|Summary: Australian copper producer PanAust has seemingly bought a bargain with the acquisition this month of a major copper and gold project in PNG. But the markets don’t think so, given the inherent geopolitical and population risks that dog the nation.|
|Key take-out: A large number of Australian mining companies have exposures in PNG and several, including BHP Billiton and Newcrest, can present detailed case studies of what can go wrong in a country known for its problems.|
|Key beneficiaries: General investors. Category: Mining stocks.|
Buying cheap shoes is never a good idea. It’s what your mum said, and it’s what Australian investors are telling company managers who think snapping up a bargain in Papua New Guinea is a bright idea.
Newcrest Mining’s trouble with local clans on Lihir Island, just off PNG’s north coast, is a case study of what can go wrong in a country known for poor governance standards and where segments of its population can be unruly.
The importance of PNG to Newcrest, which has suffered a severe share-price fall over the past 12-months, is shown in the table (below), with 57% of the company’s assets tied up in the country but only 30% of its revenue and 30% of its profits.
Other ASX-listed companies with significant PNG exposure include Oil Search, St Barbara, Horizon Oil and Marengo Mining.
|As per FY13 accounts|
|Company||ASX Code||% of assets||% of Revenue||% of EBIT|
PanAust, an Australian copper miner with its best asset in the South-East Asian country of Laos, has also just discovered the low opinion in the market of its “cheap” acquisition of an 80% stake in the Frieda River copper and gold project in PNG.
The Frieda River project, hailed by the company’s chief executive, Gary Stafford, as “awe-inspiring in terms of vision” failed to impress investors, who knocked 5% off the value of PanAust on the day it was announced, and have continued selling.
The immediate reaction is the best test of what Australian investors think of a company sending their money to a country with an appalling reputation for changing the rules and, in the case of a recent move on the Ok Tedi copper mine, backdating the changes.
Announced at 8.37am last Friday, PanAust shares fell from their overnight close of $2.02 to $1.90, before ending at $1.91, a drop of 5.5%. That fall, while seemingly modest, compares badly with the trading in other copper stocks on the day, such as OZ Minerals, which added 4c (1%).
In theory that means PanAust’s PNG adventure in an awe-inspiring, but expensive and difficult project, which has fooled previous owners and earned the company a share-price discount of between 5%-and-6%.
In time, PanAust might be able to convert Frieda River from a discovery that has been picked over since 1966 into a viable mine, but to do that it will need ironclad assurances from the PNG Government about the approvals process and local involvement.
BHP Billiton is a recent case study of what can go wrong in PNG, with the country’s government proposing to rescind a 12-year-old agreement covering the once-troubled Ok Tedi copper mine.
Undoubtedly an environmental disaster in the 1990s, Ok Tedi was cleaned up by BHP Billiton and slated for closure. But the PNG Government demanded that it be kept in production and that majority ownership be transferred into a charitable trust to assist the residents of the country’s Western Province, especially around the Fly River, which had been heavily polluted by mine-waste run-off.
A new PNG Government led by controversial Prime Minister, Peter O’Neill, is now changing the rules, taking control of the charitable trust (which its predecessors helped establish) and seeking to end an immunity from prosecution over the pollution that had been granted to BHP Billiton.
As a precedent for what the PNG Government might do to other mining and oil projects in the country, the revival of the Ok Tedi situation, and the proposed retrospective rule change, is not so much awe-inspiring as awful.
The irony of PNG is that it is a country with fabulous geology, rich in copper, gold, oil and gas. It’s the natural endowment which once attracted most of the world’s major resource companies, only to see many of them leave after a bad experience with government, or rebellious locals.
Rio Tinto, through its associate, Bougainville Copper, was one of the first to suffer financial pain in a 1989 uprising that became a civil war that ended nine years later, and after one of the world’s biggest copper mines at Panguna had been destroyed.
Newcrest’s PNG agony has been largely self-inflicted, up to now. In 2010, Newcrest paid a handsome $9.5 billion for Lihir Gold, only to discover that the primary asset of the target was not the “goldmine” it expected, suffering from rising production costs courtesy of the project being located in a still hot, but largely dormant, volcano.
