CLSAU_Mining0615

7/31/2019 CLSAU_Mining0615

1/40

for expert investors

Mine school

Dr Victor Rudenno

Summer 2006


2/40

2

Mining 101 - An overviewConducted by Dr Victor Rudenno, the guest author of our May 2006 CLSA U Blue Book Mine School -Mining basics and equity valuation, this is an essential course for investors in the resources sector whowish to understand the basics of mining. The programme provides details and simple examples of theprocesses involved from exploration and mining, to processing and marketing a mineral resource, as wellas the basics of commodity-price forecasting and equity valuation. Underinvestment in mineral exploration

and strong demand growth from developing economies has driven commodity prices to all-time highs insome cases. In the past three years, the global mining sector has grown from a market capitalisation ofabout US$180bn to more than US$500bn, according to some estimates. An understanding of all of thecritical steps required to find a mineral commodity and ultimately produce a saleable product, is critical forinvestors to successfully value resource equities.

Course instructorVictor Rudenno holds a Bachelor of Mining Engineering, a Master of Commerce and was awarded a PhDfor his thesis on Mining Economics. During his academic career he lectured at the University of New SouthWales and the University of Sydney on mining economics, geostatistics, operations research and mineralsprocessing. Published in numerous academic journals, Dr Rudenno is author ofThe Mining ValuationHandbook(2004). He is Principal Lecturer and Fellow of the Financial Services Institute of Australasia anda Member of the Australasian Institute of Mining and Metallurgy. Dr Rudenno entered the investmentbanking and stockbroking industry in 1984. He was a Director of Research at CIBC World Markets; aDirector of the Investment Banking Division of Hartley Poynton Limited; Head of Resources, CorporateFinance at Deutsche Bank and an Associate Director at McIntosh Corporate. He was Chief Operating Officerand co-founder of ECM Limited, a corporate advisory firm, which merged with InterFinancial Limited(www.interfinancial.com.au) in 2005, where he is currently an Executive Director.

Introduction


3/40

3

Introduction

! Exploration

! Resources and reserves

! Feasibility studies! Mining methods

! Mineral processing

! Marketing! Commodity-price forecasts

! Equity valuation


4/40

4

Exploration

! Exploration near known economic occurrence

! Previous success

! Adequate money to be spent

! Depth and value of target

! Proximity to infrastructure

! Availability of water

Review information

Analyse data from the air, surfaceand subsurface

Define most likely location fordrillable target

Drill to discover if orebody exists

Some things to look out for

Airborne magnetic survey

Generate drillabletargets


Physicalproperties

Physicalproperties

Explore for economic mineralisation:structure, alteration, rock type, mineralisation


Regional geologyRegional geologyGeochemistryGeochemistryRemote sensingRemote sensingRegional geophysicsfor buried structure

Regional geophysicsfor buried structure

Existing informationExisting informationGeologic models:

descriptive, genetic

Geologic models:


Geologic interpretationGeologic interpretation



Physicalproperties

Physicalproperties



Regional geologyRegional geologyGeochemistryGeochemistryRemote sensingRemote sensingRegional geophysicsfor buried structure

Regional geophysicsfor buried structure

Existing informationExisting informationGeologic models:


Geologic models:


Geologic interpretationGeologic interpretation

Defining drill targets

Source: The Mining Valuation Handbook, CLSA Asia-Pacific Markets


5/40

5

Exploration

! Obtain samples of the orebody at depth

! Determine the shape, size and location of the orebody

! Determine the ore density and grade distribution

! Rotary air blast (RAB) - least expensive but leastreliable

! Reverse circulation (RC) - more expensive but moreaccurate

RC drilling


6/40

6

Exploration

! Diamond drilling - most expensive butmost accurate as core of rock recovered

! Core cut to provide samples for assayingand a competent piece for geological

interpretation and geophysical tests

Underground Diamond Drilling

Core tray

Copper strike - Drilling cores from end 06 atEinasleigh 50m @ 6.65% Cu from 235m


7/40

7

Exploration

! Drilling designed to intersect orebody atright angles to get true width

! Often only the best results released

! Analysts need to interpret the results toget an idea of tonnage and grade

Average thickness is about 2.7 metres

Total combined depth of mineralisation is about 210 metres

Length along strike of mineralisation is about 150 metres

Thus, 210m x 150m x 2.7m x 3SG = 255,000 tonnes

With a weighted average grade of 28.4g/t gold equivalent

SG = specific gravity


8/40

8

Resources & reserves

! Increasing knowledge (primarilythrough drilling) and confidencemove resources from inferred tomeasured and reserves fromprobable to proven

