When metals prices are high, we are generally taught that we should lower the cutoff grade. Our cutoff grade versus metal price spreadsheet tells us this is the correct thing do. Our grade-tonnage curve reaffirms this since we will now get more ounces of gold in the mineral reserve. But is lowering the cutoff grade really the right thing to do?
Books have been written on the subject of cutoff grades where readers can get all kinds of detailed logic and calculations using Greek symbols (F = δV* − dV*/dT). Here is one well known book by Ken Lane that sells for $998 on Amazon the last time I checked. You can also download a 38-page abridged sample of this book at THIS LINK and the full version is available for $150 at the COMET Strategy web site.
Recently we have seen higher production cash costs at operating mines when commodity prices are high. Why is this? It may be due to higher operating costs inputs caused by increasing labour rates or supplies costs. It also may be partly due to the lowering of cutoff grades, thereby lowering the milled head grade, which then requires more tonnes to be milled to produce the same quantity of metal.
A mining construction manager once said to me that he never understood us mining guys who lower the cutoff grade when gold prices increase. His rationale was that, since the plant throughput rate is fixed, when gold prices are high you suddenly decide to lower the head grade and produce fewer ounces of gold and at a higher cash cost. His point was that we should be doing the opposite; when prices are high you should produce more ounces of gold, not fewer. In essence, in times when supply is low (or demand is high) may not be the right time to further cut back on supply by lowering head grades.
Now this is the point where the grade-tonnage curve comes into play. Certainly one can lower the cutoff grade, lower the head grade and produce fewer ounces now with the upside being extending the mine life. By doing this a company is able to report more ounces in their mineral reserve and the overall snapshot of the company looks better if it is being valued on reserve ounces.
The problem with this is that there is no assurance that metal prices will remain where they are or that the new lower cutoff grade will remain where it is. If the metal prices dip back down next year, the cutoff grade will be increased and the mineral reserve is back to where it was. All that was really done was accept a year of lower metal production for no real benefit. Such a trade-off essentially contrasts a short term vision (i.e. annual production) against a long term vision (i.e. mineral reserves).
My bottom line is that there is no simple answer on what to do with the cutoff grades, hence the need to write books about it. Different companies have different corporate objectives and each mining project will be unique with regards to the impacts of cutoff grade adjustments on their orebody. I would like to caution that one should be careful when taking your cutoff grade spreadsheet, plugging in new metal prices, and then running off to the mine operations department with the result. You need to fully understand the long term and short term impacts of that decision.
Just as a reminder for all QP’s doing financial analysis for PEA’s, don’t forget that one needs to present the financial results on an after-tax basis. Every once in a while we still see a PEA technical report issued only with pre-tax financials. That report is likely to get red- flagged by the securities regulators and the company will then have to amend their press release and technical report in order to show the after tax results. No harm done other than some red faces.
When doing a tax analysis in your model, where can you find regional tax information? For those of you that prepare financial models or are simply looking at mining projects in different jurisdictions, PWC has a very useful tax-related website. The weblink was sent to me by one of my industry colleagues and I thought it would be good to share this.
The PWC micro-site provides a host of tax and royalty information for selected countries. The page is located at http://www.pwc.com/gx/en/industries/energy-utilities-mining/mining/tax.html
On the site they have tax information for specific countries and you can either view the information on your computer screen or download a PDF version. Below is a screen capture from the PWC website.
The PWC tax and financial information includes topics such as:
Corporate tax rates
Excess profits taxes
Mineral taxes for different commodities
Rates of permissible amortization
VAT and other regulated payments
Fiscal stability agreements
Social contribution requirements
PWC has a great web site and hopefully they will keep the information up to date since changes in the laws are occurring constantly. It would be nice to see them add more countries to their 22 country database but it’s already good as it is. Check it out.
I have read several articles about how the junior mining industry must innovate to stay relevant. Innovation and changing with the times may be what is needed in this economic climate.
One company that is trying something new is Abitibi Royalties. They are promoting a new way for them to acquire royalty interests in early stage properties by offering to fund the claim fees on behalf of the property owner in return for a royalty.
Their corporate website states that they will pay, for a specified period of time, the claim fees/taxes related to existing mineral properties or related to the staking of new mineral properties. In return, Abitibi Royalties would be granted a net smelter royalty (“NSR”) on the property. It may be a gamble for them but it’s not really that risky given that the low investment needed to pay claim fees, even if one considers having to make these payments over multiple years.
