Teck Resources Ltd Q2 FY2020 Earnings Call

Ladies and gentlemen, thank you for standing by. Welcome to Teck’s Second Quarter 2020 Earnings Release Conference Call. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session. This conference call is being recorded on Thursday, July 23, 2020. I would now like to turn the conference call over to Fraser Phillips, Senior Vice President, Investor Relations and Strategic Analysis. Please go ahead.

Thanks very much, Laurie, and good morning, everyone. Thanks for joining us for Teck’s second quarter 2020 results conference call. Before we begin, I would like to draw your attention to the caution regarding forward-looking statements on slide 2. This presentation contains forward-looking statements regarding our business. This slide describes the assumptions underlying those statements. Various risks and uncertainties may cause actual results to vary. Teck does not assume the obligation to update any forward-looking statement. I would also like to point out that we use various non-GAAP measures in this presentation. You can find explanations and reconciliations regarding these measures in the Appendix. With that, I will turn the call over to Don Lindsay, our President and CEO.

Thank you, Fraser, and good morning, everyone. Thank you for joining us today. I will begin on slide 3 with our second quarter highlights followed by Ron Millos, our CFO, who will provide some additional color on the financial results. We will then conclude with a Q&A session where Ron and I and additional members of our senior management team would be happy to answer any questions. These continue to be challenging times, as the world works its way through the COVID-19 pandemic. Teck will remain focused on protecting our people and communities while continuing to operate responsibly and safely, support the economic recovery in the wake of the pandemic. We took steps during the quarter to further strengthen our financial position and reduce costs and position Teck to significantly improve margins towards the end of 2020 and early 2021 as we complete our major capital projects. We were also pleased to be recognized as one of the best 50 Corporate Citizens in Canada, ranked by Corporate Knights for the 14th consecutive year. Turning to our financial results on slide 4. In the second quarter, revenues were CAD$1.7 billion, and gross profit before depreciation and amortization was CAD$453 million. Profitability was impacted by the significant negative effects that COVID-19 had on both prices and demand for our products as well as abnormal costs because of the pandemic. Bottom line adjusted profit attributable to shareholders was CAD$89 million or CAD$0.17 per share on both a basic and a fully diluted basis. Details of the second quarter's earnings adjustments are on slide 5. The most significant adjustment was CAD$147 million of COVID-19 expenses in the quarter on an after-tax basis, which is primarily related to the suspension of our QB2 project. We also had a CAD$69 million adjustment for environmental costs, which relates to the impact of re-measuring or decommissioning and restoration provisions for our closed operations using a current credit-adjusted risk-free discount rate. In addition, we had adjustments of CAD$38 million for inventory writedowns and CAD$17 million for share-based compensation. This was partially offset by commodity derivatives and taxes and other items, which were CAD$20 million and CAD$21 million respectively. With these and other minor adjustments, bottom line adjusted profit attributable to shareholders was CAD$89 million or CAD$0.17 per share on both a basic and fully diluted basis. I'll now run through key updates for the quarter starting on slide 6. The COVID-19 pandemic obviously had a significant negative impact on our business in the quarter. While all of our operations are currently producing with comprehensive virus prevention measures in place, the economic impacts of the pandemic have reduced demand and prices for our products. We expensed CAD$260 million in costs associated with COVID-19 in the second quarter on a pre-tax basis, and this includes CAD$151 million of QB2 demobilization, remobilization, and care and maintenance costs and CAD$75 million of borrowing costs that would otherwise have been capitalized had QB2 construction not been suspended. Ron will speak to these items in a few minutes. Looking at our key updates in our steelmaking coal business on slide 7. We continue to focus on increasing margins, not volumes. Our second quarter sales were 5 million tonnes, as the pandemic continued to negatively impact supply and demand, particularly outside China. Now, I just asked if everyone could please go on mute, so we can eliminate the paper shuffling. Thanks very much. Chinese steel production returned to pre-pandemic levels during the quarter and established new average daily record highs in both May and June. We are shifting to a lower cost base due to a declining strip ratio as well as due to the Elkview plant expansion, which was completed due to the Cardinal River closure and our cost reduction and RACE21 programs. Our adjusted site cost of sales are expected to decrease over the remainder of 2020, and by the end of the year, we expect to be below CAD$60 per tonne. Our strip ratio was 11.4 to 1 in 2019, and we now expect it to decline to below 10 to 1 by 2021 as planned. We completed the major expansion of our Elkview operations plant in Q2, despite the pandemic. The plant now has the capacity to produce 9 million tonnes annually, which will enable us to replace higher cost production from Cardinal River with