Cost blowout to hit Mongolia project of Rio Tinto subsidiary

MELBOURNE Global mining giant Rio Tinto has for the first time admitted that its dispute with Mongolia government is threatening to delay production at the $US11.3 billion Oyu Tolgoi copper and gold project, which has been hit by a significant cost blowout that has wiped out $US1.5billion ($A1.4billion) of value.

Rio, through its Turquoise Hill subsidiary that is building the mine, Tuesday said it remained in discussions with Mongolian officials over a proposed 2013 budget that proposes breaking a 2010 investment agreement by imposing a progressive royalty scheme on Oyu Tolgoi, reported The Australian.

Rio and Mongolia are at loggerheads over Oyu Tolgoi and the future of one of the world's largest untapped copper deposits, just as the mine ramps up output and the Rio subsidiary (that owns it) tries to secure $4 billion for the next stage of development.

At the current juncture, the mining giant has been forced to admit that the Mongolian dispute could delay production from Oyu Tolgoi's $US6.2billion first stage, leading it to lower the production forecast and raise the operating costs expectations.

"Commencement of commercial production is expected by the end of June 2013, subject to the resolution of the issues being discussed with the Mongolian government," the Toronto-listed Turquoise Hill said, reported The Australian newspaper.

Rio, which holds 51 per cent controlling stake in Turquoise Hill, had earlier this year threatened to freeze its Simandou iron ore project in Guinea if it could not get an investment agreement signed.

In a project update, Turquoise Hill revealed it had cut the expected net present value of its base case Oyu Tolgoi development by $US1.5billion to $US9.9billion as it faced increased capital costs.

These have led it to remove a concentrator expansion and power station from the development plans, meaning higher operating costs.

The $US5.1bn cost of the yet-to-be-approved second stage was unchanged, despite the removal of the big-ticket items.

"The company estimates there has been a 30 per cent increase in the direct capital cost to construct the underground mine," Turquoise Hill said in a technical report

Dropping of plans to set up its captive power plant means the operating cost of Oyu Tolgoi in the first 10 years of the project will jump 37 per cent to US89c per pound of copper.

The changes come as Rio chief executive Sam Walsh cuts costs and vows to take a more disciplined approach to capital spending and acquisitions after $US33billion of writedowns on the Alcan and Riversdale Mining takeovers made under his predecessor, Tom Albanese, reports The Australian.

Turquoise Hill, which was formerly known as Ivanhoe Mines and run by billionaire Robert Friedland, has seen Rio spending $US3.7billion since acquisition in 2009 to get the controlling stake.

"At a time when capital commitments are subject to increasing scrutiny, the company has recognised that committing to focus on operations at 100,000 tonnes per day (capacity of the first-stage concentrator) and develop Hugo North Lift 1 (second-stage underground expansion) . . . is the most prudent use of scarce capital resources and preserves all options for future expansion," Turquoise Hill said.

Under the new plan, copper production from Oyu Tolgoi will peak at less than 1.6 million tonnes per year, down from 1.8 million tonnes under the 2012 model, while gold will peak at 600,000 ounces per year, down from 1 million ounces previously.

The mine life will extend from 27 years to 43 years as the resource takes longer to extract, meaning less early cashflow to both Rio and Mongolia. Cumulative after-tax cashflow estimates for the life of the mine have dropped by $US5bn to $US28bn.

Previously, Rio had been planning to expand the concentrator to 160,000 tonnes a day.

In August, former copper boss Andrew Harding, who has replaced Walsh as Rio's Perth-based iron ore boss, said Rio was considering delaying or reducing the size of the concentrator. Rio closed 2 per cent lower at $56.93.

The technical report, released alongside Turquoise Hill's full-year earnings, does, however, confirm that the first phase of the mine's development is on time and on budget at $6.2 billion. Commercial production is expected to start in June.

"The scope change could be to put additional pressure on the Mongolian government, as it could be seen that Rio Tinto/Turquoise Hill are unwilling to commit increased levels of capital to a project with uncertain economic outcomes," BMO mining analyst Tony Robson said in a note to clients.

"Until the political situation has been resolved, the news should weigh on the stock near term."

Rio and Turquoise Hill are currently in talks with numerous lenders to raise $3 billion to $4 billion in project financing. It expects to have a financing deal in place in the first half of 2013, reports Reuters.

Rio is the largest single investor in agriculture dominant Mongolia and one of few with the financial might and technological know-how to build and run a giant mine.

Turquoise Hill's shares fell 4.6 percent to C$6.16 in early trading on the Toronto Stock Exchange