Economic Evaluation of Mining Projects: Critical Signposts and Data Elements
By Lyman Mlambo and Earnest Rungano Chinyanga
Economic evaluation of mining projects is an exercise that seeks to find out a resource project’s worth or profitability and establish if it is worth developing and operating. The exercise depends on many technical and economic parameters and variables which are associated with the various stages of a mining project life cycle. Evaluation anticipates the values of these parameters and variables throughout the project life cycle before the project commences implementation.
Mining Project Life Cycle
Picking out important parameters and variables that feed into the mineral evaluation process involves visualizing the whole project from exploration, through mine development, operations (mining, mineral processing and marketing), to mine closure. The general mining project life cycle is presented in Figure 1. Note that mine closure plans address both closure and post closure issues related to mining impacts so that, for evaluation purposes, we may end at mine closure. Project evaluation happens in the initial stage of exploration and evaluation, for the reason that a mine can only be formally developed on the basis of a ‘go decision’ from a feasibility study. Note also that in the life cycle there are certain stages that cannot be forecast or are beyond the economic interest of the prospective mining investor, like temporary closure, return to ongoing operations, future land-use and any possibility of re-exploration of the same area for the same or different mineral. These are represented by stages 4, 5, 8 and ‘1 revisited’.
Figure 1: Mining Project Life Cycle
The evaluation process is preceded by a program design phase during which a mining company makes decisions on which minerals to mine and in which countries or regions of a country. Program design is based on literature and map study, including studies of the countries’ and regions’ investment environment defined by policies, legislations, regulations and tax regimes and their dynamic characteristics.
Exploration, Scoping, Pre-Feasibility and Feasibility Studies
The actual critical data for evaluation start to accumulate in the exploration stage, which include sub-stages such as specific area selection, data collection, target generation, target drilling, resource evaluation drilling, and resource definition. This culminates in a Resource Statement (RS), which is a technical document with geological parameters that feed into the economic evaluation process and these parameters will be identified shortly. However, it is important to note that in the early stages of exploration, before the investor can commit themselves to serious exploration activities like drilling, there is some preliminary conceptual economic evaluation process, which is based on general economic parameters and those of producing mines in the area. It is termed a scoping study.
RS contains data on types of rocks, types of minerals, mineral resources (measured, indicated and inferred), mineral reserves (proven, probable and possible), delineated mineral deposit including orebody geometry, ore grades, cut-off grade, etc. These determine technical parameters in the latter mining and mineral processing stages. Mineral resources are quantities of potentially usable minerals or metals which may or may not be profitably exploitable under the current economic and technological conditions. Measured resources are those that have been measured in detail (through detailed sampling). Indicated Resources are obtained from low sampling densities while Inferred Resources are inferred from adjacent measured or indicated areas without any sampling.
Reserves are that part of resources which can be currently exploited profitably. From measured, indicated and inferred resources we obtain proven, probable and possible reserves respectively, after applying modifying factors. Modifying factors are economic, social, political, policy, legal, regulatory, environmental and technological factors that make a resource exploitable at a profit. Generally, reported reserves are a sum of proven and probable reserves (2P). In the RS normally, proven reserves are not definitive. The grades corresponding to the various resource and reserve categories need to be known as they determine the estimated mineral content. The minimum grade that is exploitable under current conditions is the cut-off grade.
A pre-feasibility study (PFS) is an intermediate economic evaluation based on initial exploration data (RS) and economic parameters drawn from similar projects. The PFS indicates whether or not a feasibility study (FS), which is exhaustive and more expensive, is justified. The FS leads to a ‘go or no go’ decision. It would have definitive measures of all reserve categories, grades and technical details relating to mining and mineral processing methods, and equipment, besides other parameters given under the rest of the stages below. At this stage cost data accumulated relate to exploration permits, actual exploration and evaluation activities including environmental impact assessment (EIA).
