Interview: Alexander Molyneux of SouthGobi Resources (TSX: SGQ)

Alexander Molyneux, President & CEO of SouthGobi Resources, on site at the Ovoot Tolgoi mine in Mongolia.

SouthGobi Resources is focused on exploration and development of metallurgical and thermal coal deposits in Mongolia’s South Gobi Region. The company’s flagship coal mine, Ovoot Tolgoi, is producing and selling coal to customers in China. Ovoot Tolgoi is located in southern Mongolia, approximately 40 kilometres north of the Chinese border. Ivanhoe Mines is SouthGobi Resources’ largest shareholder and owns approximately 57% of the issued and outstanding shares of the company.

In August, SouthGobi Resources set a new monthly record of 441,665 tonnes of coal shipped which was a substantial increase over shipping levels from a year earlier. On an annualized basis, the company is producing at 5.3 million tonnes of coal per year and is on track to meet its production targets for the upcoming quarter.

SouthGobi, along with its major shareholder Ivanhoe Mines, have paved the way for business in Mongolia. And although the process hasn’t always been easy, the Mongolian government is proactive and pro-business. Prime Minister Sukhbaatar Batbold, age 48, has worked hard to open the doors to foreign investment. The country is only 20 years removed from the days of Soviet control and is sorting out its path towards a healthy free market economy which includes the world’s smallest stock exchange (Mongolian Stock Exchange). Established in 1991, stock exchange officials hoped the exchange would help to privatize the majority of state assets. Fast forward to 2010, the MSE reported 336 listed companies with a combined market capitalization of roughly $1 billion. SouthGobi Resources has openly expressed interest in listing on the diminutive exchange to validate the direct benefits associated with foreign ownership in Mongolia. connected with SouthGobi’s President & CEO Alexander Molyneux to learn more about the company’s plans.

For someone looking at investing in a coking coal company for the first time, what are some of the key components to consider from both a company and industry perspective?

From an industry perspective people should recognize coking coal is a “late cycle” commodity from a China perspective. China was broadly self-sufficient until around three years ago. This is much later than for copper or iron ore for example. What this means is that we haven’t yet seen the full impact that China’s demand requirements will have on the market and pricing for coking coal. In a slower growth environment, China will still increase its demand for coking coal by 7-8% per year for the rest of this decade. However, its industry really only has the capability to grow around 3-4% per year and even that growth will be endured through rapidly rising costs and continued safety issues etc. The next point from an industry perspective becomes India. Coking coal for India is much more of an upfront issue. India will meet almost all of its coking coal needs through imports. When I look at the situation, it makes me absolutely adamant that coking coal will outperform the broader commodities sector this decade because China and India will have to triple the internationally traded coking coal market just to meet their own needs.

From a company perspective the key is “location, location, location”. Coking coal is a bulk commodity and so the ability and cost of transportation to the market is much more relevant. In the case of base metals, if it’s 80:20 for geology: location, then coal is 40:60. Now this is what’s driving the emergence of new coking coal producers. The grand claims of Canada and USA becoming big suppliers to China’s coking coal needs just hasn’t come to pass. The publicly listed companies doing business there grandstand about China demand but Mongolia, which is right next door to China, is becoming the key supplier. In the month of August for example, our mine in the South Gobi desert alone sold three times the coking coal to China than all of Canada did! Mongolia is now meeting around 45-50% of China’s coking coal import needs. SouthGobi Resources’ mines are the closest coal resources to China. We are 45 kilometers away from China and less than 50 kilometers off Chinese rail. It’s a huge advantage.

Comparing apples to apples, how does SouthGobi’s direct mining cash costs compare to other coal miners in Mongolia and China?

Before China became a force in the global coking coal market, Mongolia’s coking coal deposits were relatively constrained from an infrastructure perspective. As a result some very low cost resources were never mined, including ours. Our current mine, Ovoot Tolgoi has a life of mine strip ratio of around 4 BCM of waste per tonne of coal. Our direct mining cash costs average around US$20/t… that’s around one third to one quarter of costs in Australia, Canada or China.

What are your production rates as we head towards the end of 2011 and what are your target production rates for the end of 2012?

Our target for the calendar year of 2011 is to sell between 4 and 4.5 million tonnes. We’ve really had very smooth production this year and so our run of mine coal production is now running at around 6 million tonnes annualized right now in line with our ramp-up expectations. We have 13 new 240 tonne haul trucks to commission between now and the end of 2012 plus another Liebherr 996 excavator. We will likely finish 2012 with annualized run of mine production in the region of 8 to 9 million tonnes.

There were some issues with increased sulphur content in some of your coal as reported in November of 2010 and quality control measures were implemented. Have these issues now been fully dealt with?

It wasn’t increased sulphur… it was that the sulphur in product coal from on some higher ash seams was higher than the geological work had suggested. It certainly came as a surprise when we started mining that coal for the first time in 2010. The problem is resolved though. The first step was to ‘mitigate’ the problem. That’s all we could do with the resources we had. We started screening the coal to reduce the ash from 25% to around 18% so then the customers started buying that coal because we improved the value of it in a different way. Since then we’ve raised the price of it by 40% and we sell it every day. The other thing is that our sulphur reduces with depth. That coal is already around 0.15% lower sulphur than last year. We will be processing all our coal from the start of 2012 through a combination of a dry coal handling facility at Ovoot Tolgoi and a wet washing facility that will further treat any coals that remain above 10% ash. Every tonne of coal we sell will very soon be in-spec semi-soft coking coal with low to medium sulphur.

It has been rumoured for quite some time that your majority shareholder Ivanhoe Mines has been looking for a buyer for some (or all) of its stake in SouthGobi. Has this affected your ability to operate the company in any way or is this irrelevant to your ongoing business activities?

My feeling is the rumour may have been over done a bit. Regardless, it doesn’t affect our business. We have our own operations, our own capital and continue to move ahead aggressively with our development.

In short, why should an investor take a serious look at SouthGobi Resources as we head into 2012?

We’re in absolutely the right commodity. We are a first mover in Mongolia and are benefitting from new infrastructure and market development, which is increasing the price of our coal. With our growth and introduction of processing, we have an enormous ability to generate reliable cash flows that’s just not priced into our stock.

This interview is featured in the article 5 Coal Stocks to Watch – Part 2 – CLICK HERE to read more.

Mike Luft

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