Abitibi are specifically targeting properties located near an operating mine located in the Americas. They are keeping jurisdiction risk to a minimum. Abitibi state that their due diligence and decision-making process is fast, generally within 48 hours. No waiting around here but likely this is possible due to the low investment required and often the lack of geological information to do actually do a due diligence on.
To give some recent examples, in a December 14, 2015 press release, Abitibi state that the intend to acquire a 2% NSR on two claims in Quebec and will pay approximately $11,700 and reimburse the claim owner approximately $13,750 in future exploration expenses. This cash will be used by the owner towards paying claim renewal fees and exploration work commitments due in 2016. Upon completion of the transaction, these will be the ninth and tenth royalties acquired through the Abitibi Royalty Search. For comparison, some of their other royalty acquisitions cost were in the range of $5,000 to $10,000 each (per year I assume). I think that those NSR interests are being acquired quite cheaply.
The benefit to the property owner may be twofold; they may have no other funding options available and they are building a relationship with a group that will have an interest in helping the project move forward. The downside is that they have now encumbered that property with a NSR royalty going forward.
The benefit to Abitibi Royalties is that they have acquired an early stage NSR royalty quite cheaply although there will be significant uncertainty about ever seeing any royalty payments from the project. Abitibi may also have to continue to make ongoing payments to ensure the claims remain in good standing with the owner.
It’s good to see some degree of innovation at work here, although the method of promotion for the concept may be more innovative than the concept itself. Unfortunately these Abitibi cash injections investments are not enough to pay for much actual exploration on the property and this is where the further innovation is required, whether through crowd funding, private equity, or some other means. I’m curious to see if other companies will follow the Abitibi royalty model but extend it to foreign and more risky properties.
One of the requirements of NI 43-101 for Item 22 Economic Analysis is “sensitivity or other analysis using variants in commodity price, grade, capital and operating costs, or other significant parameters, as appropriate, and discuss the impact of the results.”
The result of this 43-101 requirement is typically the graph seen below, which is easily generated from a cashflow model. Simply change a few numbers and then you get the new economics. The usual main conclusions derived from this chart are that metal price has the greatest impact on project economics followed by the operating cost. Those are probably accurate conclusions, but is the chart itself telling the true story?
I myself have created the same chart in several economic studies so I understand the limitation with it. The main assumption is that sensitivity economics are generated on the exact same reserve and production schedule as for the base case. That assumption may be applicable when applying a variable capital cost but may not be applicable when applying varying metal prices and operating costs. Does anyone think that in the example show, the NPV is still $120M with a 20% decrease in metal price or 20% increase in operating cost? Potentially a project could really be uneconomic with such a significant decrease in metal price but that is not shown by the sensitivity analysis.
Increasing the operating cost changes the cutoff grade, which changes the waste-to-ore ratio within the same pit. So assuming the same the life-of-mine production tonnage is not entirely correct in this scenario.
Reducing the metal price would also result in a change to the cutoff grade. If one were to go all the way back, these changes in economic parameters would impact on the original pit optimization used to define the pit upon which everything is based. A smaller pit size results in a different pit tonnage, which may require a smaller processing plant, which would then have new (higher) operating and lower capital costs than assumed. A smaller reserve would produce a different production schedule and shorter mine life. It can all get quite complex.
So due to all the changes these sensitivities generate, it does require a lot of work to properly examine them. However generally the project proponent does not want to incur the costs necessary to run multiple pit designs and multiple life of mine plans simply to examine sensitivities. Hence the shortcut is to simply change inputs to the cashflow model and generate outputs that are questionable but meet the 43-101 requirements.
The general consensus these days is that the junior mining sector is in a state of flux and decline. I briefly touched on this in a previous article “12. Financings – It Helps to Have a Credible Path Forward”. Currently it is difficult for junior miners to get funding and the stock prices of many are on a steady downward trend. Some observers say this just a temporary phase and the industry will cycle out of it as it always has in the past. I’m not fully convinced that this will be the case, although I am hoping so since my employment is in the mining industry.
I am reasonably confident that metal prices will improve over time, but I am not sure that alone will result in the junior mining sector invigorating. I think there is a general paradigm shift as to how personal investments are being made and how the mining industry is being viewed by the public. The following article has my personal opinions on the present and the future.
