This is my first installment of a month article which will cover a variety of mining industry and mineral economic topics. At this stage I’m very much in the dark as to who the reader might be and hope that with some constructive criticism and much appreciated feedback I can quickly evolve my writing style and topics to be inline with the needs and interests of the audience.
As an introduction, you should know that I have practiced mining engineering as a Professional Engineer of Ontario since 1984 and hold a B.Sc. (1982) and M.Sc (1992) in Mining Engineering from Queen’s University. I also have a MBA in Finance from the Schulich School of Business (2001) at York University. The timing of my enrolment into both graduate programs correspond very closely to dark and uncertain times in the mining industry (global commodities recession of 1990, and the 1997 Bre-X scandal) when I took leave of dismal employment to retool and kill time until the next economic recovery. Therefore, I have experienced and endured several mining cycle peaks and valleys, all of them seeming for different reasons but with that same boom and bust environment. People often ask “why mining’ and I have to attribute this to my father’s advice during the late 1970’s just before choosing an engineering discipline during undergraduate studies. I believe he gave this advice based on the strong demand for commodities which had occurred in the 1950’s and 1960’s and also the view that so much of Canada’s mineral riches were still yet undiscovered. Unfortunately the mining business cycle can be very “deep” and the underlying “Supercycle” can extend over a period of several decades. On entering the industry I had no idea that it would be this late in my career that mining engineering would be a very attractive carrier choice. I would like to share one quick story which I think is a good example of how the world can come full circle when it comes to the prospects for mining and commodities. During a class in business school during the fall 1999 and at the height of the “new economy” craze, a professor looking at me and made the following statement “can you imagine that at one time governments actually used dirt to back up their currencies”! In this case, he was referring to gold which at the time traded for about one-quarter of the price today and seemed to not have much purpose in a virtual world. I slumped into my chair thinking what a dinosaur I was at the age of 41 and if was there a chance that business school could enable me to escape this dated industry. Luckily for me it didn’t, and the world entered into what many are saying is the 2000s commodity boom!
For much of my career I have been involved with the evaluation of mineral deposits in almost any part of the world, commodity and also exploration/development stage. As VP of HB Global Advisors I’m introduced almost daily to various mineral property opportunities though contacts of our parent and legal firm Heenan Blaikie LLP. My goal is primarily to review and classify these opportunities and then present them to the firm’s current and also new clients with the object of earning a finders fee and/or generating legal work for the firm. In simple terms, I operate a “speed dating” service for mineral property venders and management groups both private and public who are looking for acquisitions or investments.
Technical
I would like to now present the technical portion of the article in which I will explain the importance of economic analysis of mineral deposits. In my experience, the economic analysis of mineral deposits is required for the following three primary purposes;
Purpose #1 Giving Context to Exploration Programs
Purpose #2 Identifying Acquisition Targets
Purpose #3 Due Diligence Evaluations for Mergers and Acquisitions
The following is a high level discussion of the process of economic analysis of mineral deposits in terms of geological exploration, acquisition targeting and due diligence analysis of mergers and acquisitions from a Canadian mining engineering and evaluation perspective.
Purpose #1 – Context for Exploration
One of the most basic needs of an exploration geologist is to have a through understanding of their exploration goals and targets and therefore come to terms with the risk and rewards of engaging in a new program. Very often exploration geologists are not provided with the technical and economic context need to gage what size and grade of a discovery is required to have a chance of being commercial viable. While many properties are geologically prospective, some basic preliminary economic analysis will reveal the opportunity for a commercial deposit is highly unlikely and thus avoid wasting considerable time and money.
Technically the economic relationship between deposit tonnage and grade boils down to three things, (i) Deposit location, (ii) Commodity type and (iii) Cost Structure. Location is very important since it will define accessibility to infrastructure such as electric power transmission, fresh water, labour and transportation of supplies and finished product freight. The type of commodity is also very important since the transport of “bulky” commodities such as coal, iron ore and base metal concentrates can be problematic and a major barrier to commercial production. I have been introduced recently to several world class iron ore deposits (multibillion ton and high grade (direct shipping) in locations where the nearest railroad access is +1000km (which really meant the deposits weren’t so “world class” after all!). Cost structure is also very important as it is easy to understand how a lead/zinc mine in China can operate much more cheaply than for an identical deposit located near the Sudbury basin.
