Summary

The results from the PEA look good, but the study is based on a copper price of $3.30.

Using today prices of copper, the IRR of the project drops by $1.5 billion.

Fears of a mining ban in Imbabura have compounded SolGold’s misfortunes, but I think these are overblown at the moment.

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On May 20, Ecuador-focused copper and gold mining company SolGold (OTCPK:OTCPK:SLGGF) released the published the results of the long-awaited preliminary economic assessment (PEA) for the Alpala copper/gold/silver deposit at the Cascabel project, in northern Ecuador. The study estimated a start-up capital expenditure of $2.4-billion to $2.8-billion, which the company considers low, and a net present value ranging from $4.1-billion to $4.5-billion at an 8% discount. Kudos for SolGold for using a discount rate of 8%, when most mining companies usually use 5%, but I think that the net present value is too optimistic as it’s based on a copper price of $3.30 per pound at a time when the latter is barely above $2.60 per pound.

The market noticed this trick and the shares nosedived. The slump was only made worse at the end of last week following media reports of a potential referendum on mining in Ecuador’s Imbabura province, where Cascabel is located.

The project and the main figures in the PEA:

Source: SolGold

Cascabel is located on the northern section of the Andean Copper belt around 180 km north of the capital Quito and is one of the most significant discoveries in the copper and gold sector over the past 10 years. On November 20, SolGold presented an updated mineral resource estimate, which more than doubled the project’s resource to 15.4 Mt CuEq.

Source: SolGold

While the grades are not great, the sheer size of Cascabel is astounding and SolGold is targeting a mineral resource of 10 million tonnes of copper and 25 million ounces of gold.

For the PEA, SolGold prepared four mine production cases. It seems that the most likely route for the company at the moment is the 50 Mt/a fast ramp-up option:

Source: SolGold

It’s a large project with an estimated average annual production for the first 25 years of 207,000t of copper; 438,000oz of gold and 1.4Moz of silver in concentrate. The mine life is also outstanding – ranging between 49 years and 66 years based on the different scenarios, at a time when most mining project have an initial mine life of around a decade.

I consider an internal rate of return for a mining project to be decent if it’s above 20% and Alpala’s is around the 25%-26% mark, depending on the chosen scenario. This, sadly, is an illusion:

Source: SolGold

I can stomach the use of a gold price of $1,300 per ounce, but a copper price of $3.30 per pound is just absurd. While copper prices have hovered above the $4,00 per pound mark over the past decade, they have spent most of the last five years below $3,00 per pound:

Source: InfoMine

If we use the same discount rate and gold prices of $1,300, but drop the copper price assumption to $2,64 per pound, the net present value of Alpala would drop to around $2.83 billion. This is still a very good number, just not as much as many SolGold investors hoped for. And this is a big problem because it could cool off the potential bidding war for the company between Newcrest (OTCPK:OTCPK:NCMGF) and BHP (NYSE:BHP). I’ve covered this topic on SA here.

Mining ban fears

As if the disappointment from the PEA wasn’t enough, SolGold’s shares dropped by more than 10% on Thursday as media started speculating about a potential referendum on mining in the province of Imbabura.

The fear from a mining bad is real as in 2018 Ecuadorian courts sided with rural and indigenous communities in two landmark cases, with the latter arguing the national government had failed to inform them it was setting aside parts of their territories for mineral exploitation.

It’s still very early days for SolGold’s case though. Under the law, individuals are allowed to put forward petitions to the Constitutional Court for the inclusion of specific questions in a future vote. The Constitutional Court then has todecide if the question on the future of mining is valid and legal, after which it must be approved by the electoral council to be included on ballot papers. And then the next phase is for the petitioning party to gain 10% of the signatures of the voting population of the province, which is no easy task.

Conclusion

I view Cascabel as one of the best copper-gold projects in the world and I think that the strategic investment by both BHP and Newcrest in SolGold highlights how major miners are stepping up efforts to partner with smaller sector players to restock production pipelines. However, the results from the PEA are disappointing and SolGold shouldn’t try to hide them behind a high copper price. The initial capex and IRR are unimpressive, which could cool off the interest of BHP and Newcrest and significantly narrow the funding options for SolGold. The company still has time to turn things around as a further update to the mineral resource estimate is planned before the end of 2019. This will lead to a pre-feasibility study is expected to be completed in December 2019 and a definitive feasibility study at the end of 2020.

Regarding the mining ban, I think that the market overreacted as it’s a long and hard process, which has barely begun. The organizers of the referendum will need to put in a lot of time and effort to come up with something that could threaten Cascabel.

Overall, I still think that SolGold is undervalued and the company’s management shouldn’t sugarcoat bad news.

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