higher quality coal products at lower cost from our Elkview operations. As planned, Cardinal River completed its final production in June after 51 years of mining, and the operation is now transitioning to closure. I'll come back to our steelmaking coal business in just a few minutes. Turning to QB2 on slide 8. QB2 is the key component of Teck's future growth as we rebalance our portfolio. Construction activities are ramping back up with over 3,000 people currently on site and robust COVID-19 prevention protocols in place. We are planning to continue a gradual ramp-up of the construction workforce over the next three months toward the pre-suspension workforce level as conditions allow. We expect to have approximately 4,000 people on site by the end of July and approximately 8,000 people on site by the end of October. We're also aiming to achieve overall project progress close to 40% by year-end. The impact of the suspension on cost and schedule will depend on the length of the suspension and the ramp-up period that I just described. I’ll provide more detail on QB2 in a few minutes. Looking at progress on our Neptune facility on slide 9. We continue to advance the project, which will secure a long-term, very low-cost and reliable supply chain solution for our steelmaking coal business unit. Major equipment deliveries remain on track. COVID-19 related issues have not substantially impacted work on the critical path. The project remains in line with the previously announced capital estimate and the schedule. Terminal operations were suspended for five months as we previously announced starting in May in order to improve productivity and safety at the terminal as we advance construction. Completion of construction is still expected in Q1 of 2021, just about eight months away. Turning to key updates on our financial position on slide 10. We have a strong financial position to weather the effects of the pandemic, and we took steps to enhance it even further during the second quarter. This includes adding a US$1 billion, two-year unsecured revolving credit facility, bringing the total committed credit facilities down to US$5 billion. We also issued US$550 million of 10-year notes through July 2030, bearing interest of 3.9% per annum. We used the net proceeds to purchase near-term notes and to repay amounts drawn on our US$4 billion revolving credit facility. This is a conservative move that we think is prudent during these COVID-19 times and reinforces our commitment to maintain very strong liquidity and our investment-grade credit profile. We also continue to focus on our cost reduction program. We have achieved significant reductions as of June 30th, including approximately $250 million in operating cost reductions and $430 million of capital cost reductions. Ron will provide further details later in the presentation. Looking at our guidance on slide 11. We have issued updated guidance for the second half of 2020, with revisions to reflect the continued uncertainty around the duration of the impact of the pandemic on both demand and prices for our commodities. We've also changed the categories under which we present our capital expenditures guidance. So going forward, we will present capital expenditures in three buckets: first, sustaining capital; then growth capital; and finally capitalized stripping, which you've all been getting used to for the last five years. We will continue to report QB2 capital expenditures and external funding separately. Spending previously categorized as major enhancement capital is now primarily considered sustaining capital. New mine development is now included in growth capital. The Neptune upgrade project and RACE21 are considered both growth capital. You'll find all the details in our updated guidance in the guidance tables in our press release. I will now run through highlights of our second quarter by business unit starting with steelmaking coal on slide 12. As I mentioned earlier, Q2 steelmaking coal sales were 5 million tons. This is higher than originally expected, despite steelmaking cutting production faster than during the global financial crisis in 2008 and 2009. Our adjusted site cost of sales increased to $68 per ton, reflecting the COVID-19 impacts on our production cost. Production averaged around 80% of plan in the quarter due to the pandemic. We reduced our workforce by up to 50% per physical distancing requirements starting on March 25th, and then we ramped back up to 75% on April 10th. By May 12th, we returned our workforce levels to 100%. Looking forward, we expect 5 million to 5.4 million tons of sales in Q3 given the impact of the pandemic on supply and demand, particularly ex-China. Adjusted site costs of sales are expected to decrease over the remainder of 2020, as I mentioned, and we expect to end the year below $60 per ton of site costs. Our production guidance for the second half of the year reflects the estimated impacts of the pandemic and the suspension of terminal operations of Neptune. Turning to our copper business unit. Our Q2 results are summarized on slide 13. Copper production at 59,000 tons in the quarter reflects the 43-day temporary suspension of operations at Antamina to support Peruvian COVID-19 response efforts and to facilitate a change in workforce. Antamina has since then ramped up to full production, which is ahead of our original expectations. We now expect to achieve full production in the coming quarters. At Highland Valley, after initiating a reduction in the onsite workforce by 50% and scaling back operations, we have now gradually ramped back up to full production rates. In Chile, at our Carmen