The following is an example of some very basic context I provided to a senior exploration geologist who was considering a joint venture opportunity to earn-in by funding exploration of a near surface nickel prospect on the coast of Greenland. Figure 1 shows all combinations of deposit nickel grade, reserve tonnage and stripping ratio (SR = ratio of waste rock removal to ore recovered) necessary to have a cash operating cost of less than US$3.50/lb of Ni hypothetically produced (this was the Long-term Ni price forecast at the time). The calculation was very rough but indicated to the geologist just how big a deposit he would need to find given his estimate of what the grade of the deposit might be and its geometry. In this example, the nickel anomaly was partially covered by a glacier which therefore limited the lateral extent to which the potential deposit could be diamond drilled, defined and possibly mined. This analysis led to the realization that the property wasn’t large enough to find a commercial deposit coupled with the fact that a considerable amount of expensive diamond drilling would have been required. This and other factors led to the quick decision by the geologist to not pursue the opportunity since it was unlikely to be commercially viable even if a mineral discovery were made.
Figure 1
Open Pit Nickel Deposit
Target Reserve Tonnage (Mt), Ni Grade & Stripping Ratio
Minimum US$3.50/lb Ni Operating Cost
|
Grade Ni
|
SR 1:1
|
SR 2:1
|
SR 3:1
|
SR 4:1
|
SR 5:1
|
SR 6:1
|
SR 7:1
|
SR 8:1
|
|
0.50%
|
30.0
|
40.0
|
50.0
|
55.0
|
60.0
|
|
|
|
|
0.60%
|
19.6
|
19.6
|
25.2
|
25.2
|
28.0
|
40.0
|
50.0
|
60.0
|
|
0.70%
|
11.2
|
11.2
|
14.0
|
19.6
|
22.4
|
28.0
|
35.0
|
40.0
|
|
0.80%
|
8.4
|
8.4
|
11.2
|
11.2
|
14.0
|
16.8
|
19.6
|
22.4
|
|
0.90%
|
5.6
|
5.6
|
8.4
|
8.4
|
11.2
|
11.2
|
14.0
|
14.0
|
|
1.00%
|
4.9
|
4.9
|
5.6
|
5.6
|
8.4
|
8.4
|
11.2
|
11.2
|
|
1.10%
|
4.2
|
4.2
|
4.9
|
5.3
|
5.6
|
5.6
|
8.4
|
8.4
|
|
1.20%
|
3.5
|
3.5
|
4.2
|
4.9
|
4.9
|
5.3
|
5.6
|
7.0
|
|
1.30%
|
2.8
|
2.8
|
3.5
|
4.2
|
4.2
|
4.7
|
5.2
|
5.6
|
|
1.40%
|
|
|
2.8
|
3.5
|
3.5
|
4.1
|
4.6
|
5.4
|
|
1.50%
|
|
|
|
2.8
|
2.8
|
3.5
|
4.0
|
4.7
|
Figure 2 shows the detail behind determining the operating cost of just one of the grade/tonnage/strip ratio combinations shown in Figure 1(highlighted in red). As shown, for a reserve tonnage of 14Mt and SR(stripping ratio) of 8:1 a minimum grade of 0.90% is required to have an overall cash operating cost of under $3.50/lb nickel produced.