! Applying physical and economicfactors moves a resource to areserve

! A reserve usually results in higher

grades but lower tonnage as sub-economic material is disregardedwhen computing the reserve

! Determination ultimately relies ona competent person who must

have adequate experience in thetype of mineralisation beingquantified

Ore reservesMineral resources

Probable

Proved

Exploration results

Inferred

Indicated

Measured

Increasing level ofgeological knowledge

and confidence

Consideration of mining, metallurgical, economic, marketing,legal, environmental, social and governmental factors

(the Modifying Factors").

Ore reservesMineral resources

Probable

Proved

Exploration results

Inferred

Indicated

Measured

Increasing level ofgeological knowledge

and confidence

Consideration of mining, metallurgical, economic, marketing,legal, environmental, social and governmental factors

(the Modifying Factors").

Defining drill targets


JORC Code Previous Chinese Category New Chinese Category

Measured resource A

Indicated resource B

111, 112, 121, 122, 2M11, 2M21,

2S22, 2S21, 331

C 2S11, 2S22, 332Inferred resource

D 333, 334

Classification guide

Source: Adapted from various company IPO Prospectus, CLSA Asia-Pacific Markets


9/40


10/40


11/40

11

Resources & reserves

! Grade result for one hole over one metre might represent grade applied to 6000tof ore

! Better approach is to take the average or distance-weighted average of nearby

grades! Geostatisitics and the Kriging method optimally weight the nearby grades

! First determine if there is spatial correlation between the grades using avariogram

! Next solve simultaneous equations to minimise the error

Variogram

Ore block grade determination


500E 600E 700E 800E

10,200N

10,100N

10,000N

500E 600E 700E 800E

10,200N

10,100N

10,000N

Variogram: AU_azm180pln = 60

Variogram Y(h)

Log distance (h)0.0

0.2

0.4

0.6

0.8

1.0

1.2

0 2 4 6 8 10 12 14 16 18 20


12/40

12

Feasibility studies

Geology and ore reserves - Size, shape and depth of the ore, the grade of the ore anddistribution, how homogeneous, any major faults or intrusions

Mining method and schedule Surface, open cut, underground, annual production ratevs life of mine

(High production rate, high capital expenditure, shorter mine life what is the optimum?)

Metallurgy/concentrator/washery design Recovery factor, concentrate grade,product quality

Water, power and environmental issues Source, capital and operating cost, disposal

of tailings

Permits Right to mine and discharge waste and make good

Construction schedule Timing, how long to first production the quicker the better

Construction cost Minimum expenditure to get the project operating,which varies depending on type and size of mine

Markets and marketing Transport to market (FOB or CIF), price forproduct quality sold, secondary processing costs, adequate demand forproduct

Financial analysis Put all of the above together to determine if theproject is financially viable


13/40

13

Feasibility studies

! Aim is to derive an economic valuation forthe project

! Most common methodology relies ondetermining the annual profit or cashflow

! In early stages emphasis is on reserves,later on capital and operating costs

Feasibility studies Cost Time Accuracy

Back of the envelope $100,000s months low(scoping study)

Pre-feasibility $m months fair

Final/bankable feasibility $10m year(s) good

Construction phase variable year(s) very good

Capital cost/annual production (US$)

Black coal 10-95/tonne

Copper 875-1,350/tonneGold 165-1,250/ounce

Iron ore 10-75/tonne

Lead-zinc 250-860/tonne

Nickel 4,000-6,000/tonne

can

useruleofthumb


14/40

14

Feasibility studies

Annual revenue

Product sold x product price received = revenue (net of royalties, market costs, smelter & refining costs etc)(Need to determine the cashflow that the project gets from the sale of the product not the value in the ground)

