"Whatever the mood of investors, it is too early to jump to any firm
conclusions about the fate of Gahcho Kue, but it seems likely that the
partners will find a way to make a mine at Kennady Lake
Mountain Province trips over change in technique "
Mountain Province Diamonds Inc MPV
Shares issued 50,272,170 Apr 7 close $1.49
Mon 7 Apr 2003 Street Wire
Also (CFV)
by Will Purcell
The shares of Mountain Province Diamonds Inc. and Camphor Ventures Ltd.
took a tumble on Friday, after the latest projections from De Beers failed
to live up to the market's expectations. The three Kennady Lake partners
completed their largest of several mini-bulk sampling programs last year,
in the hopes of coming up with a 15-per-cent increase in the diamond value
of two key pipes that are the basis for the Gahcho Kue project, but
instead, the projected revenues actually dropped. As a result, a Mountain
Province share could be had for $1.22 in intraday trading on Friday, just
better than half of a $2.25 peak, set just a month earlier. Despite the
disappointing news, it would be a major shock if De Beers did not find a
way to make a mine at Gahcho Kue. Nevertheless, the results leave more
questions than answers.
According to the latest modelling exercise, the AK-5034 diamonds are worth
$62.70 (U.S.) per carat, for a gross rock value of $104.70 (U.S.) per
tonne. That was a modest decline, but it turned out to be the good news for
the project. De Beers modelled the value of the Hearne diamonds to just $50
(U.S.) per carat, implying a rock value of just $83.50 (U.S.) per tonne.
That latter result is reminiscent of the Tuzo disappointment in 1999, when
a mini-bulk test of a third key Kennady Lake pipe fell far short of
expectations. Nevertheless, if the results are viewed in a historical
context, there are reasons for continued hope.
Compared with the latest big change from Hearne, things have been
remarkably stable with the projections from AK-5034. The best value from
the 13-million-tonne pipe was obtained in 1999, when the diamonds were
appraised at $69.30 (U.S.) per carat, after accounting for a 10-per-cent
reduction for marketing that De Beers had quietly been applying to its
modelled values prior to 2001. The value declined to $65.50 (U.S.) per
carat in 2001, and to $62.70 (U.S.) per carat this year, but both drops
were less than the reported overall market decline, and generally, the
modelled values have proved to be quite consistent through the years.
The Hearne pipe produced a far different and much more variable result by
far. The initial sample from the pipe, which contains about seven million
tonnes of kimberlite, was taken in 1998. De Beers processed about 62.6
tonnes of kimberlite, recovering 205 carats, and the South African diamond
giant subsequently modelled the diamond value at about $44 (U.S.) per
carat, within a range between $25 (U.S.) and $50 (U.S.) per carat.
Accounting for the 10-per-cent reduction for marketing costs, the actual
modelled value was $48.40 (U.S.) per carat.
Things seemed much better after a larger test the following year. De Beers
recovered 846 carats from 469 tonnes of Hearne kimberlite. The diamond
value took a big jump, with a best fit value of $65 (U.S.) per carat, which
translated into a value of about $71.50 (U.S.), after the 10-per-cent
reduction was restored. As things turned out, that was the high water mark
for Hearne's diamonds.
In 2001, De Beers went back to take a larger sample, but drilling problems
limited it to a 334-tonne test, which yielded 751 carats. With the larger
cumulative parcel, the modelled Hearne diamond value declined, to $63.50
(U.S.) per carat. De Beers was now reporting the full modelled value of the
diamonds, so this figure represented an 11-per-cent decline over the 1999
estimate, and the latest forecast of $50 (U.S.) per carat represents a drop
by a further 21 per cent; for a decline of nearly one-third over the 1999
result.
One of the key reasons offered for the latest drop is the depressed state
of the rough diamond market in January, 2003, when the parcels were
reassessed. The partners say that the earlier diamond parcels were
appraised at about 6 per cent less than the values obtained during the
previous assessment in August of 2001. Gahcho Kue had a similar bout of bad
luck in 2001, when the state of the diamond market was also cited as a
reason for the decline. Mountain Province said that according to analysts
and industry sources, the prices of rough diamonds in August of 2001 had
fallen by an average of around 20 per cent from a 2000 peak and at least 10
per cent since late 1999.
