Power increase may not be sustainable for Golden Star

An announcement from Ghana’s public utilities committee that power rates may more than double for mining companies and steel mills appears to be the result of growing consumption and higher oil prices. The cost of power from the West African nation’s grid is expected to rise from US10¢ per kilowatt hour (kWh) to US20¢-US24¢ beginning on July 1, but this is still under negotiation.

Ghana has experienced a chronic shortage of power that some feel poses a sever threat to economic productivity. However, new projects, some with the help of China, are expected to ease its electricity woes.

One company that will be affected is Golden Star Resources Ltd., a pure gold play with two operating mines in Ghana. Golden Star said the price hike will translate into a cost increase of US$60 to US$85 per ounce based on forecasted production of 370,000 to 425,000 ounces of gold.

“We are disappointed that the PURC appears to have specifically targeted the mining industry to carry the burden of the increased power generation costs,” company CEO Tom Mair said in a statement.

Its cash operating costs guidance is currently US$500 to US$650 per ounce, according to Credit Suisse analyst Anita Soni. She estimates a cost increase of US$40 to US$55 per ounce in fiscal 2008 and new cost guidance in the range of US$540 to US$615 per ounce. Including royalties of 3%, which are also under review and may rise to 6%, costs could climb to US$560 to US$635, Ms. Soni told clients. The analyst is forecasting US$588.

She rates Golden Star shares “neutral” and cut her price target to US$3.60 from US$4.40. Ms. Soni called a preliminary cost increase estimate of US$65 “fairly negative” and reduced her net asset value estimate for the stock from US$3.19 to US$2.81.

However, with the near-term impact potentially being bigger than the US$65 to US$80 forecast, Ms. Soni says such an increase is not sustainable and will likely not endure for the mine’s life. She also noted that this is an election year in Ghana.

The news forced Blackmont Capital analyst Richard Gray to downgrade Golden Star from “hold” to “sell.” He cut his price target by $1 to $2.75.

“While the company believes these power costs should be closer to the $0.14/kWh level, we believe the decision to increase the costs is a significant blow to the company’s ability to survive,” the analyst said in a note.

He expects cash cost to rise above US$600 per ounce, causing margins to become “dangerously slim.”