In the aftermath of the nuclear crisis is Japan, is coal the new uranium?

Thermal coal, which is the cheapest and most common type of coal, is burned to generate steam that powers turbines and produces electricity for either public grids or for large-scale industrial use. Metallurgical coal, on the other hand, is used as a fuel and as a reducing agent (coke) for smelting iron ore in a blast furnace; as such, it is also often referred to as coking coal or steelmaking coal. Metallurgical coal needs to be low in sulphur and phosphorus so these elements do not migrate to the metal during steel making.

Coal is mined in over 100 countries, and on all continents except for Antarctica. The largest reserves are found in the USA, Russia, China, India and Australia. The world’s largest coal producers are China (48%) and the United States (15%) and almost all production is used for domestic needs. On the export side, Australia (26%) is the largest exporter of coal followed by Indonesia (24%). But Indonesia may not be a reliable source of inexpensive coal. Power projects that had planned to get coal from Indonesia are yet to find a solution to a new law that may effectively increase the cost of Indonesian coal. The new regulation says coal sold from the country is to be indexed to the international price and revised annually.

After the earthquake in Japan, some investors are looking towards coal to “pick-up the slack” associated with the possibility of decreased energy output caused by the reduction of nuclear energy programs around the world. But some think this is simply a temporary blip on the energy radar as many countries will reinstate nuclear power as key energy source once the public’s concern subsides.

John Lee: "I made it a priority to add highly-qualified and competent leaders to our team and have seen very positive, tangible results."

It has been a very eventful year for Prophecy Coal. A $42 million public financing, the spin-off of sister company Prophecy Platinum (TSX-V:NKL) and now the challenge of managing growth in the face of volatile markets. Lately, the markets have had a major impact on the company’s share price. Prophecy is currently trading at $0.44 per share which yields a market cap of roughly $90 million. Currently, with $64 million in shares of Prophecy Platinum, $40 million in property and equipment; and a little less that $10 million in cash on the books (as at June 30th, 2011), you are getting the company’s Mongolian coal assets and Canadian mineral properties for, well, less than free.

In July, 2011 Prophecy Coal announced a defensive plan to give the company’s shareholders and directors time to consider alternatives should a hostile takeover attempt emerge. This was primarily in response to the released of a new resource estimate by Prophecy Platinum for its Wellgreen property in Yukon. Shares of Prophecy Platinum surged after the news from $0.60 to $6.00 per share and subsequently greatly increased the asset value of Prophecy Coal. Prophecy Platinum is currently trading at $2.82.

Prophecy Coal reports more than 1.4 billion tonnes of thermal coal on two properties in Mongolia and began selling coal to Russian and Mongolian buyers this year. Situated next to China, the world’s largest coal consumer, Prophecy’s President & CEO, John Lee, thinks Prophecy is well positioned to take advantage of China’s ever-growing energy requirements. We sat down with Mr. Lee to discuss the company’s eventful year and to find out what is on the horizon in 2012.

2011 has been a whirlwind year for Prophecy Coal and included a $42 million public offering and the commencement of mining operations at Ulaan Ovoo. Please talk about the year and some of your additional achievements.

Absolutely, 2011 has been, and continues to be, a very busy and productive year for Prophecy Coal.  By mid-year, we had hit a number of important milestones and competed key phases of project plans for both Chandgana and Ulaan Ovoo.  By way of example we successfully commissioned a new mining fleet at Ulaan Ovoo (“UO”), we commissioned UO to commercial production and stockpiled over 230,000 tonnes of coal, we obtained Chandgana Tal Mining License and submitted the Chandgana Power Plant Project feasibility with the Mongolia Government, we received official endorsement for the Chandgana Power Plant from the Mongolian Ministry of Natural Resources and Energy; and, we completed the spin-off of Prophecy’s core Canadian assets to Prophecy Platinum. We also strengthened the board and management team with the additions of Jivko Savov, Chuluunbaatar Baz, and Ronnie Van Eeden.

The Chandgana power plant project is advancing and continues to attract interest from international investment banks and other potential investors.  The power plant license application is progressing through the proper channels within the Mongolian Energy Regulatory Authority (ERA).  The Mongolian government has expressed keen interest in working with Prophecy to address the country’s critical energy shortage. Evonik industries of Germany have been engaged to complete TPP Project Bankable Feasibility Study (BFS) by the end of October, 2011, and a Hong Kong investment bank has been retained to advise on project planning and financing.  We are pleased with the advancement to date and are looking forward to continuing to develop the project in concert with the people and government of Mongolia and all stakeholders.