Based on those gloomy statistics, the rough diamond market would seem in
tatters. Other producers are experiencing an entirely different outcome
however. Aber Diamond Corporation has just completed its first sales, and
its entire parcel sold for an average of $96.22 (U.S.) per carat. That
figure represents a 33-per-cent jump over what is believed to be the
appraised value in early 2000 and a 22-per-cent increase over the modelled
value produced by WWW International Diamond Consultants Ltd. Still, Aber's
sales were made a few months after the latest valuation of the Kennady Lake
diamonds, and most analysts say that the market has been surprisingly
buoyant in recent months.
Much of the variation over the past few years has been due to economic
fluctuations in several key countries, but some of it is also attributed to
the selling activities of De Beers itself. In fact, there are conflicting
data about the state of the diamond market over the past several years.
Diamond Fields International noted a big drop in the market following the
fall of 2001, but it reported that prices surged by 20 per cent by January
of 2002, just a few months later. The performance of the Ekati mine offers
some good clues as well. The mine sold its diamonds for an average of $168
(U.S.) per carat during 1999 and for $172 (U.S.) per carat during 2000.
Through the first eight months of 2001, the Ekati mine did experience a
decrease in diamond value, as its sales produced an average of about $154
(U.S.) per carat, a drop of about 10 per cent over the 2000 value. That
result would seem to support the claim by Mountain Province that the market
was somewhat sluggish in August of 2001.
All that would suggest that the Kennady Lake valuations have been a victim
of bad timing in recent years. If so, it would be difficult to base
subsequent decisions about a Gahcho Kue mine upon diamond valuations that
are significantly out of touch with current and future realities, and
adding 10 per cent to the latest modelled values might provide a better
picture of the current market, and still larger increases are possible as
economies improve.
There are other curiosities with the Hearne result however. The updated
projections have been based upon the parcels acquired in 1999, 2001 and
2002, and in all, those diamonds weigh about 2,770 carats. After the 2001
sample, De Beers had about 1,600 carats upon which to base its $63.50
(U.S.) per carat projection, which was generally unchanged, if the poorer
market conditions are factored into the equation. That makes the latest
projection of $50 (U.S.) per carat such a shock, since it is based on a
parcel that grew by less than 1,200 carats. Even if an additional market
decline of 5 per cent is factored in, the Hearne diamonds would be worth
just $52.50 (U.S.) per carat, in comparison with the 2001 result.
The implication of that significantly lower value would logically be that
the latest Hearne diamonds were of much poorer quality. With an added
5-per-cent reduction, the 1,600 carat parcel from 1999 and 2001 would still
presumably have a modelled value of $60 (U.S.) per carat, and to achieve a
cumulative result of $50 (U.S.) per carat, the latest 1,174-carat parcel
would have a modelled value of just $36 (U.S.) per carat. That seems a
stretch, as the size distribution of the Hearne diamonds was significantly
healthier in 2002. As well, one 3.4-carat diamond was appraised at $7,140
(U.S.), and that stone alone added about $6 (U.S.) per carat to the
1,174-carat parcel collected from Hearne last year.
As a result, it seems likely that the reduced value for Hearne can be
attributed to a new method of modelling that was used by De Beers for the
first time this year, and the lower value might simply be due to a more
cautious approach. The new technique uses the modelled revenue curve for
Hearne for diamonds below two carats, but it uses a composite curve from
other, hopefully similar mines, for diamonds larger than two carats. The
switch is curious, as much of the value from a diamond mine comes from
large, quality stones, and Mountain Province described the new method as
"slightly more conservative than the technique used previously," although
the partners think that it is more representative of an actual production
scenario.
The timing of the change in techniques is curious, as De Beers had been
willing to use the entire Hearne curve in 1999, based on just nine diamonds
larger than two carats, and again after the 2001 sample, when the combined
Hearne parcel contained just 15 two-carat diamonds. The result for Hearne
likely would have been far more optimistic had the previous method been
used, as the pipe coughed up a much better collection of larger stones in
the latest sample. There were 13 additional stones larger than two carats
in the latest test, and at least five of them weighed in excess of three
carats, including two that weighed 8.7 carats and 6.4 carats respectively,
along the 3.4-carat gem that was appraised at $2,100 (U.S.) per carat. That
pointed to a significantly better diamond size distribution, but none of
the data presented by the larger stones would have been considered by the
new technique, it appears.