Mining companies have been in the media with stories of cost over-runs, mine shutdowns, fatalities, protests, and environmental incidents. In addition, the junior mining sector has had a few notable scams and companies have gone bust with little to show to investors. In some instances company management were over promoting sub-optimal projects simply for the exercise of raising the stock price and cashing out. Not all companies fell into this category, but enough to possibly give an unfavorable image of the investment side of the industry. I think it may take more time for the industry to recover from the overall image being created by the events described above. The implementation of sustainable mining practices is a real attempt by industry to rehabilitate its image, but is anyone out there listening? Regarding that I have three general observations:
Yield Investors: When many of us baby boomers were younger, in our 30’s to 40’s and working with a steady income, we were willing to speculate on the mining stocks hoping for the big payoff, and there were many payoffs in the past. Also there wasn’t much else to speculate on. Now those same baby boomer speculators are moving into early retirement and financial planners push them into fixed income and dividend paying investments with 2% to 4% yield. The risk tolerance profile for many of these investors has been shifted from speculation & growth to income & capital retention. Retirement is not that far away and therefore I am unsure how many of these people will ever re-enter into the junior mining stocks if metal prices do improve. The majority don’t pay any yield. Some do; looking at the yield for Barrick (1.7%), Goldcorp (3.2%), and Yamana (1.6%), yield seeking investors would view their stock prices at their current levels as being adequately priced. If their share prices rise, yield goes down and makes them less attractive to those yield investor.
Where to speculate now? So where are the 30 to 40 year olds speculating today? Younger people today may still speculate with their free cash, but they are not hoping to be investors in the next Voisey’s Bay, Kidd Creek, or Hemlo. They never even heard of them. They are hoping to be investors in the next Apple, Google, or Facebook. The dot com bubble of 1999–2000 seemed like the junior mining companies and their investors trying to jump into technology and it was mainly a bust at that time. However these days several of the new breed of dot-com companies are getting huge share price jumps for speculators. Is it a tech bubble – maybe so. I don’t know whether the younger speculators will ever have interest in the junior mining sector since they never heard of it and there is so much more happening out there. Anecdotally I have heard that retail investor attendance at the Toronto PDAC and the various road-shows has been declining over the last couple of years, which may confirm a general lack of interest in mining sector investment.
The perception of mining: The mining and energy news shown in the media is not helping the industry, focusing mainly on the negative aspects. The resource business appears to be somewhat analogous to the meat industry. Everyone like their aisles of nicely packaged sushi, chicken, and beef at the grocery store but nobody wants to see how it actually gets to the store shelf. Millennials also love their metallic gadgets and the energy used to power them up, but please don’t show how it actually gets from mine to smelter to store shelf– it’s quite upsetting to them.
An interesting group of companies are the mid tier producers that have operating mines and generate profits, but do not pay a dividend. I will be curious to see how such companies shares will perform since they don’t satisfy the yield investor at this stage of their life nor may they satisfy the pure speculator looking for order of magnitude gains.
The larger mining companies will always have their investors like pension funds and mutual funds, however the junior miners may be a different story. Possibly private equity and equity-based crowdfunding will be the long term solutions since they are a developing field. I have heard that one geological consulting firm already has a plan in place to help crowdfunders with their 43-101 report even though they don’t yet have the money to pay for the report. I also understand that Canada now has two private stock exchanges that allow private equity to change hands, which may facilitate more private equity involvement in the future.
My bottom line is the junior mining industry needs to have a self-examination with respect to what the future holds. The changing population demographics and society’s urbanization may result in fundamental and permanent changes to how the financial side of the junior mining industry will function. Just my opinion.
In a previous article I outlined my thoughts on the usefulness of early stage financial modelling (“Early Stage “What-if” Economic Analysis – How Useful Is It?”). My observation was that it is definitely useful to take a few days to build a simple cashflow model yourself to help you understand the project. By “simple” I mean simple.
This article describes one of the techniques that I use to take a quick look at any project; whether it is for a client wishing to understand his project at a high level; or whether it is a project that I have read about and am curious about its viability. It takes about 10 minutes to plug the numbers into the template to get quick results. The image below is an example of the simple model that I use.
I term this a one dimensional (“1D”) model since it doesn’t require the typical X-Y matrix with years across the top and production data down the page. The 1D model simply relies on life of mine (“LOM”) totals to estimate the total revenue, total operating cost, and total profit in order to determine how much capital expenditure the project can tolerate. I do this analysis on a pre-tax basis to keep things simple.
