Analyst's Notes: Orezone Gold

Executive Summary

Orezone Gold Corporation (“Orezone”) (TSX:ORE) (OTCQZ:ORZCF) has a market capitalisation of C$395 M. The company owns 100% interest in the Bomboré Project, West Africa.

After a long period of exploration and evaluation, Bomboré is now in production. The first gold pour was in September 2022 and commercial production was declared in December. Orezone’s Phase I plan is to produce an average of 118,000 ounces of gold per annum (118 kozpa) over a thirteen year mine-life. So far so good, but Crux Investor remains cautious.

Bomboré is obviously a hard nut to crack. From early exploration the company kept on drilling and carrying out economic assessments. Updated resource estimates were released regularly from 2008 to 2015. From this point on, economic and technical studies were added into the mix, culminating into the 2019 feasibility study. The 2019 study was the basis for the go-ahead decision to develop a mine. Crux Investor’s opinion is that low-grade re-treads are fraught with problems. When a project suddenly proves feasible after many years of plodding along, be extra careful. 

A full review and valuation by Crux Investor identified some reasons to be cautious. The root of the problem is that Bomboré is low grade. The reserve grade for the oxide portion is 0.69 g/t gold. This is extremely low for ore requiring treatment by Carbon in Leach (“CIL”) processing. It takes extraordinary favourable conditions to make such a low-grade project economic. 

In its favour, mining at Bomboré is free dig and processing is straightforward and cheap. Beyond that, there are other challenges for the project. In no particular order:

• royalties of 6% (when gold prices are above US$1,300/oz) are a heavy burden, 
• the income tax rate of 27% is not particularly low, 
• the strip ratio of 2.3 is not low, 
• contract mining means higher operating costs,
• grade control drilling to distinguish between waste and low-grade ore is hard to manage,
• ore haulage distances are not short, 
• climatic conditions at times disruptive (wet season rivers cross the mineralisation), 
• security in Burkina Faso is complicated.

The feasibility study reached a positive conclusion by using very low operating cost inputs. Benchmarking against actual costs of other open pit operations in Burkina Faso shows that more realistic costs are 60% higher. Interestingly, higher costs are offset by higher gold prices. The Feasibility Study used US$1,300/oz. Spot prices are US$1,877/oz. So far so good for Bomboré as an economic proposition. The project seems to make the grade after all.  

Obviously for the project to work, the real-life operating parameters of cost and grade need to match up with the estimated operating parameters of cost and grade. And when grades are very low, margins for error are reduced. Narrow operating margins introduce risk into a project and Bomboré is no exception. Crux Investor can see that Orezone’s resource estimation modelling employs some unusual practices and makes obtuse assumptions on grade continuity. If it works, it works. But with unusual practices and obtuse assumptions comes risk. Will planned grades be achieved? How robust is the resource? How well defined are the boundaries between waste and ore?

On these themes, operational data from commissioning suggests that Orezone is struggling to distinguish between waste and ore in mining. Limited information to date suggests that both run-of-mine grades and strip ratios are lower than planned, indicating a blurring of the boundaries and mine dilution. Less waste, but with the result of lower average grade delivered to stockpile.

In addition, the most recent news releases were not crystal clear about mined grade to date. Perhaps there is a discrepancy between actual and planned grades in the operation so far? Crux Investor calls for more transparency from Orezone on this key information.

The long pre-production period has resulted in the company being in a difficult working capital situation, in particular cash on hand. Orezone is exposed to teething problems which can push the company into a financial corner. Already one of the financiers had to defer start of interest payments until mid-December 2022. However, decent production in December 2022 combined with a pop in the gold price means that Orezone could start servicing this loan. This is comforting. The cash flow forecast based on all going according to plan, shows that cash flow of US$222 million would be generated until September 2026, which is precariously close to the repayment amount of US$111 million due by then plus the current US$17.5 million working capital (excluding short term portion of loans) shortfall.  