de Andacollo and Quebrada Blanca operations, we have generally maintained production levels while reducing the onsite workforce where possible. Total cash unit costs before by-product credits are significantly lower than in the same period last year due to our Cost Reduction Program and favorable exchange rates. Lower by-product credits resulted in slightly lower net cash unit costs after by-product credits in the same period. Turning to QB2 on slide 14. As I said earlier, we are planning to continue a gradual ramp-up of the construction workforce over the next three months toward the pre-suspension workforce level as conditions allow. The impact of the suspension on cost and schedule will, of course, depend on the length of the suspension and on that ramp-up period. In the second quarter, we expensed $133 million of costs associated with the QB2 project suspension and also $75 million of interest for the project that would have otherwise been capitalized had construction not been suspended. As of June 30th, we have expensed a total of $165 million due to the suspension, excluding interest. Looking forward in the third quarter, we expect to continue expensing some costs associated with the project's expansion, as well as some interest that would have otherwise been capitalized. Assuming the ramp-up proceeds through the third quarter as currently planned, the aggregate estimated impact from the suspension is expected to be approximately US$260 million to US$290 million excluding interest, with a scheduled delay of approximately five to six months. In addition, we expect to construct more camp space at an incremental cost of US$25 million to US$30 million to ensure that we can maintain necessary physical distancing protocols to protect the health and safety of our construction workforce. If we are not able to ramp up through the third quarter according to the current plan, each additional month of partial suspension impact is expected to have an additional cost impact of approximately $25 million to $35 million and one month of additional scheduled delay. Our zinc business unit results for the second quarter are summarized on slide 15, and as a reminder Antamina’s zinc related financial results are reported in our copper business unit. Red Dog zinc and concentrate sales were 93,800 tons, reflecting the normal seasonal pattern of Red Dog sales. Our net cash unit costs after by-product credits were US$0.06 per pound lower than in the same period last year, despite US$0.03 per pound in unexpected costs associated with COVID-19. Travel restrictions and a modified schedule for maintenance impacted operations at Red Dog due to the fly-in, fly-out nature of the operation. The maintenance schedule and our ability to respond to maintenance challenges were impacted as a result of that in Q2. Red Dog zinc production was lower than the same period one year ago primarily due to maintenance challenges and lower grades resulting from mine sequencing changes to manage site water level, which restricted some access to higher grade ore. We continue to implement an increased number of water-related projects in 2020 to manage increased precipitation and water levels at Red Dog, as the frequency of extreme weather events has been increasing. These projects are designed to ensure that we can continue to optimize mine operations. At Trail operations, production of refined zinc in the quarter was impacted by annual zinc roaster maintenance. Looking forward, the Red Dog concentrate shipping season commenced on July 13 following delays due to the failure of the world environment on one of our two shipping markets. Shipping will be completed with one barge operational now, and we currently expect repairs to another barge to be completed by the end of July. This will affect the timing of custom deliveries, but barring unforeseen severe weather conditions, we do expect to ship all Red Dog production during the shipping season. We expect Red Dog sales of 160,000 to 180,000 tons of contained zinc in Q3, which reflects normal seasonality. Red Dog production is expected to return to full production rates in the third quarter as throughput and grades improve. However, water levels at the site may continue to restrict access to high-grade ore in the second half of 2020. Our energy business unit results for the second quarter are summarized on slide 16. As previously announced, the Fort Hills Partners safely and efficiently reduced operations to a single train facility in the quarter, which helped reduce the negative cash flows in light of COVID-19 and the unprecedented low Western Canadian select prices. Production was also negatively impacted by extreme wet weather, resulting in flooding in the mining area in June and early July. However, we expect to remain within the full-year production guidance that we provided in Q1 of 2020. As a result of lower realized prices, we recorded an inventory write-down of $23 million in the second quarter. Please note that adjusted operating costs are low in the quarter because of inventory write-downs which are adjusted out. For the first half of the year, including $46 million in inventory write-downs, our site production costs are within our previously issued guidance of CAD$37 to CAD$40 per barrel bitumen for the period. Looking forward, our guidance for production, operating costs, and capital spending is unchanged from the disclosure provided last quarter. Fort Hills Partners continues to monitor market conditions and may adjust the operating plan accordingly. With that, I will pass it over to Ron Millos for some comments on our financial results. Ron, over to you.

