Xstrata Coal seeks buyer for Donkin stake

Joining a growing list of mining companies that are reassessing their business strategies and core assets, Xstrata Coal, a subsidiary of diversified miner Xstrata (XTA-L, XSRAF-O), says it is looking to sell its 75% stake in the Donkin coal project in Atlantic Canada.  

Erdene Resource Development Corp. (ERD-T) owns the remaining 25% of the project, which sits on tidewater on Nova Scotia’s Cape Breton Island within 30 km of a deepwater Capesize harbour capable of handling 160,000-tonne Capesive vessels.

A technical report completed in June 2011 concluded that the project was worth US$1.06 billion on a net present value basis using an 8% discount rate and has a 36% internal rate of return.

Erdene has a sixty day right of first refusal on the sale of Xstrata’s operating stake in the project, which is forecast to produce about 2.75 million tonnes per year of washed high energy thermal coal and metallurgical grade coal to markets in Brazil and across Europe and Asia.

Peter Freyberg, Xstrata Coal’s chief executive, said in a statement that core to the company’s evolution and business strategy is a focus on larger volume mining complexes.

“Xstrata has stated that their decision is based not on the technical merits of the project but rather on how the company has evolved and that their priorities have become focused on larger volume projects,” Peter Akerley, Erdene’s president and chief executive, explained on a conference call. “When you look at the future of a Glencore/Xstrata you can understand that a 2.75 million tonne per year production has little impact on a US$90 billion company. But for many, that 36% IRR and an EBITDA that will be in excess of US$200 million a year at full production will prove very attractive to many.”

Akerley noted that the announcement did not come as a great surprise. “We’ve recognized for quite some time having worked with Xstrata since 2005 that this company was headed in a different direction,” he continued. “A Glencore/Xstrata is expected to become the fourth- or fifth-largest mining entity in the world and are looking at large, multi-mine complexes in the coal industry. So we have recognized that Donkin was falling lower down the priority list and for that reason we believe that this decision brings clarity and resolution to the project and sets it on a more certain and timely course leading to production in 2014.”

Under its joint venture agreement Xstrata is committed to pay the first $10 million of Erdene’s development funding requirement.  It has promised to bring forward up to $1 million of this to cover Erdene’s share of expenditure on the project during the sales process, which it hopes will be completed before the end of the year.  

“Our company has little in the way of funding requirements until 2014 unless we decide to pursue a greater interest, which would only be done if it were deemed to be of value to our shareholders,” Akerley said.

He also emphasized that project timelines will be maintained during the sales process, including the planned completion of an environmental assessment and its subsequent approval by early 2013, engineering work, and getting the go-ahead to begin an underground exploration phase. Coal production is expected to get underway in 2014 and move to full production in 2017-2018.  

“With the right operating team and particularly one that has the technical and financial ability to operate an underground mine … we’re very confident we’ll see Donkin through its production phase,” Akerley said, adding that he believes Donkin coal can be loaded onto capesize vessels coming in at less than US$60 per tonne, which puts the project well ahead of Appalachian or West Coast producers.

“There’s a strong demand for thermal and coking coal projects, especially those that have access to seaborne markets and there are very few of these in the world,” he continued.

Apart from its relatively low-cost production, the project’s other attributes include a deep talent pool of underground miners “that is unique in the world … I don’t think you have to go out and train up people,” and the importance of the project to the government of Nova Scotia.

“Donkin is a project that ranks very highly in the economic development of Nova Scotia,” Akerley said. “We see the province of Nova Scotia working closely with us to ensure the right partner is brought in.”

When asked what the ideal partner might look like—a producer, trader or steelmaker—Akerley said he was sure there would be no shortage of potential partners.

“I don’t think there is any issue with regards to finding financial backers for this project, whether it’s off-take or traders. The real question is who fits the bill from an operator perspective. Our job will be to find the right one that fits the bill.”

“I wouldn’t say we have a tremendous amount of influence,” he added, “but we’ll be there with the province making sure the applicant meets the criteria that was initially in place.”

“Would we look at building it ourselves? Not completely. Could we bring in a few people and align ourselves … That is something we have to look at.”

Akerley also emphasized the importance to Erdene and the government of Nova Scotia of keeping the project moving forward on schedule.

“The province issued a tender to successful bidders to develop this project. They own the underlying resource and have leased it to Xstrata. They don’t want to see this drag out. If the transition is to take place it has to take place rapidly. Final bids are to be submitted by September and a decision made in November so I expect the province will take a firm hand in this to ensure the transaction is brought to completion so long as there are applicants in place.”

In other remarks, Akerley pointed out that it is a “very opportune time for Donkin to be seeking a new 75% partner as almost every major coal deposit in North America has been subject to mergers or acquisitions in the last few years and in the first quarter of this year alone, there have been over US$6 billion in coal industry deals.