2011 was also a year in which lessons were learned and adjustments made to address some of the areas in which we saw room for improvement.  While we invested over $25 million in the equipment and commissioning of Ulaan Ovoo, and were successful in the endeavour it took time to integrate our new staff in Mongolia.  Commissioning a new mine and bringing it into production is a significant challenge for any company, particularly so for a new team. Overseeing over 100 Leighton staff consumed considerable resources in addition to the time required to deal with various issues such as late equipment delivery, evolving mine plan, truck availability, local relations, stock piling, and a constrained diesel fuel supply.

Please tell our readers about your coal assets in Mongolia and how do they compare with other thermal coal regions?

In terms of the coal deposit size, Ulaan Ovoo contains 20.7 million tonnes of proven coal reserve, and 208.8 million tonnes of measured & indicated coal resource (NI 43-101; 174 Mt of measured and 34 Mt of Indicated).  In terms of quality, the resource contains bituminous (5,040 kcal/kg), low ash (11.3%), low sulphur (0.40%), thermal coal suitable for export.  I would also add that the deposit is contained within a single massive coal seam 45-80 m thick with a very low average strip ratio of 1.8:1.

One can see a significant degree of variance in the quality of coal produced among different thermal coal regions, and even within.  The tonnage pricing generally reflects the degree of difference.  Where demand is concerned, however, attention must also be paid to the logistics of delivery and associated overhead costs.  Ulaan Ovoo will feed a domestic market and is situated proximate to the secondary Russian market.  Securing year-round access to the Zeltura border crossing just 7km from the mine as well as improved rail access into Russia and to the eastern seaport, will make exports from Ulaan Ovoo that much more attractive to foreign consumers.  We are also considering the possibility of building a power plant at Ulaan Ovoo.

With respect to the Chandgana, the deposit is far larger, but with a somewhat lower calorific value.  Rather than have an isolated focus strictly upon the nature of the resource, however, one has to consider the ultimate goal of that project.  The intent is not to export the resource and incur the associated expenses.  Instead, the resource will be consumed on-site, supplying power to the people of Mongolia.  There is enough coal at Chandgana to feed a 600MW power plant for decades.  Prophecy will then look to ramp up the capacity of the power plant to 4200MW, at which point electricity – rather than thermal coal – will be exported to neighbouring China, in order to alleviate their energy deficit concerns.

Mongolia has been, at times, a challenging place for companies to do business. What have been your experiences with the government and people of Mongolia?

Prophecy has enjoyed a close relationship with both the people and government of Mongolia.  They have made it very clear from the beginning that they understand and appreciate that we are focused on moving their country closer to complete energy independence.  Our situation does differ in some fundamental ways from those that have been in the news of late.  We are confident those situations will get worked out in a way that satisfies all parties concerned.  But in the case of Prophecy, the resources extracted – or, in the case of the Chandgana Power Plant, the energy generated – are overwhelmingly destined for consumption by, and for, the people of Mongolia.

Rather than simply a partnership, Prophecy has a relationship with Mongolia. In addition to releasing the country from their dependence on imports from Russia and the economic and political benefits of that alone, Prophecy projects will provide decades worth of employment, facilitate further development, foreign and domestic investment, raise living standards, lower pollution and, longer term, we anticipate generating significant revenues through power exports to supply China’s ever-growing demand.  The political and sovereignty concerns that may exist in other current scenarios do not come into play in the case of Prophecy Coal.  The benefits of our projects will be overwhelmingly experienced by the people of Mongolia, just as the financial rewards will remain largely within that country.

There are, of course, some speed bumps along the way when embarking on large scale projects in countries like Mongolia.  But one has to keep in mind that their government is not a monolithic entity under which power is centralized to the point of being wielded by one or a few.  There are some 70 members of parliament in Mongolia, each representing the citizens and groups in their respective constituency.  There is always some degree of challenge when working with newer markets, but we are confident the situation will only get better as Mongolia’s fledgling democracy hits its stride and really starts to see the benefits of a full embrace of free market principles and practice.

It is also worth noting, that ours are infrastructure projects built by Prophecy on Prophecy-owned land through capital raised by Prophecy.  We see ourselves working and negotiating with the Mongolian Government for the benefit of all Mongolian citizens.

I really want to emphasize the point that we are facilitating and supporting Mongolia’s ongoing expansion and moves toward greater self-reliance and both the people and government have been completely supportive of our efforts in that regard.  We have no reason to expect or be concerned with experiencing any substantial challenges moving forward and, quite the contrary, expect them to improve markedly.