At the share price of C$1.31 on 10 January 2023 the diluted Enterprise Value of Orezone is US$474.7 million, which is 28% of the NPV₈ value of US$371 million based on the cash flow model of Crux Investor without any mishaps. At current valuations, Orezone already offers limited upside.

Introduction

Orezone Gold Corporation (“Orezone”) (TSX:ORE) (OTCQZ:ORZCF) has a market capitalisation of C$449 M. The company owns 100% interest in the Bomboré Project, West Africa.

After a long period of exploration and evaluation, Bomboré is now in production. The first gold pour was in September 2022 and commercial production was declared in December. Orezone’s Phase I plan is to produce an average of 118,000 ounces of gold per annum (118 kozpa) over a thirteen year mine-life. Phase I targets near surface free-dig oxides at a planned annual throughput rate of 5.2 million tonnes (5.2 Mtpa). 

Orezone is also working on a plan to incorporate underlying sulphides into a Phase II development. A 77,000 m infill and expansion drill program will lead to a new Mineral Resource Estimate, feasibility study, and production decision in H1 2023.

Crux Investor analysts have followed the exploration and development story for years. One of the reasons Bomboré has taken so long to bring into production is the low overall grade of the oxides. Low grades reduce development options and margins. Success is not guaranteed. Given that there is so little room for error, the Crux Investor Analysts decided to investigate further.

Background to the Bomboré Project

The Bomboré project is located in central Burkina Faso, approximately 85 km east of the capital city of Ouagadougou. Access is via a national highway.  

The mining right is held via a local company in which Orezone holds 10% with the balance owned by the government. There are no royalty obligations to private third parties. The government is entitled to 5% net smelter return (“NSR”) royalty when the gold price exceeds US$1,300/oz and a Local Development Fund is entitled to a further 1% NSR royalty.

Resource and Reserve Estimations

The Bomboré Shear Zone 

The deposits are present in a 1-3 km wide shear zone - called the Bomboré Shear Zone (“BSZ”). The BSZ extends for over 14 km in an arcuate shape striking southeast in the south and northeast in the north. Crux Analysts expect complex geology and mineralisation within a shear zone. Orezone has modelled the gold mineralised zones as sub-parallel, tabular zones that gradually change in strike from north-northwest, to northeast. There is a paradox between the complexity of the geology and the simplicity of the ore envelopes. It is possible, of course, for low-grade mineralisation occurs in broad swathes in the BSZ. The challenge will come when the economics of the project are reliant on mining of higher grade zones. At that point, it is important to have confidence on the location and tenor of higher grade zones. The resource estimation process and the data to back it up needs to be robust.

Mineralisation wireframes for Bomboré have been drawn using a 0.2 g/t Au threshold. Within these envelopes, the mineralisation exhibits “reasonable continuity over a strike length of approximately 10 km”. Zooming in closer, individual forms in more restricted corridors define anastomosing (interweaving) patterns, parallel and slightly oblique to the general trend of the BSZ. For the resource estimation a 0.2 g/t Au threshold was used over a minimum width of 3 m. Higher grade subdomains were defined using a threshold of 0.5 g/t Au.

Stratabound or Structural?

Crux Investor is curious by a deduction made by Roscoe Postle Associates (“RPA”), responsible for the resource estimation. RPA feels the mineralisation is stratabound based on the observation that “in some locales” elevated gold grades can be seen to be related to one specific host rock type. Crux Investor observes that in some locales elevated gold grades can be seen to be related to structure. See for yourselves, in the cross-sections, below. 

Figure 1 shows two cross sections, one from the South Zone and one from the North Zone. Crux Investor has added thick blue lines to show the trend of the high grades zones.  The top (South Zone) cross section shows that the high-grades follow lithology (denoted by the letters S1, S3 and S4). The bottom (North Zone) cross section shows that the high-grades cut across the gently dipping lithology (denoted by the letters S1, S3 and S4). Clearly, mineralisation is not always stratabound.

