Is it better to build a mine or to buy one? That’s the question vexing multinationals struggling with increased ore grade variability – resulting in reduced recovery and throughput of target metals, and a rise in operational expenditure (OPEX) – depleted reserves, more stringent global environmental legislation, and the resurgence of resource nationalism and geopolitical instability worldwide.
Concerning the latter, the Australian mining minister recently suggested that the copper price would likely be 30% higher were it not for the evolution of the relationship between the US and China.
On old adage states that ‘mines are made, not found’ – is it therefore cheaper in the current climate to develop a mine from scratch, or ‘smart buy’ an existing resources operation (or a stake in one)?
“The main capital outlays very much depend on what type of a mine it is,” notes Travis Hough, director in Frost & Sullivan’s metals and minerals practice. “An underground mine, for instance, requires a lot of money to be spent sinking the shaft and associated infrastructure.
“There are also significant costs related to power, extraction, processing and refining – depending on the jurisdiction, companies may have a smelter on-site, for example – and extensive water usage.
“The banks may stipulate that an engineering, procurement, and construction management (EPCM) contract be in place, but the EPCMs do not shoulder the major development costs, unless they seek equity in the mine, which is rare. The onus is on the operators themselves to raise finance capital.”
Do your homework: the importance of feasibility studies
Before all that comes the feasibility study; this, in plain terms, determines whether the proposed project can be mined economically. It is intended to be a definitive technical, environmental and commercial assessment as well as a critical factor in making a decision to invest or not to invest.
For example, the study may be used to justify further exploration and development expenditure or to provide a basis for a major underwriting in order to raise the required capital to fund the project.
Feasibility studies typically fall into three main categories: scoping, pre-feasibility and final feasibility. A scoping study may be conducted very early on in the exploration stage as a basis for acquiring exploration areas and funding commitments. According to AMC Consultants, for this reason the estimation accuracy may only be 30%-35% due to a relative absence of information and hard data.
As the project progresses, so the financial stakes increase. A pre-feasibility study may be used as a basis to commit to a major exploration project to the tune of tens of millions of dollars, prior to a decision to break ground. It may also be used to attract a buyer (potential buyers may also order a pre-feasibility study as part of the due diligence process), a joint venture (JV) partner or risk capital.
A final feasibility study – sometimes referred to as a ‘bankable’ study since it is acceptable for submission to bankers – may be used to raise project finance, as a basis for detailed design and construction, and to demonstrate that the project is technically sound and economically viable.
Inevitably, the development process is arduous, expensive and, above all, risky, as Hough explains.
“From discovery through to actual operation can take as long as ten years,” he says. “It is in the nature of mining that you are forced to act on raw results that may look promising but sometimes don’t pay out. As a result, the price of buying an asset increases as you move further down the line from scoping study to final feasibility.”
Informed decisions: the options open to project owners
Armed with a positive feasibility study, the project owners have a decision to make: do they want to sell the project or their company, find a suitable JV partner, or build the mine themselves?
Since management’s first responsibility is to the majority of the shareholders, selling the company for the right price may be the most responsible course of action. Offloading the project and not the organisation is inevitably more complicated, since cash or shares remain in the business.
“The second option would be to find a JV partner with the financing and or experienced team to build the mine, which is not as desirable, as the original owner will have to give up a significant amount of ownership to attract the new partner,” Fred Sveinson, president at International Mine Builders, writes in Resource World.
“The third option is for the company to build the mine itself, whereby it will need to raise funds (financing) through equity (shares), debt such as loans, convertible debentures, royalty streams, smelter off-take agreements or some combination.”
On the question of whether it is ultimately cheaper to build a mine rather than buy the whole or part of one, Hough offers as examples two South African operators – Harmony Gold and Sibanye – that have built successful businesses on a similar model.
“Both companies identify mines that are fairly close to the end of their life cycles or are running on very small profit margins, strip out costs and run those as lean as possible,” he says. “Sibanye bought up marginal gold mines and then replicated that model in the platinum industry buying up a large proportion of Anglo Platinum’s operations – and then ran those assets extremely efficiently. These operations are priced accordingly; however, that model eventually becomes limiting, for the obvious reason that you can’t run old assets at a minimal cost forever and you need to replace reserves at some point.
“The large players spread their exploration expenditure and part-fund junior exploration companies via JVs as well as focus on developing their own concessions. The JVs allow them to have a foot in the door for a new discovery, at favourable prices.”
Smart thinking: future M&A activity
‘Smart buying’ can also be a quicker way of getting reserves on a company’s balance sheet. With commodity prices rebounding, how does Hough see the build vs. buy debate evolving in the short to medium term, and what impact might it have on large-scale mergers and acquisitions (M&As)?
“A lot of the mining majors – BHP Billiton, Xstrata, Glencore, among them – invested heavily in large projects and then got burned during the subsequent downturn,” he explains. “However, some decent projects are being green-lighted now that money has started to re-enter the system.
“I think a lot of companies will focus on organic growth by expanding the assets they already own. Juniors will build and develop mines, and those with bigger balance sheets will buy or co-fund those.
“The future may well be characterised by large miners adding small bolt-ons. I imagine there will be more small-to-medium size M&As, but large mega-mergers? They look increasingly unlikely.”
The option to buy existing assets does come at a price and owners of those assets are unlikely to let them go cheaply if they are of decent quality. One only has to look at a fund like X2 Resources, which was started by Mick Davis. Despite having significant funding behind him, the fund did not execute on any deals as Davis couldn’t see any upside in the operating assets that were being offered to him.
As with all investments, there is risk and reward. You can take an early stage exploration project and develop it into a mine with the resources in the ground being heavily discounted due to the associated risk. Or you can buy an operating mine that comes with a lot less risk, but the discount on resources in the ground being heavily reduced.