Work on Oyu Tolgoi underground to resume in Q1

Turquoise Hill Resources (TSX: TRQ; NYSE: TRQ) and the Mongolian government have resolved several issues that have held up the underground expansion of the Oyu Tolgoi copper-gold mine in the country.

Turquoise Hill, the mine’s operator and 66% owner, suspended underground development in August 2013, citing uncertainty over matters between itself and the government, which owns 34% of Oyu Tolgoi.

Those matters ranged from permitting and financing to the breakdown of costs and profits between it and the government.

The Mongolian government owns 34% of Oyu Tolgoi, which began production a year ago.

The impasse was compounded in June, when the Mongolian Tax Authority presented the miner with a $130-million bill for unpaid taxes, penalties and other charges related to the mine’s development.

Turquoise Hill — which is 51% owned by Rio Tinto (NYSE: RIO; LSE: RIO) — fought the bill, insisting it was paid up under the Investment Agreement signed under Mongolian law.

On the tax issue, Mongolia’s vice-minister of mining, Oyun Erdenebulgan, confirmed that the two sides had settled on a tax payment of US$30 million, down from US$130 million the government said it was owed a few months ago.

Erdenebulgan told Reuters in mid-September that neither party wanted a delay because of the tax issue and said that the project would resume construction in the first quarter of 2015.

Turquoise Hill confirmed on Sept. 22 that it had completed a detailed review of the tax ruling, and that it has “reduced the amount of tax, interest and penalties claimed to be payable by Oyu Tolgoi LLC, from approximately US$127 million to approximately US$30 million.”

It commented that “while this significant reduction is welcome, there are aspects of the ruling that require further clarification.”

While Erdenebulgan  had declared that all outstanding disputes had been settled, Turquoise Hill clarified that several issues must still be resolved for underground development to start again, including an agreement on financing and on how the economic value from the mine will be shared, the receipt of permits, and the approval of a feasibility study that the company has just completed.

The progress at Oyu Tolgoi came ahead of a Sept. 30 deadline set by international lenders for the parties to work out an agreement. The lenders, which have committed to provide US$4 billion in debt financing for the  US$4.9-billion underground development, have already extended the deadline once this year.

Tony Robson, a mining analyst at BMO Capital Markets, wrote in a note that another extension was likely and “any quick resolution would be somewhat surprising, given that the Mongolian Parliament is not due to sit until Oct. 1.”

The initial open-pit mine cost US$6.2 billion to develop.

“Recent statements by the government of Mongolia and various government ministers or senior politicians have — from the [Turquoise Hill] shareholder point of view — become more positive in recent weeks and months, probably driven by collapsing foreign direct investment and a weakening currency,” Robson wrote.

The government has passed a series of new laws and amendments this year aimed at encouraging mining investment, including a repeal of the 2010 ban on issuing new exploration licences, opening up more land to exploration and increasing the exploration period to 12 years, from nine.

However, there are still unresolved issues with exploration licences that have been revoked without recourse — many of them related to a corruption case against former Mineral Resource Authority of Mongolia bureaucrats.

Oyu Tolgoi is located in the remote South Gobi region of Mongolia, 550 km south of Ulaanbaatar and 80 km north of the Mongolia-China border.

Turquoise Hill expects to produce 135,000 to 160,000 tonnes of copper in concentrates and 600,000 to 700,000 oz. gold in concentrates this year.

In its initial open-pit phase, the 100,000-tonne-per-day operation is mining the Southern Oyu deposits (Southwest and Central Oyu).

In its second phase, according to a newly completed feasibility study, the mine would see up to 95,000 tonnes per day of underground production via block-caving from the high-grade Hugo North and Hugo South deposits.

Based on the processing of 1.5 billion tonnes of reserves, the after-tax net present value of the underground expansion is pegged at US$7.4 billion at an 8% discount rate, and the internal rate of return stands at 29% after taxes.

The underground expansion’s mine life would be 41 years, with a payback period of nine years.

Before suspending underground work last year, lateral development at Hugo North had advanced for 16 km, and shafts 2 and 5 had been sunk to 91% and 17% of their final depths. Some US$500 million has already been spent underground.

The Southern Oyu deposits contain proven and probable reserves of 1.03 billion tonnes grading 0.45% copper, 0.31 gram gold and 1.23 grams silver per tonne for 8.2 billion lb. copper, 7.2 million oz. gold and 30.9 million oz. silver.

Hugo North contains probable reserves of 499 million tonnes at 1.66% copper, 0.35 gram gold per tonne and 3.40 grams silver for 16.7 billion lb. copper, 4.7 million oz. gold and 47.1 million oz. silver.

Turquoise Hill shares recently traded at $4.06. The shares have traded in a 52-week window of $3.20 to $5.45. The company has 2 billion shares outstanding.