Danakali — Update 20 January 2016

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Phase 1 – Capital cost is US$298m for annual production of 425ktpa SOP. This is a 30% reduction on the prior comparable PFS figure of US$428m. The decrease in development capital is largely attributable to the following:

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Water requirements for processing have been substantially reduced. Identifying subsurface water at the Colluli site has also negated the need for a seawater delivery pipeline from Anfile Bay for at least the first five years of production. Process recovery pond layouts and the construction schedule have also been revised.

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Product logistics have been simplified. A 57km existing road will be upgraded to link the site with the coastal road (total distance 230km) leading to the existing extensive port facilities at Massawa, which will be used to export SOP. Previously, a new product export terminal at Anfile Bay was proposed, which required constructing a new 85km road. This logistics option also reduces project risk by potentially reducing lead time to initial exports, has more flexibility with regard to port capacity and Massawa is already host to well-established shipping corridors.

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Mine development, based on open-pit mining, has been optimised, resulting in a more consistent waste to ore ratio, which has lowered pre-production costs.

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Phase 2 – Capital cost is US$175m to increase production to 850ktpa SOP, which is planned to begin in year six. This is a 38% reduction on the prior PFS figure of US$282m. Product-exporting options and infrastructure at Anfile Bay will be reviewed after Phase 1 commissioning.

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The deposit is shallow and can be developed as a relatively low-cost open pit rather than as a solution or underground operation.

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Open-pit allows selectivity in mining, to mine and blend the various sequences to maximum economic benefit. DNK has the ability to focus on higher-value SOP production, although it also has the ability to produce lower-priced potash products, such as MOP.

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Open-pit mining provides flexibility of the mining rate, allowing a smaller initial operation at a lower absolute capital cost with potential for a substantial increase in scale as market opportunities arise. Because of infrastructure established at the outset, subsequent expansions can be implemented at lower capital intensity (eg Colluli Phase 2 has a lower capital intensity than Phase 1).

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Evaporation pond sizes are substantially smaller relative to solution mining because salts are mined in solid form.

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Compared to some of the very large high-profile, high-capacity, capital-intensive potash projects being pursued in locations such as Canada, Colluli has a much lower capital intensity and fundable scale but still has substantial potential to expand.

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DNK believes Colluli has the potential to grow to an ultimate capacity of 4-5Mt pa of potash products.

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Mine gate cash costs – Phase 1 costs in the DFS have increased slightly (+4%) to US$168/t SOP from US$162/t SOP in the PFS. The average for the first 60 years of production for Phase 1 and Phase 2 combined is unchanged at US$141/t.

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Product logistics cash costs – DFS costs are US$66.94/t SOP and US$66.29/t SOP for Phase 1 and Phase 2, respectively. These are higher than PFS costs of US$27.42/t and US$27.35/t, respectively. The main reason for this is the longer trucking distance of 230km by road to the port of Massawa compared with the shorter distance to the previously proposed custom-built export facility at Anfile Bay.

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Royalty costs – A mining royalty of 3.5% on gross revenue applies. This adds about US$20/t SOP to costs at the SOP price (FOB Massawa) of US$572/t used in the DFS.

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Total cash costs – Phase 1 and Phase 2 total cash costs, including royalties, are US$255/t SOP and US$227/t SOP, respectively. These represent an approximate 20% increase on PFS costs of US$210/t SOP and US$189/t SOP, respectively, mainly due to the increased logistics costs as described above.

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The Colluli reserve ranks as one of the largest and shallowest potash resources globally. The JORC-2012 compliant ore reserve (Exhibit 2) is 1.11Bt at 10% K2O (19% K2SO4 equivalent). The resource remains open to the south-east of Area A and to the north of Area B. The geology is dominated by an evaporate sequence with potash-bearing minerals overlain and underlain by rock salt layers.

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Potassium salts in solid form – lower costs, better overall resource recovery and less working capital than solution mining. There is an evaporite sequence comprising three potassium salts in solid form. This provides the ability to produce a range of potash fertiliser products that includes potassium sulphate (SOP), potassium magnesium sulphate (SOP-M) and potassium chloride (MOP).

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The top potash layer is sylvinite, composed of sylvite (KCl) plus halite, which is up to 10m thick.

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Below the sylvite is the intermediate member comprising carnallitites composed of carnallite (KMgCl3.6H2O) plus halite and bischofite (MgCl2.6H20) with thickness varying from 3-25m.

