Chubut’s draft mining legislation confounds miners

Pan American Silver (PAA-T, PAAS-Q) is warning shareholders that if draft mining legislation proposed by the governor of Argentina’s Chubut province becomes law, its Navidad silver project will become uneconomic.

Ironically the draft law recently submitted to the provincial legislature for debate and review apparently modifies the province’s existing ban on open-pit mining in the area in which Navidad is situated, but the compromise comes at a prohibitively high cost with increased royalties and greater state ownership.

The draft law includes a new 5% net smelter return royalty on top of the existing 3% NSR; a new requirement that Petrominera, a company owned by the Chubut government, will receive no less than 4% of total sales; and that Petrominera will receive a new 7% direct carried net pre-tax profit interest.

If a company can prove that Petrominera’s right to receive 4% of total sales would make a project uneconomic, Petrominera’s participation on the project’s total sales would be cut by up to 75%. But in such cases, the net pre-tax profit interest would be increased to a minimum of 12%. 

The new regulations come on top of the current 10% export duty payable on concentrates and an income tax rate of 35%.

“Based on significant (+20%) inflation in Argentina over the past few years, we already believed Navidad was challenged, and we believe these additional regulations would undoubtedly eliminate the prospect for positive returns,” mining analyst Chris Lichtenheldt of UBS Investment Research wrote in a research note to clients.

Geoff Burns, president and chief executive of Pan American Silver, one of the world’s largest primary silver producers, could not be reached for comment. But in a prepared statement he described the proposed legislation as an “incredibly unfortunate development” that would make Navidad uneconomic “at any reasonable estimate of long-term silver prices,” and declared the company would have “no other reasonable option but to suspend further investment” in the project.

“This level of government participation and tax burden is unprecedented relative to any of the other jurisdictions where Pan American operates,” he continued, “including the province of Santa Cruz in Argentina, where the company’s Manantial Espejo mine is located.”

In May, Pan American said it had invested US$7.1 million in Navidad during the first quarter of 2012.  Work focused on the completion of an updated feasibility study, which is expected to be ready during the second half of the year. A scoping study completed at the end of 2010 outlined a mine life of 17 years with life-of-mine silver production of 275.5 million oz. at an average cash cost of US$6.96 per oz. silver, net of byproduct credits.

Analysts Brad Humphrey and Phil Russo of Raymond James question Chubut’s seriousness in creating a viable mining sector. “One cannot help but be concerned by the developing landscape in Chubut (in its current proposed form),” they write in a research note. “On one hand, it is positive that legislation is advancing but on the other hand, the seriousness of Chubut’s government to create a viable mining sector must be called into question with proposed regulations that would likely suffocate even the most economic projects.”

The analysts note that Pan American’s declaration that it will not move the project forward unless the draft legislation is amended to make it more reasonable “is the most sensible option for the company.” And if the legislation is amended in a meaningful way, they add, “Pan American’s intent to move a scaled-down version of Navidad forward initially is a likely move.”

Christopher Ecclestone, a mining analyst at Hallgarten & Co., concedes Chubut has never been very mining friendly but sees it all a bit differently. He argues the draft legislation will probably be passed in the legislature and is, in fact, “not out of line” when compared to many other emerging economies in Africa and in South America.

“The big thing in Argentina right now is the talk about social benefits and frankly they’re on pretty strong ground because [historically] what you’ve had has been really circumscribed benefits to the local population,” he explains in a telephone interview from his office in New York. “You’ve had fly-in-fly-out foreigners, minimum numbers of locals employed, and minimum royalties for the provinces.” He also notes that much of what has been mined to date in Argentina has been sent out of the country rather than refined or processed into value-added products locally.

“Mining companies really have to think about the social angles here,” he continues. “What are they providing for anyone? They’ll say ‘Oh, we’re investing $400 million dollars for example to build a mine…but are they talking $400 million dollars worth of mining equipment made in Argentina? No, they’re talking $375 million worth of mining equipment that is imported and perhaps $25 million that is sourced from Argentina. And they’re talking maybe 30-40 local jobs.”

“The Federal government, a month or two ago, started talking about the whole issue of local sourcing,” he adds. “There’s a lot of stuff that goes into building a mine that isn’t high-tech. Argentina has a huge steel industry, for example.”

The draft mining law will be subject to review and debate by a parliamentary sub-committee that will have the opportunity to make amendments to the proposed legislation. Once the sub-committee has completed that process, the legislation will be re-submitted to the full legislature for debate and a vote.

Other companies with assets in Chubut include U308 Corp. (UWE-V, UWEFF-O), whose Laguna Salada uranium-vanadium deposit lies 200 km southeast of the provincial capital of Rawson, and UrAmerica, a private uranium exploration company whose Cerro Solo project is about 350 km southwest of Rawson. Calypso Uranium Corp. (CLP-V) also holds claims and concessions in Chubut, as does Metallum Resources (MRV-V), which is earning a 70% interest in the M-18 silver-gold property from Silver Standard Resources, and Gold Peaks Resources (GL-T), which is exploring its La Fortuna gold project in the eastern foothills of the Andes mountains, about 1,300 km southwest of Buenos Aires. 

In June, Pacific Bay Minerals (PBM-V) reported encouraging results from a prospecting, mapping and sampling program at the July uranium project, where the Canadian junior is earning a 90% interest from state-owned Petrominera. Pacific Bay retains over 400 sq km of claims in the Cerro Solo uranium region of Chubut, including the 100% owned KM Regalo property. 

Earlier this year in January, Marifil Mines (MFM-T) signed an option agreement to purchase a 100% interest in Arroyo Verde, a 149.6 sq. km. property that hosts both an epithermal gold target and a separate porphyry copper-molybdenum target.