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Barrick Gold (NYSE: ABX ) has recently announced that it is suspending all construction activities on its huge Pascua-Lama project. This was an unexpected move that surely changed the outlook for the company's future. Without further ado, let's dive in.
Is Barrick bearish on gold?
Pascua-Lama is a gigantic mine with almost 18 million ounces of proven and probable gold reserves. It also contains 676 million ounces of silver and has an expected mine life of 25 years. Barrick had to complete Pascua-Lama's water management system on the Chilean side before it could start construction.
Barrick estimates that the suspension of the project would free as much as $1 billion next year which would otherwise have been spent on Pascua-Lama. Barrick's CEO Jamie Sokalsky stated that capital cost was not the only determinant in the Pascua-Lama decision.
I think there could be several other catalysts for such a decision. Barrick could be bearish on gold. Every gold producer is battling costs now. Barrick announced that its all-in costs per ounce were just $916 per ounce in the third quarter. Ironically, lower costs among big gold producers make more room for gold prices to fall in the absence of investment demand.
Typically, production costs serve as a floor to a metal's price. Once gold prices reach this level, inefficient producers are forced to shut their mines. This cuts supply and forces the price to rise. In addition to price environment problems, there could be additional administrative hurdles besides the problem with the water management system.
Silver Wheaton and Royal Gold are hit by this decision
Silver Wheaton (NYSE: SLW ) is entitled to purchase 25% of silver production from Pascua-Lama for the life of mine. In case Barrick fails to start producing gold, Silver Wheaton would receive its upfront cash consideration of $625 million less a credit for any silver delivered up to that date.
Silver Wheaton is currently reviewing its 2017 production forecast. During the earnings call, Barrick's CEO stated that there is no chance to get production any time in 2016. Silver Wheaton would be entitled to purchase silver from three of Barrick's producing mines throughout 2014 and 2015. However, it is unclear what would happen should the project's construction stall for a longer period of time.
Royal Gold (NASDAQ: RGLD ) is another company that is affected by Barrick's decision. Royal Gold holds a 0.78% to 5.23% sliding scale net smelter royalty on the Chilean side of the Pascua-Lama project. The company states that it does not expect this decision will have any impact on the value of its investment in the royalty at Pascua-Lama. I think that although Royal Gold's royalty contract is relatively small, Barrick's decision is still a negative for the company.
What's in the future?
Pascua-Lama caused a $5.1 billion writedown in the second quarter. Is there more to come? I think so. At the end of the year, Barrick would be testing its assets for impairment. The troubled project is the No. 1 candidate to lose a little more in value.
In my opinion, Barrick would have to continue with Pascua-Lama. I don't think it's reasonable to sell it, because the price would be cheap. In this case, impairment, which is mostly a bookkeeping term, would turn into a real loss.
Barrick finished the third quarter with $2.3 billion of cash and $14.5 billion of debt on its balance sheet. The announcement of Pascua-Lama's suspension in combination with a $3 billion equity offering means that Barrick can tolerate such leverage no more.
Barrick's plan is to proceed with the project one step at a time. The company would continue to build the water management system that would cost up to $300 million in 2014. I think that it is not the last time the project is postponed, and this is no good news for Barrick Gold.