Turquoise Hill on the rise after clearing hurdles

VANCOUVER — Copper-gold producer Turquoise Hill Resources (TSX: TRQ; NYSE: TRQ) has been on a strong run over the past eight weeks after promising press releases for its large-scale Oyu Tolgoi mine, 550 km south of Ulaanbaatar, Mongolia.

The good news culminated in May when the company reached a milestone agreement with the Mongolian government and parent company Rio Tinto (NYSE: RIO; LSE: RIO) that sets the framework for an underground expansion at the mine, which should unlock substantial long-term value.

The underground component remains a key step at Oyu Tolgoi, since Turquoise Hill estimates that the US$5.4-billion expansion scheme will help it access copper reserves that represent 80% of the project’s overall mineral value. The company has already invested US$6.6 billion in Oyu Tolgoi’s open-pit component.

Under the agreement, Rio agreed to pay US$30 million in taxes on mine development and will try raise up to US$6 billion in third-party project financing. Discussions with a group of 20 banks are set to begin in the coming days.

In terms of ironing out tax and royalty wrinkles, Turquoise Hill and Rio have agreed to pay the government a 5% sales royalty on gross revenues, as well as concede rights to a 2% net smelter return royalty acquired from BHP Billiton (NYSE: BHP; LSE: BLT) for US$37 million back in 2003. The agreements also address the sourcing Oyu Tolgoi’s power.

“The mine development and financing plan is a significant first step towards restarting underground development,” Turquoise Hill CEO Jeff Tygesen said during a conference call.

“In terms of the financial impact of the various elements of the agreement, the largest net value impact [for us] is the change in royalty calculation. The government has pledged their support for project financing. Turquoise Hill and Rio will work with the lending group in the coming months to complete the facilities,” he elaborated.

Turquoise Hill says the overall impact of the agreements is less than 2% of the net present value (NPV) of the reserve case of US$7.4 billion based on a 2014 feasibility study (FS). The company figures the new royalty calculation will impact its NPV by US$180 million.

Part of Turquoise Hill’s initial investment decision included investment in developing the Hugo North underground mine in parallel with the open pit, with the underground recognized as the most significant value driver for the project.

Hugo North has 499 million probable tonnes grading 1.7% copper, 0.35 gram gold per tonne and 3.4 grams silver per tonne. Contained metals total 16.7 billion lb. copper, 4.7 million oz. gold and 47 million oz. silver. Measured and indicated resources tack on 976 million tonnes of 1.6% copper, 0.38 gram gold and 3.56 grams silver.

Tygesen says the company aims to place the financing agreement  as early as October. The next steps will involve approving the updated underground FS, and the government approving the operating permits.

“Now that we’ve got the resolution, we’re just working out how we’ll go about modifying the submission — but the first piece of work that we need to do is to reschedule the mine with the new restart date, and reconstitute the [FS],” senior vice-president operations and technical development Stewart Beckman added.

“That will take us a few months to do. I don’t see any particular issues in the work and getting it approved, and going through the process, because we’ve been quite busy doing that work already. But … there will be work for us to go back and reschedule it based on the new start dates.”

Meanwhile, Oyu Tolgoi’s open pit operations have improved after some setbacks last year. Turquoise Hill reported first-quarter production of 33,600 tonnes copper in concentrate, and 86,000 oz. gold in concentrate. The company aims to crank out between 175,000 and 195,000 tonnes copper in concentrate and 600,000 oz. and 700,000 oz. gold in concentrate this year.

Production in the second half of 2015 is expected to trend higher, as mining returns to the higher-grade zone of the open pit. Turquoise Hill expects sales and production will be more aligned moving forward, as concentrate inventory is “worked down to normal levels.”

In related news, Turquiose Hill divested interests in beleaguered coal outfit SouthGobi Resources (TSX: SGQ) in April. The company will garner $17 million for the sale, with $8.5 million already received, and the balance due on the first anniversary of the transaction. SouthGobi is under a de-listing review with the Toronto Stock Exchange, and is battling legal troubles in Mongolia.

Shares of Turquoise Hill have gained 43%, or $1.62 over the past two months, en route to a $5.48 close at press time. The company has traded within a 52-week window of $3.17 to $5.80, and has 2 billion shares outstanding for an $11-billion market capitalization.