The change in method is also a surprise, considering the stated intention
of the 2001 mini-bulk test, which was to acquire an increased number of
carats for valuation purposes, which would increase the degree of
confidence ion the revenue modelling and would hopefully have a positive
impact on the value per carat. A similar goal was the stated intention of
the 2002 program as well, and in particular, the partners hoped to come
with more high-quality diamonds, which would allow more of their potential
value to be considered. In 2001, a 9.9-carat stone from the AK-5034 pipe
was appraised at $60,000 (U.S.), which was actually more than the modelled
value for the entire 914-carat parcel obtained during the 2001 test.
Hearne, at least, delivered one high-quality stone in 2002, but it would
seem to have been largely ignored. Curiously, late last year, De Beers's
own newsletter noted that the greater number of diamonds and the increase
in the larger stones from Hearne should lead to more confidence in the
value per carat modelling.
The latest modelling exercise had many Mountain Province shareholders
howling with anger. That is hardly an unexpected turn of events,
considering the disappointing result, but the unhappiness has also been
fuelled by a lack of information. The partners have not revealed the actual
appraised values of any of the samples, and the changing techniques and
seemingly poor timing of the valuations have undoubtedly added to the ire
of investors, many of whom believe that a significant amount of the value
contributed by the larger, high-quality diamonds has been incorrectly
discounted. All of that has aroused suspicions that De Beers is
intentionally slowing the pace at Kennady Lake, as it fights to get Snap
Lake through the approval process.
In addition to the lack of any actual valuations, the conservative nature
of the De Beers projections rankles many Mountain Province shareholders who
have watched Ekati and Diavik significantly outperform their initial
modelled values. The Ekati feasibility study valued the diamonds in the
Panda pit at $130 (U.S.) per tonne, but when all was said and done, the
Panda diamonds sold for approximately $165 (U.S.) per carat. That
represents an increase of about 25 per cent over the modelled value, a gain
similar to Aber's first sale of its Diavik diamonds. Given the admittedly
conservative nature of the latest De Beers projections, it would seem
reasonable to expect a similar increase for Gahcho Kue as well.
Whatever the mood of investors, it is too early to jump to any firm
conclusions about the fate of Gahcho Kue, but it seems likely that the
partners will find a way to make a mine at Kennady Lake. According to the
latest agreement, De Beers must update its desktop study until it produces
an internal rate of return of 15 per cent, at which point the company must
advance the project to feasibility, or have its interest diluted to a
30-per-cent stake. The project seems even further from meeting the required
rate of return, but that still does not preclude De Beers from starting a
full feasibility study. The company would be well aware of how well its
valuations stacked up against the current diamond market, and it has a
clear picture of the inherent conservatism and possible errors built into
its modelled values. If feasibility is not in the cards for Gahcho Kue, De
Beers will still have to update its desktop study on a regular basis, and
it is possible that the required increase in revenue could be achieved by a
more favourable diamond valuation in the future.
There are other factors that could improve the bottom line of the desktop
study considerably, although perhaps not this year. In addition to finding
ways to lower costs, there is new hope from the area about 10 kilometres
northeast of Kennady Lake, and if the Faraday and Kelvin bodies prove to be
economic, it could improve the revenue flow.
As well, the roller coaster ride at Hearne calls into question the
situation at Tuzo. The pipe initially seemed full of hope, as De Beers
initially modelled its diamonds at nearly $75 (U.S.) per carat, based on a
108-carat parcel, but that value plummeted to a dismal $47.30 (U.S.) per
carat after the recovery of an additional 533 carats in 1999. Tuzo has not
been mini-bulk tested since then, but given the big variations in the
modelled grade at Hearne and the continued wide margin of error, a new test
of the body might be worthwhile, as the valuation pendulum can swing both
ways.
Even based on the lowest estimates, the three main Kennady Lake pipes
contain a gross value of nearly $2.5-billion (U.S.), and it seems likely
that De Beers will find a way to make a mine at Kennady Lake. Still, the
latest news took its toll on its partners. Mountain Province closed down 58
cents Friday, at $1.35, recovering to $1.49 on Monday, while Camphor
Ventures dropped 36 cents on Friday at 53 cents, recovering to 57 cents on
Monday.
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