South Deep production halved for up to a year (May 10, 2006)

Johannesburg-listed Western Areas (WARSF-O) plans to sell shares equivalent to 10% of its current issued share capital to raise cash to keep it afloat after a recent accident that could halve production from its 50%-owned South Deep gold mine in South Africa for up to a year.

On May 4, a loaded skip broke free of its winder drum during regular rope maintenance, and plunged some 1.6 km down one of the mine’s twin shafts. The skip was followed by 6.7 km worth of rope that detached from 8 clamping devices on the winder drum while the skip was around mid-shaft.

There were no injuries and all workers were safely removed to the surface.

South Deep General manager Gordon Thompson figured it would take around 2 weeks just to clear all of the rope and have a better look at the exact extent of damages. The company has teams working around the clock to do just that.

The South African-based company initially estimates that the Main shaft, which suffered serious damage at several points, will be out of commission for 9-12 months.

While remedial work is under way, production at around 50% of normal capacity will continue via the older South shaft. The full impact on earnings has yet to be determined.

The South Deep twin-shaft expansion, which was commissioned in late 2004 after nearly a decade in development is eventually expected to boost total annual production to 750,000 oz. over 70 years.

The South Deep mine comprises the South shaft complex and newer Twin shaft complex. The South complex includes the Main shaft and sub-vertical shafts 1, 2 and 3, which service mining down to a depth of 2,692 metres below surface. The Twin shafts stretch to 2,590 metres and 2,890 metres below surface.

Western Areas is submitting a claim to its insurer. The mine’s equipment and production have insurance coverage of US$65 million though the company must cough up the first US$10 million. The company has not yet estimated repair costs.

Harmony Gold Mining (HMY-N) recently grabbed a 29.2% stake in Western Areas for around US$320 million. Harmony picked up a 14.6% interest in the mine via the deal. Likewise, Barrick Gold (ABX-T, ABX-N) inherited a half-interest in the mine through its takeover of half-owner and operator Placer Dome.

In 2005, South Deep produced a total of 461,119 oz. gold at a cash cost of US$387 per oz., up from the 428,585 oz. poured at US$383 apiece a year earlier.

Earlier this year, Western Areas and Placer halved South Deep’s reserves following a year-and-a-half review. Proven and probable reserves now total 147 million tonnes running 6.2 grams gold per tonne, for 29.3 million contained ounces.

The reduction in reserves is mostly attributed to a new geological model, an enlargement of regional pillars aimed at improving ground stability, and the inclusion of more low-grade material owing to a change in the mining method in certain parts of the mine.

Many of the trimmed ounces were shifted to the measured and indicated resource category, which now amounts to 109.9 million tonnes averaging 7.3 grams gold per tonne, for 25.9 million contained ounces. The estimates are based on a gold price of US$400 per oz.

The drop in production means Western Areas will have trouble making deliveries under its hedge book. At the end of March, the hedging commitments amounted to a derivative liability of 3.6 billion rand, when marked to market.

That hedge book saw Western Areas realize an average of US$403 for each of the 55,460 oz. of gold sold during the first three months of 2006, compared with an average spot price of US$561 per oz. Still, the realized price was better than the US$354 it got for each ounce sold during the year-earlier period.

In all, Western Areas poured some 53,973 oz. of gold at cash costs of U$422 per oz. during the first quarter. A year earlier it produced 63,841 oz. at 354 apiece.

First quarter gold production from the South Deep joint venture was around 10% below plan owing mostly to hoisting delays associated with the installation of a new skip arresting device and winder rope replacement at the Twin Shaft complex. The South shaft also temporarily lost compressed air and service water supply.

Still, the company managed to swing to a net profit of 12.2 million rand for the quarter, thanks to 35.6-million-rand insurance settlement and a 73.9-million-rand positive fair value adjustment of some of its assets owing to the strengthening of the rand versus the greenback. A year earlier, the company lost 119.1 million rand. Sales between the two periods slipped by 18% to 107.4 million rand.

At quarter’s end, the company had 133.6 million rand in cash and equivalents.