Great. Excuse me. Thanks, Don. I’ll start by addressing the changes in our cash position during the second quarter, which is shown on slide 17. We generated $300 million in cash flow from operations in the quarter. We issued US$550 million of 10-year notes and used the net proceeds to repurchase US$268 million of the notes maturing in 2021, '22, and '23. The balance was used to reduce draws on our $4 billion net revolving credit facility, resulting in the transactions being leverage neutral. In the second quarter, we had a net reduction of US$32 million on the draws against our revolver, and we didn't draw US$388 million on the QB2 project financing. This accounts for most of the increase in our total debt, which totaled $6.2 billion at the end of June versus $5.5 billion at the end of March. Our capital spending was $889 million in the quarter, of which $97 million was on stripping activities and the largest single component was $446 million on QB2. We paid $78 million in interest and finance charges and $52 million on expenditures on investments and other assets. We repaid $40 million of lease liabilities and paid $26 million for our regular $0.05 quarterly base dividend. After these and other minor items, we ended the quarter with cash and short-term investments of $336 million. Turning on to the COVID expenditures on slide 18. In terms of accounting, costs related to capital projects that do not qualify for capitalization are expensed as incurred in our other operating income expense line item. These are primarily demobilization, remobilization, and care and maintenance costs. Costs not directly related to the production of our products are expensed as incurred and are not included in our costing of inventory, so they don't flow through our future earnings when the products are ultimately sold, basically expensed in the quarter incurred. Borrowing costs on capital projects that are temporarily suspended are charged against finance expense, as they're no longer allowed to be capitalized while the project is down. That's primarily QB2. We've deducted all of our COVID-19 related costs or expenses from the profit attributable to shareholders in our adjusted earnings table to assist readers in analyzing and understanding our operating results absent the effects of the pandemic. In the second quarter, we expensed $260 million related to COVID on a pretax basis: $133 million of that related to the temporary suspension of construction at our QB2 project. $18 million was related to the temporary closure of Antamina and COVID-19 fund donations. $75 million in additional finance expense was expensed rather than capitalized against QB2 during the construction period. We had $34 million related to other incremental costs at various operations. So on a year-to-date basis, we expensed $304 million related to COVID-19. That includes $80 million of interest that would otherwise have been capitalized. Slide 19 summarizes our cost reduction program. To the end of June, we achieved approximately $250 million in operating cost reductions and $430 million in capital cost reductions. Of that total, $305 million was achieved in the second quarter. As a reminder, these reductions are against what we expected to spend back at the end of June 2019 when we started looking at cost reduction opportunities. The reductions are spread throughout the company with the majority from the operating business units. They include the satellite projects, the exploration projects, our IT systems, and our admin and operating costs throughout the company. The savings from our cost reduction program have been included in our guidance since we announced the program back in Q3 with our Q3 2019 results. They are included in our current updated guidance as well. Turning to slide 20. We have a strong financial position to weather the effects of the pandemic. As Don mentioned earlier, we took steps to enhance it further during the second quarter by adding a new two-year unsecured revolving credit facility. Together with the US$4 billion revolving credit facility, which matures in 2024, and a US$2.5 billion project financing facility for QB2, this new $1 billion facility and the extension of debt maturities give us significant liquidity as we complete QB2 and the Neptune Terminal facility upgrade while we navigate the COVID situation. We've currently drawn $195 million on our US$4 billion revolver, and our current cash balance is $430 million, which, along with the balance available on our lines of credit, gives us CAD$6.9 billion of liquidity. Importantly, our facilities do not have any earnings or cash flow-based financial covenants. We do not include a credit rating trigger, and there's no general material adverse effect borrowing condition. The only financial covenant we have is a net debt to capitalization ratio that cannot exceed 60%, and at June 30th, that ratio was 22%. For our QB2 project, we have currently drawn $563 million on the $2.5 billion limited recourse facility. Going forward, project funding will be from that project financing until the project reaches a specific ratio of project financing to total shareholders’ funding. Teck’s next contributions are not expected until the first half of 2021. This is subject to the impact of the pandemic on the project schedule and timing of the capital spending. We do not expect COVID-19 impacts to prevent us from drawing on the project financing facility. As previously mentioned, we issued the $550 million of notes due in July 2030, bearing interest of 3.9%. We used the net proceeds to purchase $268 million of the 21s, 22s, and 23s. The balance of those proceeds was used to reduce the draws on the $4 billion credit facility. We also gave notice of our intention to redeem the remaining US$13 million balance on the 2021 notes that were not tendered to our recent offer. That's expected to happen by the end of this month, leaving us with only US$258 million of notes maturing until February 2023. After that, there are no notes due until the new 10-year notes maturing in July 2030. The combination of these various transactions is leverage neutral. We also have investment-grade credit ratings from the four credit rating agencies. Overall, our financial position is in good shape to allow us to weather the challenges posed by COVID-19. With that, I will turn the call back over to Don for his closing comments.