Using estimated metal prices and recoveries, the first step is to calculate the incremental revenue generated by each tonne of ore (see a previous article “11. Rock Value Calculator – What’s My Rock Worth?”). Next that revenue per tonne is multiplied by the total ore tonnage to arrive at the total revenue over the life of mine.
The second step is to determine the life of mine operating cost, and again this simple calculation is based on estimated unit operating costs multiplied by the total tonnages being handled.
The third step is to calculate the life of mine profit based on total revenue minus total operating cost.
The potential net cashflow would be calculated by deducting an assumed capital cost from the life-of-mine profit. The average annual cashflow is estimated based on the net cashflow divided by the mine life. An approximate NPV can be calculated by determining the Present Value of a series of annual payments at a certain discount rate.
One can easily evaluate the potential impact of changing metal prices, changing recoveries, ore tonnages, operating costs, etc. to show what the economic or operational drivers are for this project. This can help you understand what you might need in order to make the project viable.
My bottom line is that a 1D economic calculation is simplistic but will still provide a conceptual vision for the project. The next step in the economic modelling process would use a 2D model based on an annual production schedule, but the 1D approach is a good first step in looking at a potential project and it doesn’t take a lot of time.
The two key nature-driven factors in the overall economics of a mining project are the ore grade and the ore tonnage. In simplistic terms, the ore grade will determine how much incremental profit can be generated by each ore tonne processed. The ore tonnage will determine whether the total profit generated all the ore will be sufficient to pay back the capital investment for the project plus provide some reasonable financial return to the investor.
Focusing on the first factor of ore grade, in order to understand the incremental profit generated by each ore tonne one must first convert the ore grade into a dollar revenue value. This calculation will obviously depend on metal prices and the amount of metal recovered. For some deposits with multiple metals, the total revenue per tonne will be based on the summation of value from each metal, some of which may have different process recoveries and different payable factors.
I have created a simplistic interactive spreadsheet at this link (Rock Value Calculator). A screenshot is shown below. The user simply enters their data in the yellow shaded cells and the rock value results are calculated. One can zero out values for the metals of no interest.
Price: represents the metal prices, in US dollars for the metals of interest.
Ore Grade: represents that head grades for the metals of interest in the units as shown (g/t and %).
Process Recovery: represents the average percent recovery for each of the metals of interest.
Payable Factor: represents the net payable percentage after various treatment, smelting, refining, penalty charges. This is simply a rough estimate depending on the specific products produced at site. For example, concentrates would have an overall lower payable factor than say gold-silver dore production.
Insitu Rock Value: this is the dollar value of the insitu rock (in US dollars), without any recovery or payable factors being applied.
NSR Rock Value: this represents the net smelter return dollar value after applying the recovery and payable factors. This represents the actual revenue that could be generated and used to pay back operating costs.
The final profit margin will be determined by subtracting the operating cost from the NSR Rock Value. These costs would include mining, processing, G&A, and offsite costs. Typically large capacity open pit operations may have total costs in the range of $10-15/tonne while underground operations could be much higher.
My bottom line is that very early on it is important to understand the net revenue that your project’s head grades may potentially deliver. This will give sense for whether you are a high margin project from an operating cost perspective or whether the ore grades are marginal and higher metal prices may be required. The more one understands the potential economics of the different ore types, the better.
Over my career I have been involved in various types of front end mine studies, ranging from desktop conceptual to definitive feasibility. Each type of study has a different purpose and therefore requires a different level of input, effort, and cost. I have sat in on a few junior mining management discussions regarding whether they should be doing a PEA or a Pre-Feasibility Study, or Feasibility instead of a Pre-Feasibility Study. Everyone at the meeting had their opinion on how to proceed based on their own reasoning. Ultimately there is no absolute correct answer but there likely is one path that is better than the others. It depends on the short term and long term objectives of the company, the quality and quantity of data on hand, and the funding available.
In my opinion there are four basic levels of study, which are listed below. My intention is not to provide a detailed comparison between the different studies although such matrix tables are readily available (contact me for an a copy of the table excerpt shown below).
Desktop or Conceptual Study
This would likely be an in-house study, non-43-101 compliant, simply used to test the project and let management know where the project may go (see a previous article at the link “Early Stage “What-if” Economic Analysis – How Useful Is It?”. I always recommend doing one of these studies. It doesn’t take much time and is not made public so the inputs can be high level or simply guesses. This type of study helps to frame the project for management.
