QUITO, ECUADOR — Lundin Gold’s (TSX: LUG; US-OTC: FTMNF) president and CEO Ron Hochstein sat down with The Northern Miner to discuss how he sees the prized Fruta del Norte gold project in Ecuador advancing in the months and years ahead.
The Northern Miner: Ecuador’s Mines Minister, Javier Cordova, says Fruta del Norte will be in production in 2018. Do you agree with that estimate?
Ron Hochstein: No. We’ve been saying 2019 … as we’re going through the feasibility study, we’re working through more of the mine development schedules … there are some things that we could do in 2016 if the markets improved — we could do what we call “early works,” which could push us through to early 2019.
But in terms of mine development, we don’t see production until 2019.
TNM: The minister also hinted you’re close to signing a stability agreement, and that it might be in December.
RH: Again, it’s a nuance there. What we’re saying is we’re going to agree to fiscal terms by December. We can’t actually sign the agreement because once we sign it, it triggers a bunch of other things in Ecuadorian law. Also there are two components to the exploitation agreement: there is the fiscal language — in terms of royalties and advanced royalty payments, that type of thing — and there is all the technical, which is the work plan, and what the mine is going to look like.
The work plan we can’t do until we complete the feasibility study, which isn’t going to be until early second-quarter 2016. We’re going to negotiate the fiscal side of things, and largely the agreement, subject to tacking on the technical.
TNM: Would you agree that the fiscal terms will be agreed upon by December?
RH: That’s what we’re all working towards — to have that done by year-end. That enables us to go out and start working on the financing side of things, because the fiscal is known. That’s step one. Step two will be completing the feasibility study, which allows us to file our exploitation application. But we can work with the banks and everything with the fiscal terms first defined, and the feasibility study completed.
TNM: The minister said there were other things that needed to be negotiated besides the royalties. For large-scale mining, royalties are between 5% and 8%. What other things need to be negotiated?
RH: There is the magnitude of advanced royalties. In Ecuador they have money put upfront — some of it is paid upon signing an exploitation agreement, and there are some other permits that are required.
All that money goes into local infrastructure and local economies, and we get a credit when we pay royalties on production. It’s a way to help prepare the local communities for eventual mine construction and operation … the advanced royalties are payable early on. That’s the intent … to help prepare the communities for all the employees.
TNM: And that goes into a common pool, and the government decides where the money goes.
RH: Yes.
TNM: The taxation in Ecuador is quite complicated. Can you explain what the main components are?
RH: It is not an easy thing to do. Value added tax (VAT) is still an issue.
The VAT is 12%, and Ecuador is one of the few countries in the world that doesn’t reimburse VAT for companies that export … there are still some things that we have to work on with the government, but the process is open, and negotiations are going well.
TNM: What are the tax incentives?
RH: The corporate income tax rate is 22%, which is lower. There is some work being done on relaxing duties for bringing in mining equipment that can’t be built here in Ecuador. They are still looking at the capital outflow tax … going back outside for interest payments, and things like that. There are different things they are looking at.
I don’t look at it as much as incentives, as I look at trying to develop a fiscal regime that is competitive with other mining regimes in Latin America. They’re looking at it as giving us some incentives, we’re looking at it as: “We need this in order for Ecuador to have a competitive fiscal regime going forward.”
TNM: Minister Cordova said the taxation rate is 27%, which he said compares favourably with the regional average.
RH: That’s a number they have calculated that the Chamber of Mines has a real issue with. When you compare all the taxes — because there are multiple levels of taxes, there’s profit sharing as well, part of that goes back to the government — it’s much closer to 50%. When you do a similar analysis for Chile and Peru, you’re looking at 42–48%. Ontario I think is 52%.
TNM: Total all-in taxes are close to 50%?
RH: Yes, total all-in sustaining taxes at the end of the day … that’s all going to government. The 27% — we’re not sure actually where that number comes from.
TNM: The minister said they hired Wood Mackenzie to look at Ecuador’s policies, and said the conclusion was that taxes were too high — so they lowered them to 27%, from 35%.
RH: That’s the income tax rate, but they’re not taking into account royalties that you are paying. A 5% net smelter return royalty is not uncompetitive, but it’s not low. And then you look at profit sharing, and profit sharing is 15% of your before-tax earnings. Three percent goes to employees and 12% goes to the government, but again, that’s going back into local governments.
If you’re not helping to fund local governments, the federal government has to fund local governments. You have to look at it as payments to government.
TNM: So you don’t think a 50% tax rate is all that bad?
RH: I don’t think it’s unrealistic. Yes, there are jurisdictions that are lower, but at the end of the day, if you are essentially sharing the wealth of the natural resource development, that’s a pretty good position to be in.
TNM: The tax burden isn’t prohibiting you from going forward with this project?