Thanks, Ron. To wrap up on slide 21. Teck has quality operating assets in stable jurisdictions. We're advancing a proper growth strategy that is funded and being implemented. We continue to progress our four key priorities, which are the QB2 project, RACE21, the Neptune Upgrade Project, and our company-wide cost reduction program to reduce spending. We are executing on these priorities to create value and position Teck for decades to come. We are confident that our strategy will drive significant value over the long-term as the world recovers from COVID-19. With that, we would be happy to answer your questions. I should say that, like many of you, most of us are on phone lines from home. So please bear with us if there is a delay while we sort out who will answer your questions. Operator, over to you for questions.

Certainly. Thank you. The first question is from Orest Wowkodaw from Scotia Bank, please go ahead.

Hi, good morning. Last quarter, you warned that you were seeing customers defer contracted coal volume. I'm just curious if you're still seeing that. Whether customers, I guess, outside of China are still deferring? And whether the guidance for Q3 assumes a higher proportion of spot sales in that number?

Okay, thanks, Orest. Good question. I'll turn that over to Real. Real Foley?

Yes. Can you hear me, Don?

Go ahead. I hear you.

Okay. Thank you. Thanks for the question, Orest. So actually, we're seeing quite the opposite right now. You're right, in Q2, we had deferred sales. But now some of the customers that had deferred sales are actually bringing some back into Q3. There are a couple of reasons for this, actually. First, if you look at the steel price, it is back to nearly what it was at the beginning of 2020 through COVID-19. Steel production is coming back, and of course, the demand for our customers’ products is increasing. We are also seeing some increased production in some areas. But as steel mills reduced production during Q2, they were also a lot quicker to reduce their inventory than they did during the global financial crisis in ‘08, ‘09. That basically leveraged the learnings, the technical learnings from that period. So, of course, as production is starting to ramp up for steel products, they need to import steelmaking coal from the market. This is what we are seeing from our customers. And your last question on the ratio of spot to contracted sales, our ratio remains very similar, around 40% of contracted sales and the balance in spot sales.

Well, that's great. Thank you. That's great to hear. And then just finally, on the costs for coal, you have talked about an exit rate this year of onsite costs looking less than $60 a ton by year-end. That's certainly a big improvement from what we've seen in the first half of the year. Should we take that to mean that for costs for 2021, at least onsite costs are going to average below that $60 a ton?

I think you mean 2021. I’ll turn that over to Ron.

Appreciate the question, Orest. A number of things have happened in the coal industry over the last few years, and I've walked the group through that a few times. I'm going to take the opportunity to take a shot at it again, just because it sets up for the structural change that's occurred. The first thing I've spoken to a number of times is the strip ratio. That’s a key cost driver for us. For the last three years, we've been transitioning from closing coal mining operations and setting up for the expansion of Elkview where we want to go from 7 million to 9 million tons. To do that, we had to run a higher strip ratio through 2019. So that was around 11.4 to 1, and we're going to come in around 10.7 to 1 in 2020. But in the second half, we're actually going to be mining at less than 10 to 1. That will continue that through 2021 and beyond. This key structural change of getting our strip ratio established at an average of 10 to 1 or below was the biggest part of getting our cost structure adjusted. The second key piece of that was bringing Cardinal River to closure. That’s been done, as mentioned. Just to put that in perspective, that operation ran at almost double the cost of sales at the business unit average. So bringing that to closure actually reduces our cost per ton by about $3 a ton, that's for cost of sales, sorry. So that's been established. The third component was completing the Elkview expansion, which we've successfully done. Elkview is now capable of producing 9 million tons per year. So when the market rebounds, we're well-positioned with that operation, which is low cost and produces a higher quality product. That structural shift from shutting down high-cost tonnage and replacing it with lower-cost tonnage has resulted in a significant change. Lastly, executing RACE21 continues to create value across the company, and certainly within the coal business unit. So, when I say we will exit 2020 at $60 a ton or lower, we will be less than $60 a ton going into 2021 and be able to sustain that. With significant opportunity to build on that performance from the efforts at RACE21, I'm pretty excited about both the second half of this year and 2021. If you look at cost of sales below $60 a ton, that's roughly US$44 ton. So on an operating basis, we're going to be operating at a good cost.

