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Antofagasta’s play makes for an interesting story to watch

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Last week’s announcement that Antofagasta is going to rescue a financially strapped Duluth Metals through acquisition was not a surprise. Duluth Metals had been in a downward spiral since Antofagasta’s July 3 announcement that it would not exercise its option to acquire another 25-percent stake in the company.

Duluth Metals stock, which once traded at over $3 a share, ended the trading day on Halloween at a frightening seven cents. The company had hoped to announce at that time that it had successfully completed a private placement in order to raise $5 million in operating cash. But it became apparent that the offer had failed to entice much interest from investors, who increasingly saw the company as circling the drain.

With cash running out, and with a roughly $12 million loan repayment owed to Antofagasta by Jan. 3, the handwriting was on the wall. For Duluth Metals, it was the only viable alternative that could salvage any investor value.

The deal demonstrated that Antofagasta knows how to play hardball. Under its Twin Metals joint venture agreement with Duluth Metals, Antofagasta had the option to acquire an additional 25 percent stake for one times Twin Metal’s net present value in a bankable feasibility study. While such a study was still a ways off, the pre-feasibility study released Aug. 20 of this year, had pegged the project’s value at about $1.16 billion U.S. A recent analysis by Edison Investment Research pegged Duluth Metal’s minimum value at approximately $245 million U.S., based on similar recent sales in the copper sector.

By declining the option, Antofagasta sent Duluth Metals into its death spiral, allowing them to pick up the company and all of its assets a few months later for about $85 million U.S. The company line is that this was a friendly acquisition, but there’s little question it was signed under some duress. And I would be shocked if Antofagasta officials didn’t have this scenario in mind when they declined the option back in July.

What it all means in terms of the Twin Metals venture remains uncertain, but two things do stand out:

‰The question of where the money would come from to develop the project appears to be settled. Antofagasta clearly has the resources to bring about a project, if such a project proves financially viable, which remains an open question.

‰ The timeframe for development of the project has likely gotten longer. Unlike Duluth Metals, which was focused almost exclusively on the Twin Metals venture, Antofagasta owns a number of existing mines and maintains a lengthy portfolio of future projects in various stages of development. According to comments earlier this summer, Antofagasta is currently focused on expansions and redevelopment of existing mining (read: brownfield) operations, where the upfront costs are far less and the returns are more predictable.

Duluth Metals had a greater incentive to move quickly because until they began production they were simply burning through cash. But Antofagasta, as one of the world’s largest existing producers of copper, has a different set of incentives. Since the historic run-up in copper prices began in the mid-2000s, the industry has seen a significant jump in production, and some analysts are currently forecasting a copper surplus in the near-term. That’s probably one reason that copper prices have remained relatively flat, at just over $3 per pound, despite the recovery from the 2008 financial crisis.

Adding more production capacity, at least in the near-term, does little to improve Antofagasta’s bottom line. For now, just tying the reserves up for what is essentially loose change for a company the size of Antofagasta, is a smart move strategically.

Antofagasta may still advance the project, but they won’t have anywhere near the same sense of urgency as Duluth Metals had.

If Antofagasta does opt to advance the project in the near-term, the big question is how the company will propose to mine the reserves. Duluth Metals was obviously sensitive to the environmental complexities of mining on the edge of a major wilderness, which resulted in a mine proposal with an eye-popping $2.8 billion price tag.

Antofagasta stated this week that they intend to redesign the plan, and that’s undoubtedly going to fuel speculation that the company may shift from an underground operation to a less expensive open pit. The Maturi deposits, which have been the initial focus of the Twin Metals venture, begin fairly close to the surface, making an open pit a viable alternative.

But that significantly complicates the politics and would require another land exchange with the U.S. Forest Service, since open pit mining isn’t currently allowed on federal lands in the Superior National Forest. As the PolyMet project has demonstrated, such land exchanges can happen, but they take time—usually lots of time.

The other question is where Antofagasta might propose to store tailings if a refined mine plan is ultimately developed. Duluth Metals had proposed a pipeline to send tailings to a basin near Babbitt, located outside the Kawishiwi River watershed. That plan represents a major upfront expense, but in the wake of the Polley Mine disaster in British Columbia earlier this summer, the prospect of a tailings basin within the Boundary Waters Canoe Area Wilderness watershed would seem to be untenable. The Polley Mine was an operating copper-gold mine until last August when its tailings basin dam gave way, turning miles of beautiful downstream lakes, streams, and forest into an environmental wasteland, wiping out local tourist operations. It’s now described as one of Canada’s largest environmental disasters in modern history. A repeat somewhere along the Kawishiwi would devastate a world-class wilderness and, along with it, much of Ely’s economy.

In other words, these are interesting times, and this will be an important story to watch, for years to come.