70 SMe Mining engineering handbook
• Financing costs. Although not included in Table 2.3-2,
these costs are a crucial element for junior miners in
particular (because they lack cash flow from produc-
ing assets), both in ongoing total cash costs and in NPV
terms. During the mining boom of 2003–2008, junior
miners had relatively easy access to equity financing,
usually at rising share prices each time, and this element
of costs could thus have been glossed over. Because of
the cyclical nature of the industry, however, all aspects of
the company’s financing issues are also cyclical—access
to debt financing alternatives; current cost of debt alter-
natives and whether this is a fixed or variable element
of costs; nature of debt covenants; whether the lend-
ers demand an element of price hedging, which would
cap the upside of the project in markets of rising prices;
whether the presence of quasi-government lenders on the
book imposes any related constraints on the company
(e.g., International Finance Corporation); whether the
company has fully covered the risks of borrowing heavily
from local banks in some of the emerging markets areas;
and whether companies have raised sufficient capital to
fund their projects to completion.
• Cost escalation over life of mine. Because of the vari-
able nature of each geological deposit, today’s snapshot
of a cost profile day is likely to be subject to significant
change over the life of mine. Factors that can cause quan-
tum moves to the cost profile include shifts in grade or
stripping ratios, or the need to move from open-pit to
underground operations. In addition, the global mining
industry is currently experiencing cyclical cost escalation
on the back of what has been (up to early 2008) the lon-
gest commodity price boom since World War II. It has
driven up both the cost and availability of energy, skills,
contractors, spares (e.g., tires), and materials. Longer
lead times combining with cost escalation in new projects
has seen capital expenditure estimates revised upward
at almost every mining company reporting period, with
implications for both NPV values and financing costs.
• Smelting and refining costs. These can also vary signifi-
cantly over the cycle for a miner that does not have a fully
integrated operation (toll smelting agreements are fixed
or variable). The efficiency of the metallurgical process
in treating more complex metals such as platinum group
metals is a key competitive element among producers, as
is the cost of energy in highly energy-intensive treatment
processes such as aluminum smelting.
• Royalties and taxes. Although in theory these should be
steady factors over the life of mine, in practice, commodity-
related charges tend to be increased by governments as they
watch the products’ prices rise through the cycle or as new
regimes take control in resource-rich nations. This trend of
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
some 6 months before concerns about a global economic
downturn emerged.
DiSCounT RATeS APPlieD To PRojeCTeD
CASh floWS
Even though this is a key factor in driving the end result of
the NPV, there are no guidelines that hold across the board.
The major areas of difference rest on assessments of cost of
capital, political risk, and project development risk.
Cost of Capital
Although this should reflect a company’s weighted aver-
age cost of capital (equity and debt), estimates have histori-
cally varied between key resources markets, with the North
American analysts tending to use lower figures, ranging from
0% to 5%, in contrast to their counterparts elsewhere who use
numbers ranging from 5% to 10% (and interestingly AIM’s
guideline number of 10% after tax). This whole spectrum of
cost of capital is likely to shift as the long period of easy and
generally low-cost finance of 2003–2008 ends in a cyclical
economic downturn. Within these average statistics, however,
the capital structure of individual companies and the cost of
the financing available will also vary widely.
Political Risk
These discount factors are even more subjective (usually
biased by proximity), primarily because each company is
unique in its aggregate exposure to generic (or sovereign)
country risk (depending on where its many projects are and to
what extent it can benefit from the portfolio effect of one type
of risk offsetting another) and to more specific project-related
risk (still within the context of political risk assessment). In
addition, most investors will be pricing political risk in differ-
ent contexts, depending on their own portfolio spreads, ability
to hedge, and even the requirement for a particular country
exposure (where a mining company’s discount rate is then
priced relative to other sectors in that country, rather than
against other geographic regions).
Project Development Risk
The key elements that equity markets consider most important
in determining the success or failure of the vital development
phase—turning a geological resource into ounces of metal
sold—are the following:
• Security of tenure, given the need for most natural
resource companies to operate in emerging market regions
• Key characteristics of the ore body, particularly grade
• Operating parameters of open-pit versus underground
mine development
• Plant and metallurgical efficiencies
• Logistics, particularly when a mine is located in a remote
region
• Management record in developing projects to production
stage
• Environmental issues that demand increasing amounts
of company time and resources, covering not only the
physical environment (where actual legislation will gov-
ern company requirements) but also the socio-cultural
component (where local communities are capable of
stalling potentially viable ventures if their concerns are
not addressed)
MARkeT CAPiTAlizATion: The finAl eleMenT
Much of this chapter has covered the issues surrounding pro-
jected cash flows for mining companies and determination of
the discount rate used to convert them into an NPV. The final
element of a mining company’s market capitalization is the
multiple which the equity market places on this theoretical
NPV. A number of factors affect it:
• Company profile in terms of the diversity of the asset
portfolio by geography and by product. Typically,