Mine Development, Mining and Mineral Processing
When exploration is successful it leads to mine development, mining and mineral processing. Development could lead to tangible equipment costs or intangible development costs (associated with shafts, tunnels, raises, etc). Mining parameters of interest include the run of mine ore (ROM) or ore production per given period, average grade exploited, ore mining recovery rate (%), recoverable reserves (a product of mining recovery rate and total reserves) and mine life expectancy, besides mining costs. Mineral processing parameters of interest include feed grade, amount of feed, concentration ratio (amount of feed per ton of concentrate produced), processing plant recovery rate (%), concentrate grade, concentrate quantity, tailings grade, tailings quantity, middlings grade, middlings quantity, and enrichment ratios (concentrate grade divided by feed grade). Of interest also are the mineral processing costs per unit of concentrate. Note that beneficiation is more of an industrial activity than a mining activity whose evaluation is not discussed in this simple brief.
A full marketing study needs to be included as a component of the feasibility report. Such study would make projections on: (i) various marketing levels of the product (for example, concentrate and matte); (ii) various products of the mine and their relationships in production and use; (iii) grades of marketed products; (iv) quantity of sales; (v) pricing model; (vi) prices based on short-term and long-term demand factors; (vii) royalties; and (viii) marketing and selling costs including advertising, export licenses/permits, MMCZ commissions, etc.
Mine Closure and Post-Closure
Temporary Mine Closure (Care & maintenance) indicates the possibility that a mine may temporarily close in times of difficulties. This is difficult to forecast and include in an evaluation. For decisive mine closure an evaluation may include the closure costs reflected in the initial mine closure plan (developed as part of EIA) to address the environmental issues that are expected to follow the closure of the mine. Mine closure plans require mines to put aside some money every year towards closure costs. However, mine closure plans are not compulsory in Zimbabwe, and hence closure costs are normally not included in FS.
Apart from mining royalties there are various fiscal instruments that an evaluation should take into account during the processes before sale and after sale. Fiscal Instruments applicable to the mining sector in Zimbabwe include taxes/levies and tax incentives. The range of taxes/levies include corporate income tax, additional profit tax, withholding tax, Aids levy, VAT (inputs qualify for deferment, while exports are zero-rated), capital gains tax, customs duties (allowed in full for all mining capital expenditure for exploration and mine development); marketing commission (% of mineral sales levied by MMCZ), EMA charges, ZIMDEF levy, radiation protection fees (for those mines using radiation generating apparatus), etc.
Incentives include allowance on mining capital expenditure, reduced income tax on special mining leases, use of Double Taxation Agreements (DTAs) that provide for lower rates of withholding taxes on payments to foreign services providers, option to choose between straight-line depreciation and accelerated depreciation (in tax planning), and allowance of interest on debt up to the debt-equity ratio of 3:1. There are also several allowable deductions for tax purposes including some types of donations, payments to Community Share Ownership Trusts, some contributions to health facilities, contribution to research institutions, some contributions to schools, donations to the Public Private Partnership Fund, and contribution to public infrastructure.
Simplified Mining Project Cash Flow Model
At the end of the evaluation exercise, we will have a cash flow generated using the process shown in Figure 2, with the extreme left block showing withdrawals from the cash flow, the extreme right block showing addition to the cash flow, and the middle blocks showing the evolution of the cash flow as the various withdrawals and additions are applied. This simplified diagram excludes the various taxes (which would enter as withdrawals) and incentives (which would enter as additions) except for royalties and income tax. The last cashflow item, the net annual cashflow, is projected over the life of the mine as are all the other entries in the model. From the net annual cash flow either the Net Present Value (NPV) or the Internal Rate of Return (IRR) of the project is calculated as a measure of profitability of the mining project. An economically feasible project is indicated by an NPV that is greater than zero or an IRR that is greater than the cost of capital estimated as a weighted average of cost of debt and cost of equity.
Figure 2: Simplified Version of Mineral Cash Flow Model
(This brief report is an abridged version of a paper on Mineral Resource Valuation in Zimbabwe presented by Lyman Mlambo on 12 October at the Tax and Business Interface Week organized by Tax Matrix in conjunction with Africa Education Services, running 9-13 October 2017 at Rainbow Towers Hotel, Harare).
Lyman Mlambo is a Mineral Economics and Policy Consultant at LMS Mining Consultancy Earnest Rungano Chinyanga is an Assistant Mineral Economist at LMS Mining Consultancy