Tuesday, May 29, 2012

valuation: Mining costs


Costs

Costs related to mining are broadly classified under the following heads.(which may change in importance depending on the type of mine being considered and locational factors.)
  1. Mining costs
  2. Processing costs
  3. Logistics costs
  4. Royalty – paid to the government or someone else
Mining, processing and logistics costs are determined based on either first principles (wherein we work out each individual component) or thumb rule (broad average costs for the whole mine based on similar mines ) or a mix of both the methods. First principles based cost estimation is generally considered to scientific but need not necessarily lead to a better estimate as a number of explicit assumptions need to be made for doing the same. Nevertheless, for a new large mine in a new location should be worked out based on first principles. It is critical that inputs from Experienced Mining and Procurement persons are taken while using first principles.
When using the thumb rule/historical costs estimates from another mine, it is critical to make adjustments for the Strip ratio, amount of blasting/ripping required, processing peculiarities (extra crushing and differences in processing methods), haulage distances, pumping requirements etc. Of these, haulage distance will change for sure with all mines and has to be critically evaluated always. The Processing and blastin/ripping is dependent on the material in the mine.
The amount of waste being mined in any mine is a cost which gets loaded on to the Ore costs. The Strip ratio is used to model the amount of Waste being mined each year. Ideally the waste to be mined should be determined by the technical team for each year (or financial period used in the financial model) and the cost of mining waste and hauling waste should be worked out based on that. The Haulage distance for waste will normally be different from the haulage distance for Ore as they are taken to different locations and the different densities of ore and waste.
As a practice, as the mine is being developed, the mine development expenses, pre-stripping expenses are considered to be a part of the capital expenditure in a mine. For the purpose of the financial evaluation, it is irrelevant as to whether they are capex or opex. What is critical is capturing the cash flows correctly and the tax implications of considering it as capex or opex. One cashflows are correctly considered, one has to look at the Tax depreciation impact of considering them as Operating or capital expenditure. The Tax laws of the particular country need to be looked at while looking at the tax impact.
Using average strip ratio: A lot of miners tend to use Average strip ratio over the life of mine for determining the cost of mining. As far as DCF models are being considered, it is not preferable to use average strip ratio over the life of mine as the strip ratios tend to vary substantially over the life of mine and therefore the timing of the cash flows related to waste removal will be inaccurate if average strip ratios are used. Due to the time value of money, the timing of cash flows will not average out. It is better to forecast the strip ratios on a yearly basis.
Generally logistics will always play a critical role in the cost estimates of any mining operation. However depending on the mineral and processing involved, the importance of Ore logistics, logistics of intermediates (semiprocessed ore/Concentrate) or finished product.
For iron ore, generally since FOB prices are considered, the shipping logistics will not come into picture and only costs till loading on the ship need to be considered. In case of other metals like Copper etc, cost of moving finished product isn’t as critical as the cost of moving concentrate (though depends on the mine location).
Peculiar to the mining business is the concept of Royalty payment to the government. In lieu of the right to mine minerals in the ground, the govt of the region is paid a “royalty” by the mining company. This is an unavoidable cost and must be considered in the financial model. Generally royalty is easy to determine as it usually based on simple formulas linked to marked price or as % of revenue. In India for example, royalty of iron ore is 10 % Advalorem (i.e. Value of the Ore at the mine gate …essentially Revenue – Logistics costs). Base metals are generally linked as % of the LME price as those commodities are heavily traded and London Metal exchange price is a widely accepted benchmark. (infact most sales in these commodities are a function of the LME prices )
In addition to the royalty paid to the government. A “Royalty” is at times paid to non-government parties. These are essentially a part of compensation paid to a mine seller for purchasing a mine. This will be in different form depending on the structure of the sale deal. It can take various forms such as Net profit interest (% of profit), % of sales, Price participation ( Fixed amount linked to the price of the metal) etc

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