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Below the intermediate member is the kainitite member composed of kainite (KMgSO4.3H2O) plus halite, which is 5-15m thick. Kainite represents about 50% of the Colluli resource.

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Very long mine life – potential for >200-year mine life.

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Significant potential for expansions – the size of the resource supports the potential to grow to an ultimate capacity of 4-5Mtpa.

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Potash mineralisation is shallow – this allows low-cost mining by open-pit. The mineralisation starts at 16m with a maximum depth of 140m. Extraction is proposed by conventional truck and shovel techniques, along with continuous miners. The ore is soft and there is no need for blasting during construction or during production activities.

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Simple, low-cost processing – lowest-energy, highest-yield conversion to high-purity SOP.

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The kainite is decomposed, which generates excess sulphate.

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Potassium chloride from decomposed sylvite and carnallite is then combined with decomposed kainite. Ore containing sylvite and carnallite is decomposed and recombined with decomposed kainite. After a reaction at ambient temperature, SOP is precipitated. This is the lowest-energy, highest-yield conversion route to product SOP.

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Potassium yields are further improved using a series of ponds to collect excess brines exiting the process plant. Overall recoveries are >80%. The Colluli process is expected to produce SOP with a purity of over 98% SOP, which is greater than 52% K2O equivalent. This compares with a typical purity of 94% for many SOP producers. After drying, the SOP is compacted into granules prior to export.

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Potential for rock salt, magnesium chloride and gypsum co-products – Above and below the potash mineralisation at the Colluli project is the 10-20m upper rock salt layer and lower rock salt layer, respectively. A JORC-2012 compliant rock salt resource of >300 Mt has been defined. Potential saleable co-products rock salt, magnesium chloride, magnesium sulphate and gypsum are associated with the potash salts and need to be partially mined to gain access to the potassium salts. All three co-products have established global markets. Depending on market demand, prices and shipping costs, additional revenue from co-products is possible.

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Debt funding – CMSC will seek to fund up to 70% of project costs through commercial debt with any shortfall to be underwritten by DNK on arm's length commercial terms with repayment and security consistent with third-party debt (interest bearing loan).

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Equity funding – The remaining 30% of project costs will be funded through equity, initially provided by DNK. The 30% contribution provided by DNK consists of 50% equity and 50% as debt (interest free loan) to fund EMAMCO’s equity contribution, which will be paid from project cash flows.

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Repayment mechanism – After CMSC’s third-party debt is serviced, 50% of the available funds for distribution will be preferentially paid to DNK to settle ENAMCO’s 50% share of the equity contribution. This preferential payment to DNK occurs until the interest free loan has been repaid.

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Available funds for distribution – Available funds will be evenly distributed across the JV ownership once ENAMCO’s equity contribution has been settled.

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Ongoing production costs – Once production at Colluli begins, shareholder funding, if required, will be equally contributed by the JV partners through CMSC.

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Board composition – CMSC has a board of five comprising three members from DNK and two from ENAMCO. Decision-making is based on consensus.

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Our base case valuation for DNK’s 50% share of the Colluli Phase 1 project development, at a long-term SOP price of US$550/t, is A$262m (at US$0.70/A$).

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Our base case valuation, at a long-term SOP price of US$550/t, for Phase 1 and Phase 2 project development combined, which involves a doubling of SOP production capacity, is A$534m.

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In a financing scenario involving an equity raising at a 20% discount (to the share price of A$0.27 at 20 January 2016), the above valuations are equivalent to A$0.51/share for Phase 1 and A$0.86/share for Phases 1 and 2 combined.

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As Colluli Phase 2 is projected to be self-funded from operating cash flow at a low capital intensity, we believe there is significant upside to the shares as milestones are delivered.

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We believe the 20% discount is reasonable given that the funds are being used to build a long life operating asset based on a globally significant potash resource. The new shares issued will depend on the prevailing DNK share price and, as a result, may vary.

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We have valued both Colluli Phase 1 (425ktpa SOP over 30 years) and Colluli Phases 1 and 2 combined (expansion to 850Ktpa after year five for a total 30-year life).

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We assume Phase 1 development capital of US$298m will be funded by debt and equity, as above. We assume development capital of US$175m for the Phase 2 development, if it proceeds, is funded from operating cash flow without using additional debt or equity.

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We also carried out scenario analysis to determine valuations at alternative long-term SOP prices of US$450/t, US$500/t and US$600/t. While the SOP market is not very transparent, according to IC Potash, the global SOP price averaged US$650/t in Q315.