Thursday, December 22, 2011

South Boulder Mines (SBMSY) And Eritrean Exploration For Potash

South Boulder Mines trades as STB in Australia, and SBMSY here in U.S. markets.  The company does have other mining projects in Australia but one newer project is worth a discussion.  They think they've found a bunch of potash in Eritrea and want to try their luck bringing it into production.  How hard can it be?

The good news is that potash deposits have fairly uniform geology, unlike metal deposits that form in veins and require more precise estimations of grade and depth.  That makes for a straightforward estimate of the mine's layout and required capex.  They have considered requirements for new roads and port facilities in advance and have budgeted to build them from scratch.  The potash site is below sea level, so pumping water to the site from the coast is feasible in energy terms.  I am curious as to whether the seawater would have to be desalinated or otherwise treated prior to use in a potash mine; there is precedence for using treated waste water.  Saltwater from oil drilling is apparently also useful in the hunt for potash, so maybe seawater isn't a worry at all.

The bad news is all about Eritrea.  The U.S. State Department has a good summary of Eritrea's political situation.  Eritrea's willingness to defray the company's capex costs is nice but the government's requirements for free carry, an option to buy a 30% stake after the bankable feasibility study, a 3.5% royalty, and a corporate tax rate of 38% all add up to a serious bite before the common shareholder will see a penny of net earnings.  The government completely controls the economy, prohibits civil liberties, and has not held free elections.  That should give foreign investors pause in considering how safe their investments will be.  Transparency International rated Eritrea as 2.5 in its Corruption Perceptions Index in 2011 (that's pretty bad).  The Heritage Foundations' Index of Economic Freedom ranks Eritrea's economy in 2011 as one of the least free in the world.  The U.S. government is also sufficiently concerned about Eritrea's support for Al Shabaab, an Al Qaeda-inspired radical Islamist terrorist group, that it advocated international sanctions against Eritrea earlier this year.  The UN enacted those sanctions and recently made them stronger.

Read that State Department political summary again for an interesting fact.  Eritrea's GDP was only $1.87B in 2009.  South Boulder Mines estimates revenue from this project of $6B over 17 years, or roughly $353M/yr.  That's almost 19% of Eritrea's total GDP, from a single project.  A country as corrupt and poor as Eritrea would be sorely tempted to nationalize a lucrative mining project.  I have no idea whether the Eritreans would actually do such a thing, but they don't seem to have much respect for the law or international norms of behavior.

The company owns a legacy nickel property and plans to spin it off. Why not sell it to raise the money they'll need for capex at the potash site?  That would make the rest of the raise easier.  It would also be easier to raise capital with working interests rather than share issuance, as the Eritrean government's potential equity stake could massively dilute shareholders.  Working interests, if creatively structured, can let revenue flow to strategic investors before the Eritrean government collects its onerous taxes.

In any Western country, a potash play this large and shallow would be a more straightforward financial decision.  Its location in a country with a questionable political structure should make investors think carefully.

Full disclosure:  No position in STB / SBMSY at this time.