That's excellent. Thank you very much for the color.

Thank you. The next question is from Greg Barnes from TD Securities. Please go ahead.

Yes. I just want to continue on the coal side. On Neptune, Don, it sounds like it is on track for completion in Q1. I just want to understand more about the rail capacity through Vancouver to get the volume of coal to Neptune that you want. Has the work been done to open that up? Is that being done as we speak? Or is it completed? And will it be ready by the time that Neptune's ready?

Yes, it is. I should say, before I turn over to Ian Anderson, that we had a terrific visit to site at Neptune just last week. It is impressive what they've accomplished so far, and it gave us a lot of confidence. So, Ian, are you there, if not Real?

Yeah, I'll take that, Don. So Greg, one thing to say is we've also had visits with CN regarding some infrastructure upgrades they are doing to address the increased tonnage. This is on schedule and progressing very well. At this point, we have no concern with capacity being sufficient to maximize the volume throughput through Neptune, which is our overall goal to ensure that we have a long-term competitive supply chain.

Thanks, Real. Don, secondarily, the guidance on QB2 construction now. Just to be clear, by October, or assuming everything goes according to plan, you will be back at full construction on the project.

That is the plan. Obviously, everything’s subject to the ramp-up from here. We're actually about 3,400 people on site today. We think we'll be at 4,000 by the end of the month. This isn't that far off, of course. Between now and then, one of the key criteria is to get to the room. We’ve developed protocols just as it has been done with the health authorities elsewhere in the country to do that. So if all goes according to plan, yes, we would be at full strength by October and starting to get that 3% to 4% completion per month thereafter. So, it isn’t done yet. Obviously, there's still a way to go, but we are encouraged to come from the demobilization level, which was about 400 people on site. We’ve now come from 400 to 3,400; we’re headed in the right direction, but still a story to tell.

Okay. And again, according to plan, a five to six-month delay in the construction schedule will mean that you get first ore in the mill hopefully by the end of 2022, or is it slipping into '23 now?

Yeah, it's in 2022. We've spent the last five to six months. Initially, we said Q2, 2022. So we should think in terms of a couple of quarters. That's right.

Okay, great. Thank you.

Thank you. The next question is from Curt Woodworth from Credit Suisse. Please go ahead.

Hey, good morning, Don.

Good morning.

First question is just on portfolio construction. So when you evaluate the copper supply landscape today, you look at Codelco and others in terms of challenges to meet mine production. I wonder if you could give us an update on projects Satellite and any monetization efforts there. I would think with the recovery we've seen in the markets that would be more momentum on that front?

Yeah, I'll turn it over to Andrew Golding in just a minute. But we remain constructive on the copper market for the long term, which is why we have a portfolio rich in opportunities to develop. We don't need to do them all ourselves. As we've said in the past, if market conditions are appropriate and interest is there, we could sell outright or contribute to another company to take back shares, that sort of thing. There are two projects of the five that are advanced enough that we think it's appropriate to look at potential transactions when the market is right. However, we’re not quite sure that market is all the way there yet. Copper, of course, has had quite a run. Why don't I stop there and turn it over to Andrew with any other thoughts that he may want to share?

Can you hear me, Don?

Yes.

Okay, good. I don't really have a great deal to add to what you said there. Clearly, there are some significant logistical constraints as a result of COVID-19 in advancing field work. And for that matter, if we want to conduct any form of sales process, it would be logistically extremely challenging right now. However, we are in very good shape for when it becomes logistically more practical to take potential buyers and interested parties to sites. We continue to receive a lot of interest. These are very good projects by world standards and obviously backdropped by a positive copper market. These are the things we'd hope to advance COVID notwithstanding in 2021.

Okay, that makes sense. And then just a follow-up, maybe for Real, on the coking coal market. It seems like there's been some increased activity out of India, but then there have been some reports around quota restrictions being kind of exhausted in China. I was wondering if you could just provide a little bit more granular outlook in terms of what you're seeing, perhaps regionally, in terms of the demand trends you're experiencing in coking coal. Thank you.