Worse was to come from Newcrest as it encountered the difficult locals, who are demanding a greater share of the declining profits and could force the closure of the mine if negotiations turn nasty.
Investment analysts are watching Newcrest’s Lihir operations closely because the latest round of haggling with the locals had been expected to be completed by Christmas but might now drag on into 2014.
UBS, in a research report on Newcrest circulated yesterday, warned of the Lihir landowner issue, which it said “remained a challenge”.
The investment bank said as long as negotiations remain unfinished “we believe there are ongoing risks for production stoppages at the mine through the traditional gorgor grievance mechanism.”
Gorgor is a plant used by local clan leaders to settle land disputes peacefully. When a gorgor is placed on mine land, it signals to everyone that the land is ‘off limits’ and that talks are needed. It is a procedure recognised by Newcrest as being part of the price of doing business in PNG.
The concern held by UBS about Newcrest’s problems on Lihir are reflected in a sell recommendation on the goldminer, complete with a 12-month share-price target of $7.30, 27% below the stock’s current price of $10.10.
Other Australian mining and oil companies have also found PNG a difficult place in which to do business, and probably suffer share price discounts accordingly, though differences in projects and the type of product make direct comparisons difficult.
St Barbara Mines is another company experiencing problems in PNG with its goldmine on Simberi island, which came with last year’s $1 billion acquisition of Allied Gold. It has been forced to cut production and retrench staff because of high and rising costs.
Oil Search, which is a major success story in the PNG oil and gas sector, trades at a discount to its Australian peers, Woodside Petroleum and Santos (which is a partner in the Oil Search-led PNG LNG project).
Marengo Mining, a copper project developer, is finding it difficult to finalise the design of its potentially world-class Yandera copper mine because of the difficult terrain and withdrawal of engineering contractors after they encountered cost and construction hurdles.
The problems encountered by Australian companies in PNG explain why it ranks 30th (out of 40) on a “world risk” list compiled by the magazine, ResourceStocks.
While such a rating will always be open to debate, the risk list rates PNG poorly on questions of red tape, sovereign risk, civil unrest, land claims and financial risk.
In terms of risk pecking order, PNG comes after countries generally regarded as high risk, including Angola, Venezuela and Colombia – but ahead of Pakistan, Egypt and Zimbabwe.
It is into the tricky world of PNG that PanAust has walked, with its deal to acquire a controlling stake in Frieda River from the mining giant Glencore Xstrata.
The purchase price of $US75 million is broken into two parts. $US25 million immediately and $US50 million at the end of 2015.
For that outlay, PanAust gets its foot on a massive resource, currently estimated to stand at 12 million tonnes of copper and 20 million ounces of gold in ore assaying an average of 0.5% copper and 0.25 grams of gold a tonne.
Glencore Xstrata’s plan was to develop a mine producing 250,000 tonnes of copper and year plus 360,000 ounces of gold.
PanAust thinks a scaled down version of the mine might work better, tentatively looking at 100,000 tonnes of copper and 160,000 ounces of gold.
Early numbers on the PanAust plan are for a capital cost of between $US1.5 billion and $US1.8 billion, with construction taking 2.5 years, first production in 2018, and for the mine to last 18 years.
Said quickly and it sounds easy. Analysed in more detail and questions pop up such as why Glencore Xstrata was pleased to sell at what looks to be a bargain-basement price, and why after almost 40 years on the radar screen of previous owners Frieda River is not in production.
The location, around 200 kilometres from the northern coastline of PNG, is one explanation for the failure to develop Frieda River. Fluctuating copper and gold prices are another, together with the high capital cost and engineering challenge associated with the location.
But, lurking in the back of every investor who has ever thought about sending some of his money into PNG is the uncertainty factor associated with the government in Port Moresby.
That uncertainty factor can be found in the proposed change to the 12-year-old deal with BHP Billiton over Ok Tedi, and in the sell-off in PanAust shares after it acquired what UBS called a “cheap option on a large scale project” – with that word “cheap” ringing in the ears of investors who remember what mum said about shoes.