Figure 2
Open Pit Nickel Deposit
Target Reserve Tonnage = 14Mt @ SR 8:1
Minimum US$3.50/lb Ni Operating Cost
|
Grade
Ni
|
Annual Ni Recovered (lbs)
|
Mining
Cost $/lb
|
Milling Cost
$/lb
|
G&A
$/lb
|
Smelting & Refining $/lb
|
Total Cost $/lb
|
|
0.50%
|
9M
|
$2.94
|
$2.45
|
$0.26
|
$0.95
|
$6.59
|
|
0.60%
|
12M
|
$2.18
|
$1.81
|
$0.26
|
$0.95
|
$5.20
|
|
0.70%
|
16M
|
$1.73
|
$1.45
|
$0.26
|
$0.95
|
$4.38
|
|
0.80%
|
19M
|
$1.43
|
$1.20
|
$0.26
|
$0.95
|
$3.84
|
|
0.90%
|
22M
|
$1.23
|
$1.02
|
$0.26
|
$0.95
|
$3.46
|
|
1.00%
|
25M
|
$1.08
|
$0.89
|
$0.26
|
$0.95
|
$3.17
|
|
1.10%
|
28M
|
$0.95
|
$0.79
|
$0.26
|
$0.95
|
$2.95
|
|
1.20%
|
32M
|
$0.85
|
$0.71
|
$0.26
|
$0.95
|
$2.77
|
|
1.30%
|
35M
|
$0.77
|
$0.65
|
$0.26
|
$0.95
|
$2.63
|
|
1.40%
|
38M
|
$0.71
|
$0.59
|
$0.26
|
$0.95
|
$2.51
|
|
1.50%
|
41M
|
$0.65
|
$0.55
|
$0.26
|
$0.95
|
$2.41
|
Purpose #2 – Identify Acquisition Targets
Successful mineral exploration and mining companies have clear corporate development criteria in targeting potential acquisitions to management. Company Board of Directors must define high level strategy in terms of their preferences of industry (commodity), geographic region, stage of development, size of targets and business culture. To meet these requirements management must be prepared to rapidly perform economic analysis on many potential mineral deposits and mining companies as part of the process of determining a short list of potential targets. Therefore access to public “on-line” information, “in-house” databases, and a extensive professional networking is key to success. In addition, it is also often necessary to apply various “short cuts” in this high level screen process of targeting acquisitions. (More detail and case studies to come in future articles).
Purpose #3 – Due Diligence Evaluation M&A
Technical Due Diligence can occur after a target is identified and an agreement has been reached between both parties to sharing of confidential information for the purpose of a corporate transaction. The economic analysis of a deposit during due diligence must again be quickly performed but also at a high level of detail in areas seen to be critical to success and value creation. (More detail and case studies to come in future articles).
Feature Commodity - Lithium
A lot of interest has been sparked in the exploration and develop of Lithium deposits as a source of feed for light weight rechargeable Lithium ion batteries. I haven’t counted but have heard that there could be as many as seventy junior exploration companies focused in this commodity. Whatever the number, the vast majority of these new enterprises will fail at some point along the mining growth cycle. This is not the same as saying that money can’t be made investing in these companies but your timing must be perfect.
Lithium can be sourced from two types of deposits which are namely brines (evaporative) or hardrock (spodumene in pegmatite). Lithium supply is predominately sourced from the Altiplano of Chile and Argentina, a remote mountainous region located at over 3000m above sea level. The largest producer of lithium (lithium carbonate) is SQM of Chile followed by FMC Lithium of Argentina. These two companies have been in the business for many years and are very powerful suppliers capable of increasing production sufficient to meet the kind of strong demand growth forecast by so many analysts. Therefore it seems to me that it will be very difficult for new entrants to establish them selves as sustainable commercial suppliers of lithium carbonate. That is not to say though that buyers are not interested in developing new supply relationships since their objectives maybe to diversify their supply risk by having a second or alternative off-take supply. However only the strongest (most cost competitive) new entrants really have a chance of meeting this criteria as secondary supplier. What companies might be the most likely candidates to assume roles as a secondary sources of lithium supply? My suggestion would be to focus only on companies that have the likelihood of being the lowest cost industry producers. The criteria in my view which should lend well to low costs are as follows:
1. Brine deposits over hardrock in which recovery is energy intensive
2. South American salar deposits over North America (slower evaporation)
3. Good infrastructure and access to services.
4. Good mining friendly regions (avoid locations where public consultation can be long and excessive).
3. Companies with potential to produce other secondary products such as Potassium Chloride (KCl), Iodine (I) etc. which will generate additional revenue (bi-products) and thus reduce the overall cost of lithium produced.
4. Companies with potential to vertically integrate their business and improve margins.
Be sure and remember one thing when in vesting in mining and minerals companies and that is that it’s easy to make a small fortune in mining… but be sure to start with a large fortune!