Second Keno Hill mine is key to Alexco’s plan

VANCOUVER — There are over 40 million oz. of indicated silver resource sitting alongside a modern mill at Alexco Resource’s (TSX: AXR; NYSE-MKT: AXU) historic Keno Hill property in the Yukon, but, with the price of silver struggling to stay above US$20 per oz., the question is how to make money mining it.

It’s a question that’s been pondered before in the storied mining camp, which produced more than 217 million oz. silver between 1913 and 1989.

A few years ago Alexco thought it had the answer. Between 2008 and 2010, it built the first new mine and mill at Keno Hill in decades, reaching production in early 2011. Over the next 32 months the Bellekeno operation churned out 5.6 million oz. silver, 45 million lb. lead and 16 million lb. zinc.

Then a falling silver price derailed the new mine. In the first half of 2013 silver prices lost as much as 40% to fall below US$20 per oz. in mid-year. A week later Alexco announced it intended to suspend Bellekeno later in the year, giving the silver market time to improve and the company time to figure out a new plan for Keno Hill.

There are a lot of components to integrate into that plan.

There are five defined deposits at Keno Hill. Three beg to be mined: Bellekeno is a developed underground mine, Lucky Queen is partially developed, and Flame and Moth has recently become the largest and easiest to develop due to its shallow depth and proximity to the mill.

Despite an abundant resource, when Bellekeno was operating, it alone couldn’t satisfy the mill. Bellekeno maxes out at 250 tonnes per day. The mill can process 400 tonnes per day.

Alexco faced other struggles in containing its unit costs at Bellekeno. With no experienced underground miners available locally, the contract mine operator had to hire workers from across Canada — and fly them in for every two-week shift. It was this combination of limited mill feed, expensive labour and a low silver price that made the mine untenable.

So what is the best way out of this dilemma?

“For the longest time we proceeded on what seemed the most logical plan: put Bellekeno back into production immediately, since it’s just sitting there on care and maintenance, and then work away at developing Flame and Moth,” said Alexco president and CEO Clynton Nauman in a conference call. “But we know that Bellekeno was never designed to produce more than 250 tonnes per day, and so in a low silver-price environment that would put us exactly where we were in early 2013: our unit costs would be high due to the low throughput, and we would be simply trading dollar for dollar.”

It was only when Nauman and his team focused on insufficient throughput that they saw the solution. Keno Hill needs another mine.

“The main key is that we need to operate the mill at Keno Hill at capacity right from the get-go,” Nauman said. “We’ve been pretty vocal about the fact that those underlying costs are high, which means your margin for profitability is small when you’re operating at 200 to 250 tonnes per day. That’s what drives us towards the 400-tonne-per-day project. That metric was the cornerstone for the various production options that we considered.”

A new preliminary economic assessment (PEA) outlines one way that could happen. Alexco would start by spending $25 million to both restart Bellekeno and develop a new underground mine at Flame and Moth, which only requires 700 metres of underground development and a 100-metre raise before mining can begin. This would take about nine months, according to the study.

“That work would start early in 2014,” Nauman said. “Later in the year we would begin to recommission the Bellekeno mine and have it ready to simultaneously go into production along with Flame and Moth. This is the profile required to achieve a mill feed of more than 400 tonnes per day as quickly as possible.”

In the third year of operations mining at Bellekeno would taper off. A new mine at Lucky Queen would replace the lost feed. Throughout its 5.5-year mine life, the operation would be anchored by 320 to 370 daily tonnes of output from the Flame and Moth mine, which would provide 73% of the 406-tonne-per-day mill feed.

Total life-of-mine project cash costs come in at $76 million, almost half of which is for underground development.

“With 23 million oz. silver already indicated in resource, the Flame and Moth deposit is the third-largest silver deposit discovered at Keno Hill in the last 50 years, and it remains open,” Nauman said. “In my view, when ultimately delineated, this deposit will become a cornerstone asset of the district and has the potential to anchor production well into the 2020s.”

The operation would process 806,900 tonnes of ore grading, on average, 745 grams silver per tonne, 0.4 gram gold per tonne, 2.7% lead and 4.7% silver. That represents only a bit more than half of the indicated resources at Bellekeno, Flame and Moth, and Lucky Queen, which is why Nauman described the PEA plan as “pretty conservative.”

The mine as envisioned in the PEA carries an after-tax net present value of $29.6 million and generates a 39% after-tax internal rate of return, enabling capital payback in 3.5 years. These numbers are based on a 5% discount rate and metal prices of US$24 per oz. silver, US95¢ per lb. lead, US85¢ per lb. zinc and US$1,300 per oz. gold.

The economics take Alexco’s deal with Silver Wheaton (TSX: SLW; NYSE:SLW) into account. In 2008 the streaming company provided US$50 million to help build Bellekeno, which was a $61-million project. In exchange Silver Wheaton has the right to buy 25% of the payable silver produced from the Keno Hill district for $3.90 per oz.

All of the regulatory requirements for mining activities at Bellekeno and Lucky Queen are already in place (Alexco previously drove a decline to within a few hundred metres of the deposit at Lucky Queen).  Permitting for development and production at Flame and Moth is underway. Alexco is familiar with the Yukon permitting process: permitting Flame and Moth will represent the company’s ninth time through an environmental assessment.

Nauman stressed that plans for Keno Hill are still a work in progress. The PEA represents one viable option, but others are under consideration, and plans could change if the markets move.

“One of the things I like about this overall strategy is the optionality that we retain,” Nauman said. “If there is — and Godspeed the day — a spike in the silver price, we could move relatively quickly to put Bellekeno back into production. At Lucky Queen there are a couple hundred metres of development to finish up to put that deposit online. And we also have Onek, which is essentially developed. It’s a zinc-based resource that would be interesting if there’s a zinc-price increase.”

Alexco is also working on ways to reduce its costs at Bellekeno, one of which will be a shift to owner-operated mining. The company already owns the underground mining fleet, but had used a contractor to operate the machines.

Located 330 km north of Whitehorse, the project is connected to the Yukon’s power grid and is road accessible. There are some 35 historic mine sites within the 234 sq. km property.

In 85 years of production the Keno Hill district produced 5 million tonnes of ore carrying average grades of 1,390 grams silver per tonne, 5.62% lead and 3.14% zinc. During Bellekeno’s last quarter of production the mill
processed 283 tonnes per day. Head grades averaged 751 grams silver, 7.1% lead and 4% zinc.

On news of the PEA Alexco’s share price gained a cent to close at $1.32. In February, shares were worth $4.60. Alexco has 63 million shares outstanding.