Yeah. So thanks, Curt. So let’s look at maybe China first to address one part of your question on the import restrictions. The Chinese economy is really continuing to recover and is showing well. The steel industry is producing very strongly right now, achieving record production in both May and June. Year-to-date, they're running at a high level. The seaborn coking coal imports into China have also been robust, with May year-to-date up 11 million tons year-over-year. There are a couple of reasons for this. Reduced Mongolian coking coal imports are one factor; they're down 9 million tons year-over-year and lower domestic coking coal production; those are actually down 3 million tons year-over-year. Seaborne prices are also still lower than the domestic coking coal price, around $60 and above $50 for some time now. Additionally, we're seeing sustained demand from coastal steel mills. All of this is contributing positively to the seaborne market. Now, when we look outside of China, depending on the market areas, there is definite still risk with the pandemic. However, we are seeing some economies reopen. As I answered earlier, we are seeing some customers bring back the original deferred tons into Q3, which is a result of opening economies but is also a result of expected supply disruptions this year, along with expected further production cuts due to COVID-19 or other mine disruptions. If you look at the overall seaborn exports for this year, they're forecasted to be down 30 million tons, which includes somewhere around 10 million tons from the U.S., a little bit less from Australia, and Russia, Canada, and Mozambique, somewhere in the 2 million to 3 million ton range. The lower Chinese steel exports this year are also contributing to continued support on production as the economy recovers in those other parts of the world. In India, monsoon season will be over during the quarter. We expect to see some demand return as a result of that as well.

Great, I really appreciate it. Thank you.

Thank you. The next question is from Jackie Przybylowski from BMO Capital Markets. Please go ahead.

Thanks very much. I just wanted to get some more color from you guys on what's happening at Red Dog, if you don't mind. I know in the MD&A it says that there's a risk to grade for the second half of the year if the water conditions continue to restrict access. Can you tell me a little bit about what is the risk to the guidance that you've given and how much additional work might need to be done or CapEx might need to be spent to mitigate those risks? Thanks.

Okay. Thanks, Jackie. We'll turn that over to Dale or Shehzad.

Yeah, it's Dale. Thanks, Don, and thanks Jackie. To give you a bit more color on the issue, we've experienced changing climate conditions with higher precipitation levels at Red Dog in recent years, and our discharge capacity for the water we collect on site is restricted. It’s also dependent on background levels in our discharge water. We’re seeing naturally higher levels, which restrict discharge. To manage those water balances, we're storing water in various areas at the site, including in our pits. When we store water in our pits, it restricts our access to higher grade at the bottom and forces us to mine lower grades toward the top. To address this, we’re raising the tailings dam to store more water in that facility, which will be complete in the next two to three months for the next lift of the tailings dam. We’re also building, which is normal course, but we’re staging that in a different way to increase capacity earlier. Additionally, we're increasing our water treatment capacity. The cost for that is probably in the range of $25 million U.S. that wasn't originally budgeted.

Thank you. Both of those expenses are one-time costs, and afterward, you should have enough water capacity to manage moving forward.

Yeah, through future tailings dam lifts and other water management efforts. Exactly.

Great. And if I could just ask one follow-up question on Red Dog. I noticed that at the back of the MD&A, where you talk about the costs, the royalties for Red Dog seem to be a credit to tax this quarter? Can you just help me, maybe interpret or explain what happened with the royalties in the zinc division this quarter? Thanks.

Ron, I'm not sure if you want to take that one.

Ron Millos, are you there?

It's a cash flow royalty-based calculation. It might require digging into the numbers there. It ties into when we receive receipts from sales and when we pay our bills. In the first half of the year, we're generally buying a lot of supplies, paying for those supplies to prepare for the shipping season. Lower sales volumes also mean lower revenue coming in. So there's a good chance that they catch up in the latter half of the year when the largest royalty payments are typically made in Q1 based on Q4 results.

Okay. Got it. Thanks a lot, Ron. That's it for me.

Thank you. The next question is from Oscar Cabrera from CIBC. Please go ahead.

Thank you very much, and good morning, everyone. So I'm just wondering, in QB2, there're reports coming out of different companies in Chile, where there has been workforce reductions reported. So I’m wondering regarding your labor force ramp-up assumptions for the QB2 construction. What are your assumptions in terms of allowance by the government to do everything safely? Secondly, there's also been reports of labor reluctant to return to site without strict COVID-19 policies? I just wonder if you can comment on that as well.