Show Your Working

More questions arise if one looks at the variography used in the resource calculation. As a reminder, variography is the analysis of how grade varies over distance within a region. Some deposit types such as gold, have high spatial variability between samples, whereas others, such as iron, have relatively low spatial variability between samples. Understanding how sample grades relate to each other in space is a vital step in informing grades in a block model. A variogram is used to quantify this spatial variability between samples. 

To establish the range of influence of composite grades, RPA carried out variography studies in a few selected areas which had sufficient drilling density. RPA then applied the results from these selected areas at other mineralised areas along the Bomboré Shear Zone. Remember that the BSZ is banana-shaped. To account for the changes in the strike of each of the individual mineralised wireframe models along the arc of the BSZ, the geometries of the search ellipses were “suitably modified”. 

Crux Investor likes to see the results of the studies. No results of the variographs are presented in the NI 43-101 Technical Report, which makes it hard for outside parties to judge the robustness of the variographs and therefore the conclusions. More transparency and information please. Crux Investor notes it is a stretch to assume the selected areas as representative for all of the mineralised envelopes included in the resource estimate. 

Low Grade Resources

The conceptual pit outlines are based on input parameters that yielded cut-off grades slightly in excess of 0.2 g/t Au, which is just above the threshold grade used to defined low grade mineralisation. Table 1 shows the Mineral Resource statement, effective 5 January 2017.

The Projection Problem

RPA has validated its block models in an unconventional manner by comparing these to longitudinal sections onto which the gold values were projected, instead of showing cross sections through the block models with the grade intersections of boreholes as is the conventional manner.  

Figure 2 shows the validation by RPA for a selected sub-domain in the South Block. The problem Crux Investor has with such a “validation” is that it is unclear whether the projections are for one high grade outline, or numerous high grade outlines on different planes. It is also impossible to determine whether the block grade in a particular high-grade outline matches up with the drill intersection grades in that particular grade outline. Projecting complex 3D structures onto a single longitudinal section always runs the risk of over-simplification (and obfuscation). 

Notable Factors Affecting Mining

The Feasibility Study calculates dilution using a minimum selective mining unit (“SMU”) of 3 m x 6.25 m x 3 m (height). This SMU is very small for open pit mining and needs small equipment to control dilution. Small equipment leads to a relatively high mining cost. Estimated dilution varies from 1.2% to 13.7% in oxide material and transitional material and between 3.6% and 12.2% in fresh rock.

The presence of high-water saturation zones has a large impact on the pit slopes. A number of wet-season rivers cross the mineralised area. In areas with 33% saturation of saprolite the overall slope angles are as low as 24° by the time the pit reaches a depth of 100 m. In areas with 10% saturation the overall slope angles are as low as 32°.

The pit design incorporated more than 60 separate pits varying from 18 m to 140 m depth along 12.2 km strike and 3 km wide.  

Table 2 contains the mineral reserve statement, effective 26 June 2019.

The reserves amount to 1.8 Moz at an average grade of 0.81 g/t Au. The grade is remarkably constant for the reserve categories. Associated with the reserves is 164.4 Mt waste for a strip ratio of 2.34.

The overall conversion of gold contained in mineral resources is 36% at a grade that is 17% higher despite the impact of dilution. This is probably due to much higher cut-off grades applied than the 0.2 g/t Au assumed for the conceptual pits for mineral resources.  

Ramping Up Operations

Review of the actual performance versus plan shows that the pre-production periods lasted six months longer than planned. Ore and waste were delivered to stockpiles at a strip ratio that was 1.65 instead of 2.26 planned. A total of 6.3 Mt of ore was delivered to the ROM (“run of mine”) pad.  

Based on the Q4 2022 production results announced on 10 January 2023 Crux Investors could compare the actual first 1.0 Mt processed to planned production for this amount. The processed amount had a grade of 0.92 g/t Au compared to 1.02 g/t Au planned, despite having the benefit of a very large stockpile (i.e. 6.3 Mt), which should allow to select the highest grade mined. The strip ratio mined in Q3 was again very much lower than planned: 1.2 versus 3.0 planned. Crux Investor notes the absence of details on mine production in the 10 January 2023 press release, in particular grade mined. Mined grade is a crucial piece of information for the market. More information please.

