Would you walk away from $50 to $200 per ounce gold? Barrick Gold just did.
So why would the company — with average all-in costs around $975 — ditch over 15 million ounces of proven and probable gold reserves and 675 million ounces of silver when extraction costs are so absurdly low?
The answer is the only one that could possibly make sense: They didn’t have a choice.
Hidden Costs
Barrick’s troubled massive mine is the Pascua Lama project straddling the border between Chile and Argentina, high in the Andes Mountains.
The company launched the project in 2006 and bet big on it, for obvious reasons. Tons of cheap gold at low total costs was a no-brainer.
Unfortunately, the drop in gold prices through late 2012 and all of 2013 hurt the long-term prospects for the company. Investors fled the sector and share prices dropped by two-thirds.
The company, worth about $21 billion right now, has already spent $5 billion on the project so far. The total cost could have been in excess of $8.5 billion.
The company had no choice but to slow capital expenditures and mothball projects. Pascua Lama, with its massive capital requirements, was on the chopping block. It took $300 million just to ramp-down the project.
Now, it looks like Pascua Lama will be on ice for many years, if it is revisited at all.
Coupled with corporate governance blunders — shareholders have a class action lawsuit alleging “misrepresentations and failures” — and lower gold prices, an often overlooked factor resulted in the coup de grâce — water.
Parched Land
Pascua Lama is located in one of the harshest and driest areas on the globe, the Atacama Desert.
This region gets an average of 8 to 13 millimeters of rain per year. Some weather stations have never recorded precipitation, and evidence suggests no significant precipitation at all between 1570 and 1971.
With so little water coming from precipitation, communities in the area often depend on a single source of water, normally streams coming from ever-shrinking glaciers.
Virtually all of Barrick’s problems with Pascua Lama can be traced to this extremely tenuous situation. Barrick has not done nearly enough to balance competition for water and contamination concerns.
Chilean courts have slammed the company’s plans. Lawsuits resulted in halted work on the mine, rejected environmental impact reports, and surging capital expenditures.
$16 million in fines on Barrick were revoked only because the court said the government erred in lumping 22 violations into five groups. Instead, it said Barrick should be punished for each and every one individually.
Other cases have ruled in favor of local populations regarding water contamination from Barrick’s operations, upheld strict environmental requirements and demanding a monitoring program for the three glaciers next to Pascua Lama.
Barrick isn’t the only company feeling the heat either. Earlier this year, Chilean lawmakers presented a bill that would force mining companies to make massive investments in water infrastructure.
The measure would force all mining companies which extract more than 150 liters of water per second to incorporate desalinated seawater into their operations.
Some companies, such as BHP and Freeport-McMoRan have already done this, but the costs are prohibitively high.
The cost of desalination in Chile is about $5 per cubic meter, as compared to around $2.30 in the U.S.A. This has resulted in the mining industry’s energy operating costs soaring as high as 14% of total production costs.
All-in costs for mining operations would spike up from previous estimates if and when the law goes into effect, potentially curtailing copper, silver, and gold production and shutting down other projects in the region.
Bad Management
Barrick, even though it is one of the largest mining companies in the world, perfectly illustrates two kinds of threats all investors should consider before buying mining company shares.
First up, you have to take a careful look at the regional and local risks involved with a project on your own.
Water issues, environmental impacts, rejected and delayed reports, and a slew of other factors can completely undermine profit potential and the viability of projects.
Pascua Lama was estimated to need $1.5 billion in initial capital. The company has pumped in $5 billion so far, and the estimated final bill is $8.5 billion.
Needless to say, the early estimates for all-in cash costs increased in tandem. Ultimately, they were meaningless for Pascua Lama since the project sits untapped. It is just a pure loss.
That is why Barrick took a $5 billion write-off and had to cut dividend payments last year, making its funding issues even worse as investors fled.
The second threat is management. Wildly inaccurate cost estimates, inadequate responses to an adverse gold market, and disregard for local concerns turned the Chilean government and investors against the company and its leaders.
Chilean courts have set a precedent that will keep Pascua Lama on indefinite hold and result in much higher fines.
Mismanagement ultimately led to the class action lawsuit, which has a good chance of costing the company another $6 billion.
Barrick executives should have known that building a massive open pit mine right in the heart of three major sources of water in the most arid desert in the world would be far more expensive than they suggested to investors.
The Other Side of the Coin
For as horrible as mismanagement can be to a mining company, the opposite is true as well. Good management can yield amazing results.
Companies with honest, responsible, and experienced management teams do a great job of anticipating any hurdles, accurately estimating all-in cash costs for projects, winning over governments and locals, and minimizing delays.
All of these keep capital expenditures as low as possible and ensure an economically feasible project turns into a profitable mine.
Not too long ago, I sat down with fellow Outsider Club editor Nick Hodge and took a look at three junior gold miners he has researched with a focus on management and viability of their flagship projects.
Quite frankly, these kinds of opportunities to invest in low all-in cash cost projects with stellar management track records are rare at such attractive share prices.
He already has one junior gold miner in his portfolio, and Nick’s next two picks will be sent out to his Like Minded People readers within a couple weeks.
