Lundin, Ecuador gov’t agree to advance Fruta del Norte

VANCOUVER — It has taken half a year of negotiations for Lundin Gold (TSX: LUG; US-OTC: FTMNF) to come to a financial agreement with the government of Ecuador to develop its flagship Fruta del Norte high-grade underground gold deposit, 80 km east of the city of Loja. On Jan. 14 the company revealed a deal that could put it on track to meet a production target at the project by early 2020.

When Lundin picked up Fruta for US$240 million from Kinross Gold (TSX: K; NYSE: KGC) in mid-2015, Ecuador’s taxation and mining law seemed to threaten the deposit from being economically developed.

Perhaps the main reason Kinross unloaded the project was a 70% windfall tax on mining that torpedoed the producer’s attempts at developing the project in 2011.

Under Lundin’s new exploitation agreement, the government of Ecuador will tax the difference between net smelter revenue and what revenue would be using the base price at a 70% rate. The base price — determined on a monthly basis — will equal the trailing 10-year average of the daily price of gold or silver.

In addition to the gold price requirement, Lundin can recoup the cumulative investment in Fruta before any tax is needed, including US$280 million spent on the project before the company’s involvement.

After taking into account a 5% net smelter return royalty at Fruta it seems unlikely the windfall tax will come into play unless gold moves  above US$1,550 per oz.

“We came to this agreement after around six months of negotiation, which, when taken in conjunction with the existing rules and regulations, establishes a fiscal regime and operating regime for the project,” president and CEO Ron Hochstein said during a conference call. “This also opens up the door for project financing, and is the first of many milestones to come.”

Lundin has agreed to advance $65 million in royalty payments to Ecuador, with US$25 million due on executing the agreement.

The balance of the payment will be due in two equal disbursements on the first and second anniversaries of signing, which Lundin figures should happen by mid-year.

The total benefit received by the government cannot be less than 50% of the free cash flow from the operation.

In the event that the amount of money received is less than 50%, the company needs to pay an annual sovereign adjustment under Ecuadorian law.

“I don’t think there’s been too much of a change in recent months in terms of Ecuador’s attitude towards mining in light of oil prices,” Hochstein added. “It’s been something we noticed early with the formation of the mining ministry one year ago, and if you listen to the speeches by the vice-president … you’ll hear that what he’s saying is pro-mining. We’ve signed this agreement and there’s no turning back. We’re committed to building a mining industry in the country.”

BMO Capital Markets analyst Brian Quast has an “outperform” rating on Lundin and a $4.50-per-share price target, and noted that “the government of Ecuador has been viewed by many investors as the elephant in the room, impeding what we view as a world-class asset.” BMO Research speculates that the exploitation permit represents a “significant step to help alleviate such concerns.”

Fruta hosts indicated resources of 23.5 million tonnes grading 9.59 grams gold per tonne and 12.9 grams silver per tonne, for nearly 7.3 million contained oz. gold and 10 million contained oz. silver. Inferred resources total 14.5 million tonnes of 5.46 grams gold and 11.3 grams silver.

The next milestones include a feasibility study expected to be completed by late April and the upcoming exploitation permitting in mid-June.

“We prioritized completing the exploitation agreement so that our feasibility study could be completed and efforts to finance development could move ahead in earnest,” Hochstein said. “Financing negotiations are already underway along with non-disclosure agreements signed with multiple institutions, and we’ll accelerate those talks in 2016, with the goal of having the project funded by year-end. We’re looking at different structures, but I can say with confidence that we’ve had quite a lot of interest.”

Lundin Gold shares have traded within a 52-week window of $3.46 to $4.15, and jumped nearly 9%, or 33¢, on news of the agreement, en route to a $4.15-per-share close at press time.

The company has 101.3 million shares outstanding for $405-million market capitalization.