this decade. The underground was, and is, vital to provide a real return on equity,” Robson notes.

He forecasts that output from the underground mine at Oyu Tolgoi should start in 2018 instead of 2016, pushing out cash flows and profits. He has slashed his price target on Turquoise Hill to $5.50 from $10, and has downgraded the stock to “market perform.”