You last news release stated that Prophecy’s cash position and equity holdings total over $90-million (U.S.) as of Sept. 1, 2011, how do you plan on putting the capital to work?

Apart from day to day operations, we have no major expenses on the immediate horizon.  Once we get the Chandgana power plant license, which, we expect will be awarded before the end of 2011, we will be directing capital to the construction of the physical plant and infrastructure.  We have been in discussions with major investors from around the world as well as looking to shortlist EPC contractors so we will be in a position to move forward expeditiously.  We anticipate construction cost to be upwards of $800 million.  We are considering various options of financing the Chandgana project and it will likely be a combination of different types of financing.  We prefer to have minimal dilution, thus, only part of the financing will be equity based.

The recent market meltdown has actually not impacted the price of thermal coal to any large degree. What is your take on the price of thermal coal going forward?

We are confident that the price of thermal coal will rise as we move forward and possibly as high as the $180 USD/t range.  There are a lot of factors at play, particularly in terms of simple supply and demand influences.  For example, we expect continued growth in China in spite of the economic turmoil in Europe and the United States and the effect this may have on the global economy.  While it may not be in a straight line, GDP growth in China should see a sustained increase of 8-10% per year.  And, of course, power will be needed to fuel that growth.  The fact that the Chinese have been buying coal all the way from Columbia is a clear indication that demand is extremely high.

Exacerbating their energy supply deficit, is the fact that the Chinese have slowed both the output of existing nuclear power plants and the construction of new ones following the recent incident in Japan.  We anticipate higher coal demand coming from Japan, as well.  Just as it is expected that demand for zinc and other commodities will rise, Japan will need new energy sources to fuel its reconstruction efforts and to compensate for reduced supply in the wake of the recent nuclear crisis.

We are also interested in supply from Australia, given recent developments in the political arena.  A rather comprehensive carbon tax has been proposed which the ACA has stated could cost that industry nearly $18 billion over the next ten years.  There has also been some concern with the degree to which foreign investment has increased their stake in Australian mining concerns, particularly Chinese stake in coal production.  Whether this potential hot button issue will negatively affect exports to any significant degree remains to be seen, however, it is something to keep an eye on.  Then, of course, there are the usual weather pattern disruptions, and rising shipping costs to consider.

Globally, we expect that energy demand will increase.  We also anticipate oil prices to rise and this should push the price of coal significantly higher as nations look to minimize their energy expenditures and reduce reliance on OPEC.   This is particularly true with respect to Asia, where a sustained rise in demand will support higher thermal coal prices, going forward.

One final point worth mentioning here is that coal, particularly outside the Western world, is gaining ever more acceptance by the public.  This is due, in large part, to innovative, new clean coal technology that has dramatically reduced emissions as well as stringent environmental standards governing the construction, operation and efficiency of mines and power plants.  This is a key factor for the Chandgana project, as we plan to construct a state of the art power plant that utilizes the most advanced clean coal technology available today.

What are your key milestones for 2012 and how might they impact the company going forward?

2012 is going to a busy year at Prophecy, as our Chandgana power plant project will have progressed from the exploration phase, through administration and licensing – along with initial mine development – and into the financing stage.  We are expecting the Bankable Feasibility Study commissioned through Evonik, will be complete and ready by q4 2011 at which point we can look to finalize a Power Purchase Agreement and financing arrangements.

Our goal is to secure all necessary financing in 2012, in order to commence power plant construction in 2013.  Clearly, this will also involve a great deal of advance planning as well and we will be very proactive in that regard.

It is also important to note that Prophecy Coal holds roughly a 42% share (22.5 million shares) of Prophecy Platinum (TSX.V: NKL), and the two companies are closely affiliated.  2011 has been a very important year in the development of NKL and, in particular, the company’s flagship Wellgreen property – a nickel PGM property in the Yukon Territory.  We came out with a new resource estimate that sent shares sharply upwards and undertook a drilling program which yielded impressive results to date.  We have engaged Wardrop Tetra Tech to start a Preliminary Economic Assessment on the Wellgreen project as well as SGS Canada to perform metallurgical tests.

We are very optimistic about the future of both companies and are excited about what we will see in 2012 as we continue to make efforts to maximize the potential of all Prophecy projects.

This interview is featured in the article 5 Coal Stocks to Watch – Part 1 – CLICK HERE to read more.

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