Annual costsAnnual mining rate x mining cost per tonne = mining cost (adjust for stripping ratio, dilution, mine recovery etc)

Annual milling rate x milling cost per tonne = milling or washing cost (milling rate


15/40


16/40

16

Feasibility studies

! Consideration must be given to the risksassociated with a project

! Sensitivity analysis shows the sensitivity ofproject economics to variation in criticalparameter values

! Probability analysis defines distributions oflikely outcomes for each critical variable andgenerates random NPVs to produce aprobability distribution of the possible results

min maxMilling cost

0%

100%

min max

Probability

Gold price

min max

Mining cost

NPV sensitivity analysis


0

50

100

150

200

(30%) (20%) (10%) 0% 10% 20% 30%

Change from base case

NPV (US$m) Gold price

Mining cost

Milling cost

0

5

10

15

20

25

30

35

40

45

50

-8 4 16 28 41 53 65 77 89 101 114

NPV $m

0

20

40

60

80

100

120(%) (%)

Cumulative probability (RHS)

Probability (LHS)


17/40


18/40

18

Mining methods

! May need to drill and blast waste rockand ore if it is too hard

! If an open cut, must move wastematerial to access economic ore

! Ratio of waste to ore can greatly affect

the project economics

Drilling rig for blast holes

Blasted zone in open cut

Open-cut cross-section


mined ore blocks

ore blockswaste block

mined waste block

surface

1

2

4

3

mined ore blocks

ore blockswaste block

mined waste block

surface

1

2

4

3


19/40

19

Mining methods - Mucking

! Aim is to move dirt (waste or ore) ascheaply as possible, so economies ofscale count

! Underground minimise dilution andmaximise recovery, maintain supportintegrity while minimising costs

Underground load haul dump (LHD) vehicle

Front- endloader anddump truck

Electric shovel


20/40

20

Mining methods

! Economies of scale allow largevolume of waste or overburden tobe moved

! Moving the processing plant saveson transport and rehandling costs

Dragline

Sand dredge

Strip mining


Alluvial mining


surface

coalseam

wastenext overburden cut

surface

coalseam

wastenext overburden cut

plant

waste

suction cutter head dredge

heavy mineral sands pond

plant

waste

suction cutter head dredge

heavy mineral sands pond


21/40


22/40

22

Mineral processing

Issues

! Consumption of consumables

! Energy costs for grinding

! Mill recovery

! Adequate supply of water

! Disposal of tailings

! Downstream smelting and refining

Tailings dam Mine waste can be an environmental issue

Gold pour

Smelting process

Source: Falconbridge, CLSA Asia-Pacific Markets


23/40


24/40


25/40


26/40


27/40


28/40


29/40

Commodity price forecasts


30/40

30


! New economies catch upwith increasing intensityof usage

! Synchronised worldeconomies

! Old economies, more

substitution likely

! Oil price still below 1980real price level of aroundUS$100/bbl

! US economy and currentaccount deficit

0

5

10

15

20

25

30

0 10000 20000 30000 40000

China

Poland

SKoreaUS

Japan

$ per capita

kg

perperson

Aluminium intensity of usage



31/40

31


! The relationship between stocksand prices can be quite strong

!

However the slope of therelationship and hence the priceforecast can change as themarket becomes more attunedto the changing situation

! Movements in inventory levelscan be a reasonable leadingindicator of changes incommodity prices

! But not all world inventories areidentifiable, so terminal marketsmight decrease but fabricatorinventories might increase

Smelting process

Source: Falconbridge, CLSA Asia-Pacific Markets

Scattergram of LME stocks and prices

5000

5200

5400

5600

5800

6000

6200

6400

4000 6000 8000 10000 12000 14000

Stocks (tonnes)

Price (US$/tonne)

Last eight months

Previous eight months

0

200,000

400,000

600,000800,000

1,000,000

1,200,000

1,400,000

1,600,000

1,800,000

Jan 00 Jan 01 Jan 02 Jan 03 Jan 04 Jan 05 Jan 06

(US$/tonne)(tonnes)

0

1,000

2,000

3,000

4,000

5,000

6,000

SHFE LME COMEX LME 3M Copper Price (RHS)



32/40

32


! Supply- and demand-sideforecasting aims to determinethe likely change in inventory

