Terrane Bites The Bullet And Delays Mt. Milligan

SITE VISIT

SMITHERS, B. C. — As Robert Pease, the president and CEO of Terrane Metals (TRX-V, TRXOF-O), would later describe it, the timing of the site visit to the Mt. Milligan copper-gold project was unfortunate. It was August. Economists were still loath to use the word recession. And Terrane was talking about getting construction of a $917-million open-pit copper-gold mine started, 155 km northwest of Prince George, B. C., within about a year.

“When we did that analyst trip, we were really just starting to kick off our major, let’s-go-out-and-put-debt- together effort,” Pease says.

Management was out in full force onsite. Peter Marshall, senior vice-president project development, talked excitedly about finalizing contracts on long lead-time equipment. Terrane had recently inked deals with Metso on a primary crusher, a 40-tonne semi-autogenous grinding mill, and two ball mills, among other equipment. Down payments were low, he said, and Terrane hadn’t had to burn the $40-million line of credit extended to it by its major shareholder Goldcorp (G-T, GG-N). Terrane had nailed down delivery of the mills to 2011, he said.

Marshall was especially happy that most of Terrane’s purchases had come in on budget, though he said they were getting “bitten” on steel-intensive items, such as trucks and shovels. They came in between 10% and 15% over budget. As for pit equipment, Marshall said the company was still considering bids. Management wasn’t in a hurry, he said. As a colleague at Goldcorp reasoned with him, “It’s not too often you spend $120 million. So you may as well get it right.”

He also spoke about Terrane’s July 2009 target to begin construction, saying there were “two things to punch in now, water dams and an access road.” But he noted that “one of the neat things about Milligan is how little we have to spend on off-site infrastructure — four per cent.” He said, “You’ve got 100 megawatts of power just waiting to be used.” Terrane would have to put in a 92- km power line at a cost of about $30 million but it had secured the rights to power with BC Hydro.

Pease spoke about the upsides of the project: lots of copper and lots of gold (334 million proven and probable tonnes grading 0.217% copper and 0.428 gram gold per tonne for 1.6 billion lbs. copper and 4.59 million oz. gold), a low strip ratio (0.82), found in a neat, near-surface package in a politically stable country and close to existing infrastructure.

The plan as it was then set out in Terrane’s recently completed feasibility study was to begin building a conventional truck-and-shovel open-pit mine using a 60,000- tonne-per-day copper flotation concentrator during the second quarter of 2009. Then it would go to production in the first quarter of 2012, producing about 88 million lbs. copper and 217,000 oz. gold a year over a period of just over 15 years.

That plan, using a base-case scenario of US$2.75-per-lb. copper and US$600-per-oz. gold, gave an internal rate of return (IRR) of 18.1%, a net present value (NPV) discounted at 8% of $606 million and a payback period of 3.7 years.

What’s more, Goldcorp had lubricated the project’s wheels with a $40-million convertible line of credit. In converting, Goldcorp could basically opt to switch its equity interest to a 30-60% joint-venture interest. “And ya, that was really Plan A, if you will,” Pease says. “Plan A would have been Goldcorp stepping into a joint venture.”

But that was August.

“And then,” Pease says, “the markets really started to run away from us.”

In October, Goldcorp told Terrane not to depend on Plan A to finance the project. “Their exact words to us were: ‘You know, even if we owned this project 100 per cent ourselves, we’re not even sure we could finance it for the fall of ’09,’ ” Pease says. “So they said, ‘Let’s just slow this down a bit given the state of the markets.'”

Pease emphasizes “slow down.” Goldcorp is still backing the project, he notes, and not only does its president and CEO, Charles Jeannes, sit on Terrane’s board of directors but more importantly, Goldcorp’s $40-million line of credit is still in place.

“We have a friendly shareholder there who takes a risk view and says: ‘Hey, this is a good bet. We should make sure these guys continue to be financed (in a project) that we have a nice strategic interest in. It keeps that project moving forward, it keeps that team together,'” Pease says.

With a rotten credit market and financing a remote possibility, Terrane has had to make swift changes to its plan as set out during the August visit to Mt. Milligan.