Preliminary Economic Assessment (“PEA”)
The PEA is 43-101 compliant and would present the first snap shot of the project scope, size, and potential economics to investors. Generally the resource may still be uncertain (inferred classification), capital and operating costs are approximate and may be on the low side since not all the operational or environmental issues are known at this time. Please do not treat the PEA as a feasibility study.
I also recommend not announcing or undertaking a PEA until you are confident in what the outcome of the PEA will be. A reasonably thorough desktop study done beforehand will let one know if the economics for the PEA will be good or bad. I have seen situations where companies have announced the timing for completing a PEA and then during the study, things were not working out as well as planned. The economics were looking poorer than hoped and so a lot of re-scoping of the project was required. The PEA was delayed and shareholders and financial analysts were not impressed with the delay.
The PEA can be used to evaluate different development options for the project (i.e. open pit, underground, small capacity, large capacity, heap leach, CIL, etc.) . However the accuracy of the PEA is limited and therefore I suggest that the PEA option analysis only be used to discard obviously sub-optimal scenarios. Options that are within a +/-30% range of each other many be too close to discard at this stage.
Pre-Feasibility Study (“PFS”)
The PFS will be developed using only measured and indicated resources (not inferred) and the costing accuracy will be better than a PEA. Therefore the PFS is a good time to definitively evaluate the remaining development options and then make the decision on the single path forward. More data will be required for the PFS, possibly including a comprehensive infill drilling program to upgrade the resource classification. Many companies, especially those with smaller projects could skip the PFS stage entirely and move directly to Feasibility. I cannot disagree with this approach if the project is fairly simple and had a well defined scope at the PEA stage.
Feasibility Study (“FS”)
The Feasibility Study is the final stage study prior to making a production decision. The feasibility study should preferably be done on a single project scope. Try to avoid more option analysis at this stage.
Small companies must be careful entering the FS stage since once the FS is complete, shareholders will be waiting to hear about the production decision. If the company had only intended to sell the project with no intention of going into production, they have now hit a wall. What do they do next? Sometimes management feels that a FS may be needed to better sell the project, however I am not sure that is concern is real. Many potential buyers would do their own in-house due diligence and possible design studies and likely information from a PFS would be sufficient to tell them what they need to know. A well advanced Environmental-Socio Impact Assessment program may give as much or more comfort to them than a Feasibility Study would.
My bottom line recommendation is that there is no right answer as to what study is required at what point in time. Different paths can be followed but remember that consideration must be given to the future and what is in store for the company after the study is completed. Also what is the best use of shareholder money? Company management may see pressure applied from retail shareholders, majority shareholders, financial analysts, and the board of directors, and management must decide what path is in the best interests of the company.
Over the years I have worked with both large and small mining companies and watched how they studied potential acquisitions. Large mining companies often have internal evaluation teams that can jump on a potential opportunity that comes in the door and they start examining it quickly. These evaluation teams are experienced at what they do and can provide their management with advice even if working with only limited data. This help management decide early on whether to pursue the opportunity or walk away. They are not right all of the time but more than often they save their company from wasting money on projects unlikely to fly.
If you are a small mining company, what are your options? You don’t have an in-house technical team ready to hit the ground running. If the project is early stage, management often feels it is better to put money into the ground rather than on early “studies”. However my experience tells me how do you know if you have arrived at your destination if you don’t know what your destination is. Early stage modelling can help define your destination.
The exploration team and upper management will have some overall vision of the potential project, even for those projects at the exploration stage. They may all have opinions on the potential size and scope of what may exist on the property. However the question is whether it has sufficient potential to warrant spending more shareholder money on the project.
Some of the junior mining management teams that I have worked with have found it beneficial early on to have a simple internal cashflow model that is easy to tweak to examine “what-if’s” for the project. Input the potential deposit size and mine life, potential head grades, expected metallurgy, and typical costs to see what the economic outcome is. Does this project have a chance and if not, what tonnage, head grade, recovery, or metal price is required?
The tangible benefits from such an exercise are:
It helps management to think about and better understand their project, both the good and the bad aspects of it.
It helps management to understand what parameters are most important to resolve and what technical factors can be considered secondary. This helps guide on-going exploration and data collection efforts.
Periodically updating the economic model with better information as it becomes available will show the trends how economics are getting better or worse and the potential magnitude of those changes.