Prophecy Coal targets Mongolia’s growing power demand

VANCOUVER — With the Mongolian economy growing at one of the fastest rates in the world, and China eyeing its neighbour as a potential long-term power source, Vancouver-based Prophecy Coal (PCY-T) is optimistic about its prospects for a power purchase agreement (PPA) with the Mongolian government, which would lead to the construction of a 600-megawatt (MW) power project 120 km from Baganuur.

In mid-July Prophecy consolidated its land position in Mongolia’s Chandgana coal basin by acquiring the Tugalgatai licenses from Tethys Mining — a subsidiary of Brazilian mining-giant Vale (VALE-N).

The Tugalgatai licenses sit next to Prophecy’s Chandgana property, which hosts 1.2 billion measured-and-indicated tonnes thermal coal. Tugalgatai comes with a non-compliant resource of 2.33 billion tonnes thermal coal on the back of exploration work Tethys completed since 2005.

“Our reason for increasing the stake is that we’re looking at eventually taking this thing to around 4,000 megawatt capacity,” explains Director Greg Hall during a phone interview. “Obviously that’s a world-scale project and we would likely not be in the driver seat on it, but that’s the goal. The advantage for Prophecy is that we do have a long-term plan to supply power to China, but in the near-term we’re looking at being a domestic supplier in Mongolia.”

Under terms of the agreement Prophecy paid US$10 million upfront for Tugalgatai, and included an 8.5% royalty on all of its future coal sales. The royalty can be bought back for US$20 million until 2021 or US$25 million thereafter. According to a statement from Chairman and CEO John Lee, the acquisition will allow Prophecy to explore greater economies of scale and increase long-term coal resources.

Prophecy envisions itself as a vertically-integrated, base-line energy provider that will directly tap into its coal reserves through the construction of an on-site thermal coal power plant.

In late May, Prophecy entered into a covenant with the Mongolian Energy Authority to bring a 600-MW coal-fueled plant online and supply electricity to the country’s central and eastern power grids. Prophecy would supply 100-MW of net electric output starting in early 2016, with plant capacity increasing to 400-MW by the end of 2017.

An integral step will be the approval of the company’s PPA, which involves negotiations over tariff structure, price setting, and grid connections. Prophecy submitted its PPA proposal to the Mongolian government in early August, and is hoping for a reply by the end of the year.

“The process with the purchase agreements is evolving. We are not the first to submit a purchase proposal, there have been at least six granted to other companies in the last eighteen months,” Hall explains. “There has been one large-scale coal agreement signed, so we’re not doing anything new here. The difference is that we’re the first proposal in over twenty years to supply the domestic market with substantial base-line power. Our final [proposal] has been submitted, so now it is really in the hands of the government.”

Receiving a purchase agreement with the Mongolian authorities is the major determining factor in whether Prophecy will be able to meet its construction goals. The company is hoping to begin its initial build-out in the first half of 2013, with a second-phase scheduled to begin in 2014.

Prophecy has signed a coal supply agreement with its wholly-owned subsidiary, Prophecy Power, to supply 3 million tonnes of coal per year over a 25-year period. Initial coal prices will be pegged on economic factors including the price of diesel and Mongolia’s consumer price index. The overall project cost is estimated at US$1.2 billion, which Prophecy intends to finance through a combination of debt and equity instruments, as well as possible joint-venture participation.

“We’ve been working on the financing side for the better part of a year, but the process is dependent on the government reviewing our PPA,” Hall comments. “We’ve received all the environmental permits and operational licenses so the only thing left is that power agreement. Once you have a PPA with a government, and I’m not just talking about Mongolia here, the global finance industry pounces on these things very quickly because what you’re really talking about is long-term annuity.”

Prophecy intends to fulfill its supply agreements through traditional truck-and-shovel mining of the Chandgana coal resource. Strip ratio would be relatively low at 2 to 1 since the majority of the coal seams are within 260 metres of surface. The project also lies 160 km from rail transport, 16 km from paved highway routes, and 150km from a power line with connection to the main grid.

By constructing its own power facility, Prophecy could also alleviate some of the over-supply issues it has encountered at its operational, 100%-owned Ulaan Ovoo coal deposit 430 km from Ulaanbataar, Mongolia’s capital city. Prophecy suspended activities at Ulaan Ovoo in early August, reporting its stockpile of 187,000 tonnes of coal sufficient to meet supply obligations through the remainder of the year.

The company expects the shutdown will last six months — roughly 65 workers were laid off due to the closure. According to a Prophecy release the effect of the suspension is “modestly cash-flow positive” since the operation has not yet achieved break-even levels.

Prophecy has 223 million shares outstanding and a $43 million market capitalization. The company has traded within a 52-week range of 16¢ and 77¢ — closing at 19¢ at presstime. Prophecy Coal’s share movements are tied to its sister-company Prophecy Platinum (NKL-V), as the energy company continues to hold roughly 42% of the shares in the platinum explorer after a spin-out in 2010 involving Red Hill Energy.