Soaring construction costs at one of the world’s most promising copper projects have hit the mining industry, creating uncertainty about how much the sector has truly changed.
Canada’s Turquoise Hill Resources Ltd., which owns two-thirds of the Oyu Tolgoi (OT) project in Mongolia, unexpectedly announced this month that an underground expansion of its mine will take much longer, and will cost much more, than originally planned.
Already expected to cost US$5.3-billion, the OT expansion will now require up to an additional US$1.9-billion in capital spending to complete. Sustainable production from the project has also been delayed by 16 to 30 months from original estimates, to between May, 2022, and June, 2023.
On a conference call, Turquoise Hill attributed the woes to geotechnical issues and ground conditions. “We must stop and pause and take the appropriate action, and that’s what we’re doing,” chief executive Ulf Quellmann said.
Global giant Rio Tinto PLC owns 51 per cent of Turquoise Hill and operates the OT project, having acquired the controlling stake from Canadian mining financier Robert Friedland. Turquoise Hill used to be called Ivanhoe Mines Ltd.
Political risk and heavy capital requirements have weighed on Turquoise Hill’s shares for years. That pressure only compounded after the soaring costs and major delay were announced on July 15, sending the stock plummeting another 46 per cent since.
Turquoise Hill now has a market value worth $1.5-billion, down from $13.3-billion at the height of the commodity supercycle in 2011.
The update has bolstered fears that miners still can’t control project costs. “That perception continues, and [news] like Turquoise Hill’s just reinforces it,” said Glenn Ives, chair of Deloitte and head of the firm’s North American metals and mining practice.
Miners have a history with cost overruns, particularly with megaprojects. Famous examples of developments with runaway costs include Barrick Gold Corp.’s Pascua-Lama project in the Andes, where total spending jumped to $8-billion from $1.5-billion – and then the project was put on hold. Anglo American PLC’s Minas-Rio iron ore project in Brazil also took four years longer to build than expected and cost twice its original budget.
A 2015 study by Export Development Canada, which helps finance a number of mining projects in riskier regions, found that between 1994 and 2015 mining projects had an average cost overrun of 37 per cent. Megaprojects that cost $2-billion or more to build had an average cost overrun above 60 per cent.
For many years, the runaway spending was masked by rising metals prices. Once the supercycle crashed, however, many miners’ balance sheets were left loaded with debt. Between 2015 and 2018, the industry focused on paying down debt and selling assets. Miners also slashed their annual spending in order to boost free cash flow, with capital expenditures plummeting in 2017 by roughly two-thirds from their peak of US$80-billion across the industry in 2012, according to a study by Deloitte.
With their balance sheets now in order, the sector is on much better footing. Mining executives have also promised that they’ve learned from their past blunders.
“Many mistakes were made in the haste to bring new supply on line as soon as possible," some of the world’s largest miners acknowledged in a joint study by consultancy Spencer Stuart and the Center for Copper and Mining Studies (CESCO) in 2018. "Ore bodies must be adequately understood and tested, engineering advanced and host communities fully consulted and supportive before projects are approved.”
The hope is that this new discipline will bring generalist investors – or those that do not specialize in metals and mining – back to the sector. At the start of 2011, the materials subindex accounted for 22 per cent of the S&P/TSX’s total value. Today, it makes up just 11 per cent.
OT’s problems, though, serve as a setback. Turquoise Hill declined to comment for this story.
The timing is particularly bad because many miners must start exploring and developing again in order to replace depleting assets. “At some point, a new capex [capital expenditure] boom is going to come along to plug a supply shortfall,” Simon Redmond, the commodities head at rating agency S&P Global, told Deloitte for its study last year.
The irony is that OT is needed to provide new copper supply. It is a massive project, and by 2027 it is expected to be the world’s third-largest copper mine. Crucially, it is also projected to have some of the world’s lowest-cost production once it is up and running.
However, its expansion requires block caving, which is an extremely technical type of underground development. The complexity has led to extra costs and a major delay – conjuring up memories of all the sector’s construction problems over the past decade.
Mr. Ives of Deloitte says he hopes investors ultimately see OT as an outlier, because it is "a very difficult project in a very difficult location,” he said. “This is a fantastic deposit, it’s just a hellishly difficult place to operate.”
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Tim Kiladze