70 SMe Mining engineering handbook

• Financing costs. Although not included in Table 2.3-2, Cost of Capital

these costs are a crucial element for junior miners in Although this should reflect a company’s weighted aver-
particular (because they lack cash flow from produc- age cost of capital (equity and debt), estimates have histori-
ing assets), both in ongoing total cash costs and in NPV cally varied between key resources markets, with the North
terms. During the mining boom of 2003–2008, junior American analysts tending to use lower figures, ranging from
miners had relatively easy access to equity financing, 0% to 5%, in contrast to their counterparts elsewhere who use
usually at rising share prices each time, and this element numbers ranging from 5% to 10% (and interestingly AIM’s
of costs could thus have been glossed over. Because of guideline number of 10% after tax). This whole spectrum of
the cyclical nature of the industry, however, all aspects of cost of capital is likely to shift as the long period of easy and
the company’s financing issues are also cyclical—access generally low-cost finance of 2003–2008 ends in a cyclical
to debt financing alternatives; current cost of debt alter- economic downturn. Within these average statistics, however,
natives and whether this is a fixed or variable element the capital structure of individual companies and the cost of
of costs; nature of debt covenants; whether the lend- the financing available will also vary widely.
ers demand an element of price hedging, which would
cap the upside of the project in markets of rising prices; Political Risk
whether the presence of quasi-government lenders on the These discount factors are even more subjective (usually
book imposes any related constraints on the company biased by proximity), primarily because each company is
(e.g., International Finance Corporation); whether the unique in its aggregate exposure to generic (or sovereign)
company has fully covered the risks of borrowing heavily country risk (depending on where its many projects are and to
from local banks in some of the emerging markets areas; what extent it can benefit from the portfolio effect of one type
and whether companies have raised sufficient capital to of risk offsetting another) and to more specific project-related
fund their projects to completion. risk (still within the context of political risk assessment). In
• Cost escalation over life of mine. Because of the vari- addition, most investors will be pricing political risk in differ-
able nature of each geological deposit, today’s snapshot ent contexts, depending on their own portfolio spreads, ability
of a cost profile day is likely to be subject to significant to hedge, and even the requirement for a particular country
change over the life of mine. Factors that can cause quan- exposure (where a mining company’s discount rate is then
tum moves to the cost profile include shifts in grade or priced relative to other sectors in that country, rather than
stripping ratios, or the need to move from open-pit to against other geographic regions).
underground operations. In addition, the global mining
industry is currently experiencing cyclical cost escalation Project Development Risk
on the back of what has been (up to early 2008) the lon- The key elements that equity markets consider most important
gest commodity price boom since World War II. It has in determining the success or failure of the vital development
driven up both the cost and availability of energy, skills, phase—turning a geological resource into ounces of metal
contractors, spares (e.g., tires), and materials. Longer sold—are the following:
lead times combining with cost escalation in new projects
• Security of tenure, given the need for most natural
has seen capital expenditure estimates revised upward
resource companies to operate in emerging market regions
at almost every mining company reporting period, with
• Key characteristics of the ore body, particularly grade
implications for both NPV values and financing costs.
• Operating parameters of open-pit versus underground
• Smelting and refining costs. These can also vary signifi-
mine development
cantly over the cycle for a miner that does not have a fully
• Plant and metallurgical efficiencies
integrated operation (toll smelting agreements are fixed
• Logistics, particularly when a mine is located in a remote
or variable). The efficiency of the metallurgical process
region
in treating more complex metals such as platinum group
• Management record in developing projects to production
metals is a key competitive element among producers, as
stage
is the cost of energy in highly energy-intensive treatment
• Environmental issues that demand increasing amounts
processes such as aluminum smelting.
of company time and resources, covering not only the
• Royalties and taxes. Although in theory these should be
physical environment (where actual legislation will gov-
steady factors over the life of mine, in practice, commodity-
ern company requirements) but also the socio-cultural
related charges tend to be increased by governments as they
component (where local communities are capable of
watch the products’ prices rise through the cycle or as new
stalling potentially viable ventures if their concerns are
regimes take control in resource-rich nations. This trend of
not addressed)
so-called economic nationalism has been evident on almost
every continent and resulted in a rise in the risk premium
assigned to many companies operating in emerging markets MARkeT CAPiTAlizATion: The finAl eleMenT
some 6 months before concerns about a global economic Much of this chapter has covered the issues surrounding pro-
downturn emerged. jected cash flows for mining companies and determination of
the discount rate used to convert them into an NPV. The final
DiSCounT RATeS APPlieD To PRojeCTeD element of a mining company’s market capitalization is the
CASh floWS multiple which the equity market places on this theoretical
Even though this is a key factor in driving the end result of NPV. A number of factors affect it:
the NPV, there are no guidelines that hold across the board.
• Company profile in terms of the diversity of the asset
The major areas of difference rest on assessments of cost of
portfolio by geography and by product. Typically,
capital, political risk, and project development risk.