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After nearly 18 years of producing zinc, lead and silver, the Red Dog mine in Northwest Alaska has finally recovered about a billion dollars in initial and ongoing capital costs and its operator will begin paying its Native landowner a net profits percentage of its open-pit mine business.
The timing couldn't be better for the Red Dog landowner NANA Regional Corp., as the remote mine is on track to produce another record year of billion-dollar profits. In 2006, thanks to dramatic increases in zinc prices, Red Dog earned a record $1.08 billion in profits, compared to $325 million in 2005, according to the mine's operator, Teck Cominco.
The trend of profitability should continue this year. For the first six months of 2007, Red Dog's profits have been consistently higher than those reported during the same period in 2006, setting the stage for another potential record-setting profitability rate this year. Revenues were up to $422 million for the first six months of 2007, compared to $362 million in 2006. Operating profit for the same period was $265 million, compared to $240 million in 2006.
Given a steady production rate comparable to 2006 and the continued strong market prices for zinc, the greatest contributor of the mine's revenues, mine managers expect Red Dog will likely produce similar profits in 2007.
"Red Dog has sort of matured and reached right now a steady state," said James Kulas, environmental superintendent at Red Dog. "What we're loving right now are the metal prices."
The recent substantial gain in profits will help to shift the distribution of mine earnings from royalties based on production to profit-sharing under the financial and operating agreement between NANA and Teck Cominco.
Since production began in late 1989, NANA has received an advance net smelter royalty of 4.5 percent each year, while the mine's operator, initially Cominco American Inc. and now Teck Cominco, retained the remaining profits.
In some years, as recently as 2002 when zinc prices averaged 35 cents per pound, Teck Cominco posted a loss at Red Dog of $28 million.
Despite some lean years, annual royalty payments to NANA have grown, hand-in-hand with the increased rate of metal production at the remote mine operation. In the fiscal year 2006, NANA received $29.6 million in net smelter royalties from Teck Cominco, an increase of nearly $13.7 million over the prior year, according to the Native corporation's annual report.
Total royalty payments from Teck Cominco to NANA from 1989 through 2006 is $177 million, according to Kulas.
Now, the owners of Red Dog are planning for a shift in the division of profits, as capital expenditures, accrued interest and advance royalties for the mine have been recovered by Teck Cominco.
PROFIT-SHARING BEGINS
With an initial construction cost of about $400 million at Red Dog, capital recovery was expected to be complete by the mid-1990s, shifting finances to profit-sharing, according to Helvi Sandvik, president and CEO of NANA Development Corp., the operating entity of NANA Regional Corp.
But shortly after the mine began producing, zinc prices fell to the 30-plus cent range, slowing the capital recovery process.
"It's taken a lot longer than we believed to repay the initial investment, which was substantially higher than originally estimated," Sandvik said.
Additional capital investment was made in the mine and mill complex, beginning in 1996 with the PRI project. Completed in 1998, the Production Rate Increase project was designed to increase through put by 40 percent, with a cost of $200 million.
Despite increasing the production rate of mining and milling the Red Dog deposit, the mine life was not shortened, as geologists working on-site found additional zinc and lead mineralization. Currently, the mine life calls for closure in 2031, Kulas said, but more mineralization has been located nearby.
"We're actively exploring, and we have higher metal prices than what was used for that (mine life) reserve, so it's a very conservative number," he said. "We have a two-drill program and we're evaluating an area to the north, an area where we've had successes in past years."
A second substantial expansion project, called VIP, added another $100 million to the total capital costs to recover. The Value Improvement Project, completed in 2001, was designed to improve recovery and concentrate quality, Kulas said.
Capital costs and interest costs were recovered by Teck Cominco in 2006, according to the company's annual report, and now, the operation has a small amount in advance royalty payments to recoup before the magic milestone for profit-sharing is reached.
MINE AGREEMENT
According to the original agreement, NANA will receive 25 percent of the net production proceeds during the next five years, a percentage distribution that will increase five percent for each five-year period until the Native corporation receives half of the net production profits.
"When we evaluate the Red Dog project over time, the financial return has been significant, but nowhere near what was anticipated," Sandvik said.
That may change, and soon, according to Teck Cominco's second-quarter report released in late July.
With only $19 million in advance royalty payments to recover after June 30, Teck Cominco estimates the payment of the 25 percent royalty to NANA beginning in the third quarter of 2007, before press time. "The actual timing will depend on metal prices, sales volumes and other items affecting the calculation of net proceeds," the company said in its report.
What the profit-sharing will do for the Native corporation remains to be seen. NANA management noted the uncertainty of the level of profit revenues from the mine in its 2006 annual report.
"The amount of net proceeds that the mine generates is dependent on a number of factors including, but not limited to, market prices of zinc, lead and silver; operating costs at the mine site; negotiated terms with refiners and a number of other factors," the annual report said. "While management believes that net proceeds payments will be significantly higher than previous advance net-smelter royalties paid in the past, the nature of many of the factors mentioned is extremely volatile and accordingly, management cannot provide reliable estimates for net natural resources revenues for 2007."
Whatever the level of profits from Red Dog are paid to NANA this year and in the future, the money goes much further than to the northwestern part of Alaska. Profits earned by Alaska Native corporations through resource development on their lands are shared, putting mining profits into the hands of all Alaska Natives.
"For every dollar we receive in royalty, 62 cents is paid to other regional and village corporations," said Sandvik. "It provides an economic contribution to every single regional and village corporation in the state ... the economic impact of resource development is very profound to the economy of Alaska."
RED DOG JOBS HELP PRESERVE RURAL LIFE
The decision to develop Red Dog in the 1980s was one of survival for the people of the NANA region, Sandvik said, as the lack of employment in the remote northwestern part of Alaska was limited. Residents of the region wrestled with the choice, concerned that mine development and traditional subsistence use of the land might not co-exist.
"Back in time, when we were debating whether Red Dog ought to be developed, certainly there was anticipation of royalties, but the primary driver of the decision to develop was to create employment opportunities," she said. "In our region, we had no surface transportation, it's very remote, the cost of living was very high, and there were just no jobs available."
NANA shareholders had opportunities to work in the corporation's oil industry service subsidiaries on the North Slope, but that took folks away from home for long periods of time, Sandvik said.
"The real issue in developing the resource is the significant quantity of jobs the mine creates, the employment opportunities in the region. You can go work in a skilled profession and still live in the region," Sandvik said. "The strength we have is knowing who we are, having a sense of our culture and pride in living in our culture ... our region is a better place because we have tremendous choices now."
The agreement signed in 1982 between NANA and Cominco American Inc. reflected those values. In addition to crafting a financial agreement to develop one of the largest and richest zinc deposits in the world, Cominco was required to provide employment opportunities for its Native partner--offering first preference on all Red Dog jobs to Natives in the NANA region, and to protect the subsistence lifestyle in the region.
Currently, the mine employs 453 full-time, year-round workers and 91 seasonal workers, hired during the summer months when additional hands are needed for the shipping port and barge-loading of the metal concentrate. Shareholder hire averages 61 percent for all categories of Red Dog workers, according to Kulas.
Between 1989 and 2006, a total of $223 million in wages was paid to NANA shareholders working at Red Dog, Kulas added.
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"Our goal is 100 percent shareholder-hire at the mine, and in 18 years, we've not hit the target yet," Sandvik said. "It's a good project and we have shareholders working from entry level to mid level to supervisory, but the upper echelon of mining expertise we have not penetrated yet ... our philosophy is to create opportunities and to go to the ends of the earth to help shareholders take advantage of those opportunities."
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