RH: No. And what we are cognizant of is that Fruta del Norte is one of the best undeveloped gold deposits in the world. When we’re talking to government, we have to think about what’s competitive for the mining industry, not Fruta del Norte. Because it is a rich deposit.
There are other potential projects here. There’s Mirador to the north, which is a large copper porphyry; there is a company called Odin Mining here, which is exploring … so we have to work with the government to make sure that we are creating a long-term, sustainable fiscal regime.
TNM: The stability agreement is good for an initial 15 years, and can be renewed for another 15 years?
RH: We’re negotiating for a 25-year term that can be exten
ded for another 25 years.
TNM: The goal posts seem to change depending on who you talk to.
RH: It’s new, so it’s at times challenging. But it’s rewarding as well to be first.
TNM: The minister said Ecuador should sign this deal soon to prove that its mining sector is open for business.
RH: Yes, we were at a meeting here recently with some other mining companies, and they said Lundin Gold is the one. It’s important because of the profile of the project and the profile of the company. The Lundins have a following [in the industry], so there’s one thing, I don’t want to sound arrogant about the family, but look at what they did in the Congo, what they did in Argentina … what they’ve done in oil and gas in some parts of the world. They have been successful working with governments.
If they’re not successful here, it’s not just another mining company that was unsuccessful, it was the Lundin family that was unsuccessful. So it really is putting on a lot of pressure — and not only pressure internally, but also pressure from outside.
TNM: You have your hands full with Fruta del Norte, but would you look at acquiring more ground in the country?
RH: No, we acquired a fairly large land package from Kinross. The Fruta del Norte project is 50 sq. km and there were 860 sq. km in total, and Kinross had done a lot of work on some of those, so we’re looking at that, but our focus is on the fiscal and regulatory regime, environmental permitting and feasibility study. We have done exploration work, but we’re putting that on hold until we get some of the key things done … that’s probably the latter half of next year.
TNM: All of the environmental applications submitted so far have been approved?
RH: So far, and some are in progress, but we have worked with them. One of the things we’re working on with the Lundin Foundation is training of Ministry of Environment personnel, because a lot of them don’t understand mining. They understand oil and gas, but oil and gas and mining are not the same, and that’s part of the education we have to do here as well … but they are quick studies, and with the right people in the room, you can make things happen.
TNM: The mines minister was quite critical of Kinross for abandoning the project, and Lundin paid just US$240 million for it. That was quite a good deal.
RH: If you look at the market, yes, we got it for a pretty good deal. Kinross still owns 22% of the company, so they can still participate in the upside if we’re successful. They still have the potential to earn a lot more.
The main thing that people forget is timing. When Kinross was here, oil was high. This country was awash in fiscal inputs into the country. The gross domestic product was growing like crazy, and you had a good, solid leader — and you still do — who was putting money back into the country, so the country was really growing. You had countries all over the world — Australia, Mongolia, Chile — who were talking about windfall profit taxes. So what [President Rafael Correa] put in wasn’t all that unheard of. It was a combination of things, but most of it was timing.
If you look at the environment we’re in today, it’s US$40 to US$50 per barrel of oil. I was in Guatemala last week to tour Escobal’s operations just as a benchmark, and they’re also nervous because El Niño this year has got a lot of people on this coast very concerned.
They’ve looked at what else they can do to push the economy other than oil and gas. They’ve put a big push on tourism. Tourism has grown, but as we know, tourism is not big dollars. They realize mining is the only thing that they can really do here that can help backfill oil and gas.
TNM: The minister said so far this year Ecuador has lost US$7 billion in revenue from the oil and gas sector, and pointed out there is no leverage, because the currency is tied to the U.S. dollar.
RH: [Yes.] That’s the other aspect, the strong U.S. dollar.
TNM: Can you explain the windfall profits tax?
RH: There are two big things that have changed since Kinross was here.
The first is that now you can recover all your capital before it kicks in. So that’s big.
The other is that they have set the price on the Wood Mackenzie formula, which is a 10-year average, plus one standard deviation, and brought to today’s dollars. So you have inflation working for you. A lot of the modelling we have done would not have an impact.
If you have, say, a gold company that is operating in Canada or Chile, or any place else, and you’ve got us that has this windfall profits tax, it puts us at a disadvantage, because the potential upside is limited … the modelling we’ve done, you’d need a rapid spike in gold for it to kick in.
Nevertheless, when investors look at it, they see a potential ceiling. So we continue to discuss this with the government. We’ve got bigger and more important things right now … but we continue to raise it.
There is only one other country that has a windfall profits tax that I’m aware of, and it’s Bolivia. A lot of the countries walked away from it. Mongolia walked away from it. Australia walked away from it. As far as I can tell, it’s Bolivia and Ecuador that are left.
Again, what we’re trying to do — not just Lundin Gold, but the government — is create a competitive, sustainable fiscal regime in the country.
There’s definately a lot to learn about this subject.
I like all the points you made.