“We had to bite the bullet and say there is going to be a delay in the project,” Pease says.

First, the company renegotiated equipment contracts, getting extensions from its long lead-time suppliers. Terrane has been able to keep those orders in place, but has suspended delivery and its down-payment schedule.

With a 2009 start date out of the question, Terrane has also had to reevaluate what it could accomplish on Mt. Milligan in the near term, to continue to “add value” as Pease puts it, while it rides out a stormy credit climate.

Permitting, he says, will keep moving forward. Terrane submitted its provincial environmental assessment this summer and Pease expects a decision to come in late March. Likewise, it will push ahead with the somewhat lengthier federal process. And a Wardrop team, albeit a smaller one, that Terrane awarded an engineering contract in October will continue work on aspects of detailed engineering.

“We’re not going to be out there drawing blueprints for the sake of drawing blueprints,” he says. Terrane will be pinning down more exact locations of equipment such as the primary crusher, ball mills, power lines and tailings pond.

Then there is the flip-flopping value of copper and gold in the ground at Mt. Milligan. In August, Marshall speculated, “Are we a gold company or are we a copper company?” To which Pease answered, “At today’s prices, we’re a copper company.” In terms of metal value, Terrane was then about 60/40 copper- gold.

“It’s exactly the other way around now,” Pease says, with 60/40 gold-copper.

How does that change the project’s economics? Pease doesn’t believe the copper and gold flip-flop at Mt. Milligan will significantly affect these as set out in its 2008 feasibility study. For example, dropping the US$2.75-per-lb. copper used in the base case to US$2 while increasing the base-case US$600-peroz. gold to US$800, gives an NPV of $455 million, an IRR of 16% and a payback period of 3.9 years. That’s not far off the base case’s 18.1% IRR, $606 million NPV and payback period of 3.7 years.

And he notes that at US$2 per lb. copper and today’s gold price, “the cash costs effectively go negative.” In the 2008 feasibility, the projected production cost of an ounce of gold, net of copper credit, was in fact negative US$268.

Still, Pease says, as Terrane considers future financing plans, it will need to update the feasibility study.

“Part of our motivation for updating the feasibility is you’re now going to be going out there for major debt financing and you’re going to want to have a feasibility study that’s not a year old.”

But there are upsides to the update, he says. He sees potential to cut costs — nothing overly significant, he stresses — due to lower prices of steel and fuel. He says there are already de-escalation clauses in its purchase agreements for steel-intensive items: cheaper steel means cheaper equipment.

Likewise, he expects not only to cut costs on construction contracts, as the sector is hungry for projects, but to potentially get higher quality of workmanship.

“If we’re in a position to move forward with (Mt. Milligan) in 2010. . . you’ll be able to get the A-list construction company working there at a discount to what you would have paid the C-list construction crew a year ago.”

And while some mining companies
pare down the scale of their projects to put forward projects with significantly lower capital costs — a sort of production imperative increasingly valued by investors — don’t expect to see a smaller-sized mine plan at Mt. Milligan, Pease says.

For instance, he notes, even if Terrane halved the breadth of throughput to 30,000 tonnes per day from 60,000 tonnes, it wouldn’t halve the capital costs. “It doesn’t really work,” he says. “It’s the nature of the big, low-grade deposit.”

While Pease could sound dejected given the turn of events at Mt. Milligan, he does not. And in fact, he sees a bonus in not having secured large chunks of project financing in late summer or early fall.

“People say to me now, ‘You know, it’s too bad you missed that (a friendlier loan market),'” Pease says. But if the company had been halfway through financing and committed to start construction when the market busted, “we could have been in a really tight spot.”

With potentially heavy loans on its books and more needed to get the project to completion, Pease wonders what might have occurred. Could they have sourced more financing? Would the credit terms have been punishing? Or worse still, might receivership have been a real threat?

“The bad news is the debt market fell apart on us,” he says. “But the good news is we didn’t get committed to production. We had the opportunity to put the brakes on and say, ‘Whoa-whoa-whoa-whoa, whereas if we had been a little further into it, we could have been really burned.”