LONDON, May 15, 2018 /PRNewswire/ --
At first look, Teck's recent decision to increase its stake in a Chilean copper mine considered a loss-making asset and near the end of its life appears a peculiar one. But a potential brownfield expansion to the site could see the increased Canadian miner's stake translated into a profitable business – though nonetheless with risks.
How Quebrada Blanca would traditionally be valued
Up until recently, Canadian miner Teck held a 76.5% stake in Quebrada Blanca, a copper mine located in northern Chile. Teck increased its stake in the mine to 90% at the beginning of April this year. Interestingly, based on CRU's Copper Cost Services, Quebrada Blanca is a loss-making asset fast approaching the end of its life as a mine. So, why did Teck decide to acquire an additional 13.5% stake from local shareholders? The quick answer would be that they are considering a brownfield expansion – Quebrada Blanca 2 (QB2) – which would put the mine in the third quartile of the copper industry cost curve. But there are two large risks surrounding this expansion:
· Environmental permits: The company is currently applying for them, but Chilean environmental authority has yet to provide an answer.
· Market environment at the time of the investment decision: The copper market is volatile, and although currently there is positive momentum regarding price, the market environment at the time of the decision may not be the same as it is today.
By using the traditional valuation approach, assuming CRU's current price forecast and that Teck will be granted environmental permits, we can conclude that the traditional Net-Present Value (NPV) of the asset1 – considering the expansion – would be 2.0 USD billion; thus, the 13.5% stake on the operation would be valued at 276 USD million.
Quebrada Blanca is an open pit mine that began operations in 1994. The mine is located 4,400 metres above sea level. The operation produced 23 kt of copper in 2017 – steadily decreasing from over 80 kt one decade before. The mine produces copper cathode via ore leaching and an SX-EW plant. While the original operation has greatly exceeded its original life expectancy, its reserves are finally due to be exhausted in the next few years. As it stands, Quebrada Blanca is located in the fourth quartile of the CRU copper industry cost curve.
Quebrada Blanca has a Project for a brownfield expansion – Quebrada Blanca 2 (QB2). In this expansion the operation would begin concentrate production – a much more water intensive process than the one currently in use. QB2 is estimated to require an investment of around 4.7 USD billion; which includes a concentrate plant, tailing dam, pumping and piping facilities to extract seawater – amongst other investments. This expansion is expected to prolong the life of the mine for around 30 years, achieve a copper production of around 238 ktpa – plus molybdenum production as by-product – and will then place Quebrada Blanca in the third quartile of the copper industry cost curve.
A big caveat is that the project is in the process of obtaining the environmental permits – which have not been awarded.
The actual sale
In fact, the actual sale was structured in four streams2
· 52.5 USD million upfront
· 60 USD million once they have environmental permits for Quebrada Blanca 2
· 50 USD million one month after Quebrada Blanca 2 commences production
· Up to 100 USD million if copper price exceeds a $3.15/lb threshold – equivalent to $6,944/t.
The questions that arise then are: why was the sale structured in this particular way? And, why was the minority interest bought at a total of 162.5 USD million3 when the traditional method places its value at 276 USD million?
A real options analysis can explain both the value and the structure of the actual sale.
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