Okay, thank you, Oscar. Good question. I'll turn that over to either Alex or Dale. Alex, are you there?

Yes, Alex here. Our priorities continue to be the safety of our workforce and supporting the Chilean efforts to limit the transmission of COVID-19. The project team, Bechtel, has been working very closely with the government, subcontractors, and unions. They've done a really good job of developing and implementing protocols to manage the workforce, the camp environment, and transportation of workers to and from the site. We've spent significant time ensuring protocols are working well. The government has typically complimented us on our process. We have a trigger action response plan in place to manage the situation, should we see an outbreak. We are looking at testing, quarantine, and medical treatment, and we are working with the government on that. We have a COVID committee that meets regularly to review our plan. As a result, we haven't seen any substantive challenges to date. However, we do have a response plan prepared to manage any potential issues.

No, I think you’ve covered it well, Alex.

For those who have followed us closely through the beginning of construction of this project, you may recall that we had several delays related to permitting at the project’s early stages. One of the silver linings to the COVID delay is that federal, local governments, and independent regulators have worked very hard in getting through that. So yesterday, we got the final group of permits that had been outstanding. We’re very pleased to be able to go forward with construction.

That's helpful. Thank you, Don, Alex, and Dale. Now just if I may move back to the coal market. It sounds like you're more optimistic on the fundamentals of metallurgical coal. However, we haven't seen prices move above $110 a tonne for the last month or so. I was just wondering if you can comment on this notion of Chinese restocking in the first half of the year to ensure enough materials for processing in the second half, should we have more disruptions. The bearish argument states restocking is quite high, while the bullish argument is that there is enough demand in the second half, and therefore, that all of the factors you've mentioned would suggest higher coking coal prices in the second half of the year. Can you please add more color on that?

Those are interesting concepts regarding commodities markets; you can create both bullish and bearish scenarios based on several factors. Ron, I’ll turn it over to you if you want to address that.

Yes, sure. Thanks, Oscar. Yes, the price is holding around CAD$110 right now. We are seeing positive signs in terms of demand, whether it's out of China or markets outside of China. However, uncertainty persists with the pandemic. We've seen reductions on both the demand and supply side. The market is still trying to find balance, for sure. However, we are cautiously more optimistic about Q3 than we were at the beginning of Q2; we are seeing changes. With respect to restocking, we haven't really seen it in China right now because the Chinese steel industry is running at record levels. Last year, while seaborn supply has increased slightly, it is balancing out reductions in Mongolian imports and domestic coking coal production. I don't know if that answers your question.

Yes, that does. Thanks very much. And congratulations on strong performance under challenging situations.

Thank you. Well, operator, I think we've got time for maybe one more question here before we hit the top of the hour.

Certainly. The next question and last question is from Alex Hacking from Citi. Please go ahead.

I just wanted to clarify something on the QB2 CapEx. I think when you put out the update a few months ago, you said that the sensitivity to the peso, I think you would republish that at 775 as the underlying assumption, and said if the peso went to 850, there would be about a CAD$240 million benefit on the CapEx. Should we assume that relationship is linear? Obviously, copper has strengthened, and the peso strengthens. If the peso were to go back to 700, would it be fair to assume kind of a CAD$240 million headwind? I'm just trying to understand how that relationship works.

Okay. That would be for Alex, please. At the time that we published in pesos, it was at 850, actually, so we did that sensitivity. It's right close to the 775 or 770 or so right now. Alex, over to you.

Thanks, Alex. As the exchange rate changes, the exposure to the exchange rate is somewhat different, but the relationship is close to linear. The lower the peso becomes against the U.S. dollar, the less exposure we have to the Chilean peso. Inside of a couple hundred pesos to the U.S. dollar exchange rate, you can assume that it’s close to linear, with approximately 70% or 69% of our go-to capital exposed to the Chilean peso.

Thank you.

Thank you.

So, I think that was the last question. I just want to say thank you to everybody for joining us for the call today. We're very pleased to get Q2 behind us. Q2 2020 was a tough one for sure. Things have improved significantly. We're delighted to have completed the Elkview plant expansion despite COVID. We're also delighted to be ramping up slowly but surely at QB2. We look forward to getting back to full strength there in October. We're excited about the continued global recovery from the pandemic throughout Q3 and Q4. We'll speak to you again in October. Thanks very much all. Meeting adjourned.

Thank you. The conference has now ended. Please disconnect your lines at this time, and we thank you for your participation.