Kemess costs plague Royal Oak — Company may restructure debt or issue shares to finance mine

A sizable cost overrun at the Kemess gold-copper project in north-central British Columbia has pulled Royal Oak Mines (RYO-T) into troubled financial waters.

The company recently announced that its capital cost estimate for the nearly completed mine will ring in at $470 million, 9.3% over budget. The $40-million overrun has been attributed to escalating costs associated with the construction of the tailings dam and pipeline system. An additional tailings pipeline was added in order to decrease operating risks.

Power-line clearing and government-assessed stumpage costs accounted for $4.5 million, and another $3 million was attributed to indirect costs associated with staff requirements, site accommodations, travel, freight and fuel. The remaining costs were associated with redesign requirements during the mechanical piping and electrical stage of the project construction.

“We are naturally disappointed that the capital cost has increased above our budget estimate but compared to other major projects recently constructed, we believe the project team has done an admirable job in minimizing the overruns to less than 10%,” Royal Oak President Margaret Witte said. “We believe that the economics of the Kemess project are still excellent even at these depressed gold and copper prices.”

As a result of the overrun, Royal Oak has found itself in technical default with respect to senior secured debentures related to its trade payables. The company is carrying more than the agreed amount of debt; $3 million in payables are more than 90 days overdue.

As a result, Royal Oak’s mechanical contractor has terminated work at the site, with only three to four weeks of construction remaining. Other work at the site not related to the mechanical contractor is proceeding, and startup is still scheduled for late April.

“The company is experiencing a short-term liquidity problem, not a value issue here.” Witte said in a conference call.

Royal Oak is trying to find ways to fund the rest of the project and provide sufficient working capital until Kemess generates a positive cash flow.

Funding sources available to the company include a restructuring of the senior secured debt, restructuring of all of the company’s debt, use of equity markets and convertible preferred stock.

“We are essentially looking not at a Band-aid solution here, but a long-term, bulletproof solution for the company,” Witte said.

The company’s goal is to secure enough money to pay interest payments on existing debts, finish the Kemess project and have enough working capital to cover any unforeseeable future hiccups. Royal Oak feels that financing in the range of US$50 to 60 million would cover these costs.

“We are in very serious discussions with at least two parties with respect to providing the US$50 to 60 million of liquidity to the company.” Witte said.

If the company fails to raise the required cash, all construction at Kemess will be halted until financing is in place.

Royal Oak currently has about $2.5 million in its treasury, more than enough to meet its payroll obligations, the company stated.

Witte described Kemess as a “key element” in Royal Oak’s return to profitability. Cost-cutting measures implemented in the fourth quarter of last year at the company’s Pamour mine in Ontario and Giant mine in the Northwest Territories left the operations with an average cash cost of US$285 per oz. gold, which is below the current gold price.

The Kemess project is expected to have a mine life of 16 years. The total net cost of the project is estimated to be about $518 million, including $202 million in acquisition costs, $470 million in construction costs. The government of British Columbia is contributing $154 million.

The average life-of-mine production rate is estimated to be 250,000 oz. gold at an average cash cost of US$128 per oz., net of copper credits valued at US80cents per lb. Undiluted minable reserves are calculated at 204 million tonnes grading 0.22% copper and 0.62 gram gold per tonne, equivalent to 4.06 million oz. gold and 990 million lbs. copper. The stripping ratio is expected to be 1.28 to 1.