Following a recent Edumine four-day short course, “Valuation of Mineral Projects Based on Technical and Financial Modelling” in POHTO’s Oulu facility in Finland, one of the delegates raised an interesting point that has wide relevance to active operations.
The Valuation course covers project appraisal as a forward-looking
perspective at the pre-production stage.
As a manager on an active operation the delegate, in his daily work, has
to deal with multiple development scenarios which are an inherent part of mine
The delegate asked about the utility of applying the
principles of discount cash flow modelling at the pre-funding stage, which
allows comparison between development scenarios in an active operation based on
the performance indicators of NVP, IRR and pay-back.
These would provide a snapshot of the value derived
from a given period of production where there is a simple relationship between
the amount of ore produced and the capital cost. In an active operation though, an investment
in a particular element, for example footwall pre-production development and drill
hole sampling, might be part of the normal cycle of mining as production
proceeds. There is no fixed end point
which can be incorporated into a DCF model. Other performance indicators, such
as cash costs and tonnage of ore delineated, then become more relevant in
ranking development decisions. He pointed out that the scenarios are seldom so marginal
that DCF modelling is likely to expose a feature that would not already be
apparent from normal mine planning.
The Valuation course may add more content around the
boundary condition that applies to the normal allocation of sustaining capital
in pre-production development on an active mining operation with a defined mine
life, compared to the creation of what is essentially a new mine, albeit
exploiting the same deposit.
In the former case this is part of routine mine
planning with costs met from cash flow. There is no merit in setting up a DCF
model if for no other reason than that the time span is seldom more than five
years whereas the optimum period for applying the technique at a 10% discount
rate is about 15 years. The main flexibility is around allocation of cost
between capital expenditure and operating costs. In accounting terms, it is
best if this can be allocated to operating costs to allow immediate tax
relief. Tax relief on capital cost is
obtained through depreciation where benefit is deferred.
With the development of a new mine in the Valuation course I use a hypothetical case study, the objective of which is to evaluate the diﬀerent alternatives available to a mining company operating in the Peruvian Andes following the discovery of an undeveloped deposit close to its operating mine.
This grants them options such as the opportunity to extend mine life, increase annual production and to introduce a drastic change in the mineral processing method. I then go on to point out that using debt also means that the full Capex of $460M does not have to be met from the cash ﬂows of the parent company generated from their existing operations. These can then be distributed as dividends.
This in turn enhances share price and allows the
equity portion of the capital requirements to be raised through a rights issue.
Equity investors also have the comfort that in order to secure this level of
debt the bankers would have undertaken a rigorous technical review of the
project. The role of independent
engineers instructed by the banks ensures better planning and better management
at the EPC stage.
The case studies in the Valuation course also covered the transition from surface to underground which often involves significant capital investment ($2.6B in the case of Venetia). These are manifestly new mines that will exploit deep extensions of the same deposit.
In summary, a medium sized company considering developing essentially a new mine (albeit on the same deposit) at a cost of around $500M should consider the use of project finance.
The banks will be very comfortable as operating cost estimates will be well constrained and production will be undertaken by experienced operators. Where the development of the new mine is going to cost over $2B then, this is the domain of the large international mining companies that will use their corporate cost of capital for evaluation studies and act essentially as their own investment bank. Lending to subsidiaries on a rolling basis ensures they manage the corporate gearing that supports their share price and sets the corporate cost of capital. This does impact on mine planning where a major pit push back is proposed.
Pit optimisation algorithms have to assume a discount rate ﬁxed by the parent company. The operation cannot therefore use a gearing optimisation approach where the subsidiary cannot act as an independent company and raise fresh equity and secure debt from an independent investment bank. They must use the parent’s corporate cost of capital.
This must impact on stripping ratios and may even sterilize some ore — a source of some frustration to planning departments on mines. In some cases, the discount rate they are required to use in mine planning is well above the corporate cost of capital which means a much more conservative stripping ratio is generated.
The next delivery of the Valuation course will be in Vancouver from March 31 – April 3, 2020 inclusive.
Learn more here.
(By Dennis Buchanan, Director of the MSc in Metals and Energy Finance, Department of Earth Science and Engineering, Imperial College, London.)
Written by Amanda Stutt.
View the original article at here.