The lower strip ratio may point to the operation having difficulty in distinguishing between ore and waste. As a result, more material that was previously modelled as waste is being mined as ore.  If this is the case, the average grade will be lower than expected.

Financial Modelling of Bomboré

Crux Investor has created two financial models of the Bomboré project. One model uses all of the feasibility study inputs and principally aims to check the tax model against Orezone’s estimates of total tax. Using the feasibility study inputs, Crux Investor arrives at an estimate of total tax 5% lower than the Orezone numbers. This shows that Crux Investor modelling introduces a slight positive bias to the results.

The second model uses modifying factors to arrive at a more realistic assessment of the project. The modifying factors include benchmarked costs, and the incorporation of the government’s free carried interest, withholding taxes, and corporate overheads. 

A Note on Benchmarking Operating Costs

Benchmarking compares the rates suggested by Orezone with costs at other open pit operations in Burkina Faso. As you can see from Table 3, projected costs from other operations are significantly higher than the projected costs used in the Orezone feasibility study.

Mining at Bomboré is done by a mining contractor. The use of mining contractors reduces capex, but increases opex. For this reason the mining cost at Bomboré should be distinctly higher than the estimated mining cost without drilling and at Wagnion (US$1.70), a rate that was estimated in 2017.

Table 3, above, illustrates that the cost provisions for Bomboré are significantly lower than cost projections for other open pit operations in Burkina Faso. Furthermore, actual overall costs have proven to be higher than forecast. 

In terms of type of operation, production rate and amount of free-dig, Wagnion is probably the most comparable benchmark. It had estimated its mining cost rate at US$2.18/t mined on average, with US$1.70/t for free-dig material. However actual cost is 36% higher than total theoretical cost when applying the suggested rates.  It is unlikely that processing cost will vary to that extent from estimated cost.  If the cost provision for processing is accepted, the actual (mining + G&A) cost are 58.5% higher. This would imply a mining cost of US$2.7/t mined for free-dig material.

The Financial Model

Discussing the Financial Model of Bomboré…

The table illustrates that the effect of the much higher spot gold price more than compensates for the 60% higher operating costs used. However, Crux Investor also accounts for the government’s free carried interest, withholding taxes and corporate overheads to arrive at much lower cash flow attributable to shareholders.  

A Marginal Project is Extremely Sensitive to Grade Achieved During Mining

At the current gold price the NPV₈ is US$371 M. Sensitivity analysis shows that a 38% drop in grade (i.e. revenue drop) to 0.50 g/t Au would wipe out the NPV₈ value.

The Enterprise Value of Orezone is 50% than the NPV₈ Calculated by Crux Investor

At the share price of C$1.31 on 10 January 2023 the diluted Enterprise Value of Orezone is US$475 M, 28% higher than the NPV₈ calculated by Crux Investor.  

Large Trade Payables Fall Due in 2023

At 30 September 2022 Orezone had net current assets of US$42 M negative (including the short term portion of debt), with a significant portion of the trade payables falling due in 2023. Payables with contractual payment terms that extend into 2023 include accruals made for the power plant, construction retentions, employee bonuses, and mining contractor works totalling $16.5 M.

Figure 4 shows the cash flow forecast by Crux Investor generated in Burkina Faso before the government’s share. 

The above picture is actually flattering as Crux Investor did not model debt servicing and repayment which stood at 30 September 2022 at US$112 M, including a Convertible Note Facility which can partially be serviced issuing shares, but which will become unattractive should the share price drop below US$1.08 (at current exchange rate equivalent to C$1.45). The full repayment is due before September 2026 (October 2026 for the Convertible Note Facility), during which time Bomboré would generate US$222 M if there are no mishaps.

