Let's say for a moment that you are a conservative investor with $1.6 billion to invest. You might be pleased to receive a guaranteed 10% return on your cash. After all, that's about $160 million annually.
But if that modest rate of return was subject to fluctuating commodity prices and highly sensitive to a U.S. to Canadian dollar exchange rate, perhaps you would seek other, less dicey options.
That's pretty much the choice Shore Gold (SGF-T) laid before investors after a 209-page prefeasibility study on Shore's wholly owned Star kimberlite in Saskatchewan said a mine would cost $1.67-billion and generate a return of 10% over 12 years (though it would take 5.2 years to recover capital costs and contingencies).
What's more, Shore wants to be in production by 2014, but to do so it would need to start building work by late 2010. That means Shore needs to spend, according to the prefeasibility study, $123 million at Star next year.
Shore got the ball rolling on its fundraising push in October with an equity financing that netted $27.5 million - 14.3 million common shares at $1.05 each, and another 10 million flow-through shares at $1.25 apiece.
With 224.5 million shares outstanding (234 million fully diluted) as of mid-October, and with its shares trading at $0.82, Shore had a market cap of $200 million.
The odds do not seem to favour Shore but don't tell that to George Read, Shore Gold's senior vice-president of exploration - and, largely, the face of the company.
"The diamond market is showing a lot more signs of life," Read says, adding that Shore could take on a partner, and has looked at debt financing.
He's right. Rio Tinto (RTP-N) recently raised by 15% the price it receives for diamonds mined in Canada. Rio also resumed a $1.8-billion expansion of its Argyle mine in Western Australia, the largest diamond mine in the world by volume.
But lenders and project partners demand substantial rates of return because of the intrinsic optimism that often finds its way into mining project economics. History has shown revenues, especially those of diamond projects, often fall shy of expectations and operating costs typically exceed prefeasibility estimates.
One recent example is the crippled Tahera mine in Nunavut, where much lower than expected diamond grades and rapidly escalating production costs forced the closure of what was Canada's third diamond mine.
Even at the venerable Diavik, Canada's second diamond mine in the Northwest Territories, grades have averaged around 10% less than prefeasibility estimates, while costs continue to exceed projections.
Like Diavik, Star would be an open-pit operation. The study calls for the world's largest processing plant capable of processing ore at a rate of 40,000 tonnes per day.
Star's after tax net present value, using a 7% discount rate, is $291 million. The economics are so marginal that if revenue falls 15% below the base-case level, the net present value of Star becomes negative, and that is certainly not outside the realm of possibility. In fact, there are several ways it could happen.
One is a sharp rise in the Canadian dollar.
Shore's study assumes an exchange rate of US$0.85. At presstime, the U.S. to Canadian exchange rate was about US$0.94. A lower Canadian dollar means higher margins for Shore because its production costs would be in loonies, while it would sell gems for greenbacks.
Read admits the prefeasibility study numbers are most sensitive to the exchange rate but says history is on his side.
"The US$0.85 exchange rate is a 50-year average and, if you want to tell me what the exchange rate is going to be hopefully in 2014 when we start selling, then (go ahead)," Read says.
Secondly, the study uses a modelled diamond price of US$225 per carat, the highest in a range set by U.K.-based WWW Diamond Consultants in its March 2008 price book. The low end of WWW's range was US$141 per carat.
"The important thing is that diamond price wasn't chosen by Shore Gold, that diamond price was chosen by the consulting engineers," Read says. "They thought that that was very reasonable in light of the behaviour of the diamond price over the last number of years."
Since WWW's valuation, the global diamond market, in lockstep with the global recession, has seen rough prices dip by as much as 40% after reaching all-time highs in August 2008.
WWW Diamond Consultants reports that diamond prices are now between 10-15% lower than in March 2008, owing to a rise in diamond prices during recent months. Read explains that the decline in diamond prices was mostly offset by gains made by the Canadian dollar over the same period.
"Our sensitivity studies have shown that (the economics) are most sensitive to exchange rate and diamond pricing But, if you look at what the difference is if we use the high or the low modelled values for the different diamond prices, then there isn't an enormous difference (in the overall economics)," Read argues.
The study says Star boasts reserves of 171 million tonnes at a weighted average grade of 12 carats per hundred tonnes (0.12 carat per tonne), for a total of roughly 20 million carats. The only problem is that Shore boosted the grades on all of its large-diameter drilling tests by factors "that range from 1.62 to 1.67," as published in an April release.
The grade boost was based on diamond losses and breakage Shore believes occurred during large-diameter drilling. The determination was made after more impressive diamond grades were recovered from an underground bulk sample taken from the same area where the drilling had been done. Shore's "boost" left many in the Canadian diamond industry scratching their heads.
"Are they allowed to do that?" asked a president and CEO of a Canadian diamond junior, who asked to remain nameless.
Skepticism abounds until you look at what could prove to be Read's ace in the hole, just north of Star. There lies the Orion South kimberlite, 40% of which is owned by Newmont Mining (NMC-T) under the terms of the Fort a la Corne Joint Venture (FALC-JC).
(Newmont recently raised $2.1 billion by selling bonds and was contacted for comment on the Star story but declined.)
P&E Mining Consultants calculates the mineral resource at Orion South at 84 million tonnes averaging 13.83 carats per hundred tonnes (cpht). Another 98 million tonnes running 12.83 cpht are in the inferred category (but inferred material can't be included in the resource under National Instrument 43-101 guidelines).
Orion South is one of the largest diamond-bearing kimberlites in the world, with a surface area totalling some 403 hectares.
Shore handed over its Star and Orion South data to P&E this fall and the firm will complete a prefeasibility study on the economics of a combined operation. The results should be out by early 2010.
A positive decision could lead to a bankable feasibility study on both projects by late 2010.
"We could spend time doing the combined detailed feasibility study on Star and Orion South next year and then still get into production in 2014 or sooner because of the more amenable stratigraphy on Orion South," Read says. "The stratigraphy on Orion South is probably easier to mine than it is on Star."
Another positive for Read and his team is Star's location, about 60 km east of Prince Albert, Sask., a supply centre for northern Saskatchewan. A paved highway, a network of forestry roads provide year-round access to the Fort a la Corne Joint Venture.
Shore recently signed a letter of intent that would provide Saskatchewan Power with up to $500,000 to carry out preliminary engineering and environmental studies to determine a preferred route of transmission lines between the project and the provincial power grid.
The study says the 230-kilovolt transmission line would span 16 km. The work should be done by the end of June 2010.
"Certainly accessibility and the fact that we will ultimately plug into the Saskatchewan power grid is extremely favourable," Read says.
Read estimates that if Star were situated in a location similar to Diavik's in the Northwest
Territories, one could add another billion dollars to the project's capital costs.
Then again, what Read wouldn't give for Diavik's grade.
© 2010Mining Markets. All Rights Reserved.