! On the supply side it isnecessary to forecast mine

expansions, closures and newdevelopments

! On the demand side it isnecessary to estimate thelikely growth in industrial

production, which is areasonable predictor ofdemand

! In recent times the failure toadequately predict growth in

the China market has failed toforetell significant increases incommodity prices

1997 1998 (est) 1999 (est) 2000 (est) 2001 (est)

Supply (tonnes Sn)

Bolivia 15,000 15,000 15,500 16,000 165,000

Brazil 20,000 19,000 20,000 21,000 22,000

Indonesia 49,000 47,000 50,000 52,000 54,000

Malaysia 35,000 31,000 28,000 23,000 20,000

Peru 10,000 15,000 17,000 20,000 20,000

Thailand 12,000 14,000 14,000 14,000 14,000

Other 12,000 11,000 11,000 10,000 10,000China exports 25,000 26,000 28,000 29,000 30,000

CIS exports 8,000 8,000 8,000 8,000 8,000

USA strategic 11,200 11,000 11,000 11,000 11,000

Total supply 197,200 197,000 202,500 204,000 205,500

Demand (tonnes Sn)

USA 3,8325 3,9706 41,001 42,321 44,167

IP growth (%) 5.0 2.3 2.0 2.0 2.0

Japan 28,003 28,507 29,077 29,659 30,252IP growth (%) 4.1 1.8 2.0 2.0 2.0

Germany 20,384 21,077 21,499 21,929 22,367

IP growth (%) 4.0 3.4 2.0 2.0 2.0

UK 10,748 10,877 11,073 11,295 11,521

IP growth (%) 1.4 1.2 1.8 2.0 2.0

France 8,404 8,618 8,808 8,984 9,163

IP growth (%) 3.8 2.5 2.2 2.0 2.0

Rest of Europe 22,000 23,500 25,000 26,000 27,000

Other industrials 6,500 6,500 6,600 6,700 6,800

Developing countries 51,000 53,000 57,000 60,000 63,000

Total 185,386 1,917 200,067 206,896 214,280

Reported stocks 45,889 48,491 49,707 48,259 43,869

LME stockpiles 11,000 11,624 11,915 11,568 10,516

Stock/demand (weeks) 12.9 13.1 12.9 12.1 10.6

LME price (US$/lb) 2.55 2.55 2.60 2.70 2.80

Actual price (US$/lb) 2.48 2.42 2.42 2.00



33/40

33


! Quality differentials canresult in different pricesfor the same commodity

! Evergreen contracts areusually set on a yearlybasis such as coal,bauxite and iron ore

!

Most prices for bulkcommodities are on a freeon board basis (FOB) atthe port of loading


34/40

Equity valuation


35/40

35

Equity valuation

! Determine future cashflow (negative and positive) on yearly basis - for thecompany or a project

! Cashflow should be discretionary - that is, the amount generated from a projectafter all costs, or the surplus funds that a company could pay its shareholders

! For a company or project, stay in business capital expenditure and workingcapital has to be deducted from the cashflow

! The resultant cashflow is then discounted by the appropriate discount rate

(hurdle rate) - for companies this is the weighted average cost of capital (WACC)

! WACC is the weighted average of the cost of debt and the cost of equity

! The cost of equity is the after-tax return expected for that class of company

! If a firm takes on a more risky project, the markets cost of equity might rise

! The internal rate of return (IRR) is the maximum rate of return achievable fromthe cashflow


36/40

Conclusion


37/40

37

Conclusion

What to look for

! Good management with plenty of experience getting resourceprojects off the ground

! Strong ratio of exploration ground to firms size, in the right areas

! A successful exploration track record

! Projects with good grades and hence medium-to-highvalue per tonne of ore - grade is king

! Open cut preferable to underground, if all other

factors equal

! Companies with projects where production likely tostart in the near to medium term


38/40

38

CLSA U is an ongoing executive education programme designed to bring youfirsthand information. Draw your own conclusions and make more informed

investment decisions - all in a conducive learning environment reminiscent ofuniversity days.

Contact: Angelique Marcil at [email protected]

Notes


39/40

39

Notes


40/40

Documents

CLSAU_Mining0615