How Rio Tinto dug itself a hole in Mongolia

Alarm bells started to ring for the engineers working underground at Rio Tinto's Oyu Tolgoi mine when they had to abandon attempts to drill a fairly simple borehole for ventilation.

Rather than carve a discrete tunnel through the rock to surface, the bore collapsed into an ungainly void, unfit for use.

As they conducted a post mortem into the borehole failure, the engineers were mindful the incident could be the proverbial canary in the coal mine for Rio's plan to build a huge network of tunnels more than a kilometre beneath the Mongolian desert as part of a $US5.3 billion expansion.

"We are pretty confident that it is stress-related and or fault-related, or both," wrote Oyu Tolgoi's then manager of Vertical Development and Mass Excavation Scott Ramsay, when discussing the cause of the bore failure.

"If it is stress alone due to depth, then we recognise that we have a much, much greater problem, as you'd be aware, because we have not only internal vent raises, but also vertical ore passes and ore bins and underground crusher stations to excavate at 1300 metres below surface for the success of this mine".

The more things have changed at Oyu Tolgoi in the seven years since Mr Ramsay sent that letter to Oyu Tolgoi's bore drilling contractor, the more they have stayed the same.

The reliability of the rock underground at Oyu Tolgoi remains a worry. Sovereign risk in Mongolia's young democracy remains a worry.

As Rio prepares to update investors on the cost and schedule blowouts affecting the most important growth project in its global business, shareholders are wondering what sized hole the company has found itself in.

Oyu Tolgoi has been pulling modest amounts of copper, gold and silver out of an open pit in Mongolia's South Gobi Desert for six years.

Right from the start, the main game was an underground expansion project, which holds about 80 per cent of Oyu Tolgoi’s value and will turn it into one of the world's top three copper mines.

For a small, poor population that emerged from socialist rule less than 30 years ago, the prospect of hosting one of the world’s most lucrative mines for at least 40 and maybe 100 years is understandably exciting.

The mine dominates political debate in Mongolia, and consumes half of all foreign direct investment into the nation.

A rare period of harmony between Rio and the Mongolian government emerged in 2015, when they struck an agreement that allowed the mine to borrow $US4.4 billion from lenders like Australia's export credit agency, ANZ and NAB to build a $US5.3 billion underground mine expansion that would deliver "sustainable first production’’ in the early weeks of 2021.

The $US5.3 billion budget was understood to have a 14 per cent buffer for future cost blowouts.

While Rio is the project developer and mine operator, it does not directly own a stake in Oyu Tolgoi.

The mine is 66 per cent owned by Canadia’s Turquoise Hill Resources (TRQ) and 34 per cent owned by the Mongolian Government.

Rio owns 50.79 per cent of TRQ, meaning it effectively, but indirectly, owns just 33.52 per cent of Oyu Tolgoi.

As 2018 dragged on, it was increasingly clear to people working on the project that development of Oyu Tolgoi's "shaft two" was not going to plan.

With a 10-metre diameter and plunging to depths of almost 1300 metres, shaft two was intended to be a critical enabler of the underground project, allowing equipment, people, oxygen and huge volumes of ore to move between the underground mining areas and the surface.

Shaft two was supposed to be finished in mid-2018. But it was October 2018 by the time Rio fleetingly told its shareholders there would be a "revised ramp-up schedule'' on the project.

TRQ gave its shareholders more information, saying the delays could be about nine months.

By February, Rio was more forthcoming and pessimistic, flagging “some potentially significant changes to the design” and suggesting the delays would be greater than the nine months disclosed by TRQ.

TRQ reiterated those comments, and added that work was under way to understand the impact on project cost.

Some who have worked on the project feel Rio should have told investors about the problems at shaft two sooner. An investigation by Rio’s law firm Baker Mackenzie has left the company confident it did not breach disclosure rules.

For a ''block cave'' mine to work at Oyu Tolgoi, Rio needs the weak and fractured rock to collapse under pressure from blasting and gravity.

But there are fears the rock may collapse too well; meaning the underground passages and tunnels through which the ore is extracted (known as extraction drives and ore passes) may also collapse, rendering sections of the mine unworkable.

Studies have continued through 2019 with relocation of the ore passes being a top priority.

Rio is also considering mining a different section of rock first, to target structurally reliable areas.

This may mean a section of rock with particularly high copper grades is mined later than originally planned.

''This is critical to the economics in our view as it affects the pace of ramp-up
to full production and in turn affects cashflow and profitability,'' Deutsche analyst James Gurry said.

''We are therefore expecting a slower ramp-up, less concurrent caving initially but a redesign that sets up the mine optimally for the following decades of life.''

Based on this year's disclosures, the project schedule appears vulnerable to at least one year's delay and some analysts have built a two-year delay into their models.

The cost blowout is harder to quantify.

RBC has added $US500 million to the existing $US5.3 billion budget.

Deutsche has assumed an $US800 million cost blowout, taking the capital spend to $US6.1 billion.

Goldman Sachs analyst Paul Young has assumed a total cost of $US6.4 billion, which would be a billion-dollar blowout.

Some argue the true cost will be much higher than those estimates now that Mongolia has ruled Oyu Tolgoi must be powered by a domestic energy source rather than continue to import power from China.

That means a new power station must be built, and the Oyu Tolgoi shareholders have agreed to own, and therefore fund, at least 51 per cent, and potentially all of the power station.

The cost of a power station is not included in Rio's official $US5.3 billion budget.

If forced to build a power station, Rio has always wanted to do it at the Oyu Tolgoi mine site.

But on December 30 Rio acceded to the Mongolian government's desire for the power station to be built at the Tavan Tolgoi coalfields, approximately 150 kilometres from Oyu Tolgoi.

Rio's copper boss Arnaud Soirat warned in November that the Tavan Tolgoi option would take six years to complete. Less than two months later Rio had pledged to build it in four and a half years.

Most pundits expect the power solution will cost between $US1 billion and $US1.5 billion.

Rio has already set aside $US500 million in its capital spending budgets for its share of power station costs.

TRQ management did not disagree on an investor call earlier this year when an analyst suggested the power station would cost about $US1 billion.

Combined with the blowout in mining costs, the addition of the power station has left many observers predicting a total capital spending bill north of $US7 billion.

Source:www.afr.com