Wednesday, November 30, 2011

Canadian Arctic fails to yield diamond boom

A 78-carat diamond found in BHP Billiton's Ekati diamond mine in the Northwest Territories.

When huge diamond deposits were discovered in the Canadian Arctic in the early 1990s, geologists were optimistic there would be many more to come.

It didn’t happen. Despite massive spending on exploration, no large mine has been discovered in the territories in almost 15 years, and the diamond boom never lived up to its initial promise.

BHP Billiton Ltd. admitted as much Tuesday as it announced it will study a potential sale of its Ekati mine in the Northwest Territories. Ekati is a great asset and is performing well, but after years of “extensive” exploration, BHP was never able to follow up with another big discovery. With Ekati set to run out of diamonds near the end of the decade, BHP will review whether it should get out of the business.

“BHP has been singularly unsuccessful [in diamond exploration], and they’ve thrown a lot of money and resources at it in Canada and elsewhere,” said Patrick Evans, chief executive of Mountain Province Diamonds Inc. “But it’s no particular judgment on BHP’s skills. Everyone has been unsuccessful.”

Ekati is one of three operating diamond mines in the Northwest Territories (along with Diavik and Snap Lake) and they were all found in the 1990s. Mountain Province’s Gahcho KuĂ© project (a joint venture with De Beers) is likely to be the fourth, but that discovery also dates back to the 1990s.

Since then, many junior companies have made initial finds in the Far North that got investors excited, but eventually fizzled out.

One new mine called Jericho actually opened in 2006, but was forced to shut down less than two years later after numerous operating problems.

The three existing mines have transformed the economy of the NWT (mining is about a third of the province’s GDP) even if the overall impact of diamond mining has disappointed.

Looking forward, one of the most promising Arctic discoveries right now is Chidliak, a joint venture between BHP and Peregrine Diamonds Ltd. in Nunavut. There will be questions about the future direction of that project if BHP decides to get out.

After BHP’s announcement Tuesday, industry insiders focused on what Ekati is worth, and who would buy the mine if it is put on the block.

The mine has generated average earnings (before interest and taxes) of about US$500-million over the past two years, meaning that it is very profitable and spins off plenty of cash. However, it is due to close in 2019, and any buyer would have to inherit the environmental liabilities that go along with closing a large mine.

“It’s a tough call on the valuation, and whoever buys it will be saying that there’s more [diamonds] to find,” said Des Kilalea, an analyst at RBC Capital Markets.

Mr. Evans said he suspects BHP will want US$1.5-billion to US$2-billion for its 80% stake in Ekati, though analysts tossed out many other numbers.

He suggested the logical buyers are either De Beers or Rio Tinto Ltd., as they both have existing mines in the NWT and know how to operate in that environment (Rio could also buy the mine jointly with Harry Winston Diamond Corp. through their Diavik partnership).

“If it’s cheap enough, they’ll buy it. But BHP won’t walk away from half a billion dollars of free cash flow a year for a song,” he said. “My sense is it’s probably unlikely we’ll see a transaction.”

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