Orezone is Financially Constrained

Considering the large negative amount for net current assets and in particular the cash balance of US$7.3 M at 30 September 2022, two months before start of commercial production, Orezone is financially constrained. The Company is reliant on good gold prices and operating results if it is to avoid seeking additional financing.

Conclusion

Bomboré is obviously a hard nut to crack. From early exploration the company kept on drilling and carrying out economic assessments. Updated resource estimates were released regularly from 2008 to 2015. From this point on, economic and technical studies were added into the mix, culminating into the 2019 feasibility study. The 2019 study was the basis for the go-ahead decision to develop a mine. Crux Investor’s opinion is that low-grade re-treads are fraught with problems. When a project suddenly proves feasible after many years of plodding along, be extra careful.

A full review and valuation by Crux Investor identified some Red Flags. The root of the problem is that Bombore is low grade. The reserve grade for the oxide portion is 0.69 g/t gold. This is extremely low. It takes extraordinary favourable conditions to make such a low-grade project economic.  

In its favour, mining at Bomboré is free dig and processing is straightforward and cheap. Beyond that, there are other challenges for the project. In no particular order:

• royalties of 6% (when gold prices are above US$1300/oz) are a heavy burden, 
• the income tax rate of 27% is not particularly low 
• the strip ratio of 2.3 is not low 
• contract mining means higher operating costs
• grade control drilling to distinguish between waste and low-grade ore is hard to manage
• ore haulage distances are not short 
• climatic conditions at times disruptive (wet season rivers cross the mineralisation) 
• security in Burkina Faso is complicated

The feasibility study reached a positive conclusion by using very low operating cost inputs. Benchmarking against actual costs of other open pit operations in Burkina Faso shows that more realistic costs are 60% higher. Interestingly, higher costs are offset by higher gold prices. The Feasibility Study used US$1,300/oz. Spot prices are US$1,877/oz. So far so good for Bomboré as an economic proposition. The project seems to make the grade after all.  

Obviously for the project to work, the real-life operating parameters of cost and grade need to match up with the estimated operating parameters of cost and grade. And when grades are very low, margins for error are reduced. Narrow operating margins introduce risk into a project and Bomboré is no exception. Crux Investor can see that Orezone’s resource estimation modelling employs some unusual practices and makes obtuse assumptions on grade continuity. If it works, it works. But with unusual practices and obtuse assumptions comes risk. Will planned grades be achieved? How robust is the resource? How well defined are the boundaries between waste and ore?

On these themes, operational data from commissioning suggests that Orezone is struggling to distinguish between waste and ore in mining. Limited information to date suggests that both run-of-mine grades and strip ratios are lower than planned, indicating a blurring of the boundaries and mine dilution. Less waste, but with the result of lower average grade delivered to stockpile.

The plant production numbers for Q4 2022 announced on 10 January 2023 are good, but the company reports no numbers for mine production. Processing could have benefited from preferentially treating high grade portions of its large stockpile.  Based on much lower strip ratios than planned Crux Investor wonders if the operation is not able to properly distinguish between ore and grade. This would mean the operation has sent more “waste” than planned for processing. More information please.

The long pre-production period has resulted in the company being in a difficult working capital situation, in particular cash on hand. Orezone is exposed to teething problems which can push the Company into a financial corner. The cash flow forecast based on all going according to plan, shows that cash flow of US$222 million would be generated until September 2026, which is precariously close to the repayment amount of US$111 million due by then plus the current US$17.5 million working capital shortfall (excluding the short term portion of debt)..  

At the share price of C$1.31 on 10 January 2023 the diluted Enterprise Value of Orezone is US$474.7 million, which is 28% above the NPV₈ value of US$371 million based on the cash flow model of Crux Investor without any mishaps. At current valuations, Orezone already offers limited upside. It’s now over to Orezone to tell us what it is going to do about it.

‍

If you are a Family Office investor, or an Institutional investor, and you would like the full report behind this article, please contact matthew@cruxinvestor.com

‍