Roundtable discussion on mine finance

For decades, guidelines like the Canadian Securities Administrators’ NI 43-101 (Standards of Disclosure for Mineral Projects), the U.S. Securities and Exchange Commission’s S-K 1300 (Modernization of Property Disclosures for Mining Registrants) and Australia’s JORC code (Australasian Code for Reporting of Exploration Results, Mineral Resources and Ore Reserves) have been in place for conducting mining studies, including preliminary economic assessments, prefeasibility studies and feasibility studies. Several recent SME conferences have hosted discussion panels related to these studies, featuring the perspectives of various involved subgroups. This article summarizes a recent roundtable discussion among four industry insiders, each representing a different perspective: Douglas B. Silver, a financer; Jon Gilligan, an owner; Tim Arnold, an engineer; and Tom Rauch, a constructor. Silver is chief executive officer of Balfour Holdings LLC; Gilligan is president, chief executive officer and director of Liberty Gold; Arnold is a semiretired mining engineer at Barr Engineering Co. with more than 45 years of experience in hard rock mining; and Rauch is chief operating officer at McCarl’s LLC. Palo: You all represent different aspects of the mining development landscape. What are we doing well these days in the mining finance arena? Rauch: From my experience in other markets, the fact that we can talk openly about where we need to improve, and how, is a strength that should drive better performance. I think we set very high expectations, and we see speed in delivery of projects once they are approved and financed. We do pretty well getting them online. A lot of things drive that, not the least of which are engineering studies and early spending, before programs are fully funded. But also, there are very high expectations from investors that once money starts being spent, it should be driving toward something valuable. We don’t see nearly as many projects that stall out or turn into 10-year quagmires of continual spending. Another strength is that we have strong contracts. In the United States, we have a very strong legal and technical basis for what we should and should not be doing and making sure that everybody’s on the same page about what a successful project looks like, and that’s ultimately tied back to contracts. Silver: I would back up to the 50,000-ft level. I think with the establishment of NI 43-101, we have seen an increased standardization that’s helped us better define what needs to be discussed in engineering reports. We are seeing it now in tailings and other areas, and it allows me, as an investor, to compare apples to apples — although sometimes the apples are different species. Gilligan: Yes, I think we are at that point with the NI 43-101. We are seeing improved discipline in the system today. By that, I mean people are broadly adhering to the engineering standards driven by increased technical scrutiny from lenders and equity investors, and the expectation that things are done right. Ultimately, the outcome will be that robust projects get funded and nonrobust projects don’t. Arnold: Since the financing’s gotten a little bit looser — I don’t want to say easier to get — at least projects are getting financed. When we saw metal prices grow, I was worried that poor projects and the promoters out there were going to completely flood the market. But what we are seeing is good projects getting financed for all the reasons you guys just spoke of, and they are being advanced because the financers have a better feel for who can put together a good project based on a realistic technical report versus the people who are just out there promoting a project that will never go into production. I’m happy to see good projects being advanced a lot faster than they were even five years ago. So, are we getting better at knowing the difference between a good and a bad project? Gilligan: I think the market is getting a bit more savvy. We are not there yet, but we are getting more savvy. Okay, so what do we need to improve on? Gilligan: Over-optimism in early studies remains a problem. A preliminary economic assessment (PEA) is always the best possible outcome; then the economics deteriorate as the project advances. We need to stop underestimating execution risk and better understand the execution and construction requirements. Study assumptions are too often disconnected from real market conditions, particularly for consumables, labor and supply chain. We see it most often in earlier studies but it also occurs at later stages. What’s missing is an “owner’s mindset”: doing the work with the intention of being accountable for delivering the project. Silver: I have an entirely different perspective on this. What I find really annoying is the way these engineering reports are designed. They have to be done independently, but we need to figure out a way to incorporate the financial information, such as taxes, inflation and permitting timelines, into the technical report. I think a lot of investors don’t realize that these engineering studies assume you’re breaking ground tomorrow, regardless of your permitting or financing status. The problem we have, of course, is that those financial metrics are really not the purview of the engineering firm, which is more technical — focused on design timelines, cost, etc. — whereas tax, inflation, metal price and everything else is really a financial objective. I think this is why these reports read so poorly. They are lacking huge economic information, because it’s not the responsibility of the engineering firm. Arnold: If you want to do something better, quite honestly, it’s educating the people who are making the decisions. It’s not usually the engineering firms or the mine’s engineering or metallurgy or geology group. It’s the CEOs and the people who do not recognize how important it is to put a proper cash flow together. And when they do see the numbers, they jump up and down and scream and yell, and say the capital needs to be less. It is important to get the decision-makers educated on how to really build a mine. Rauch: I think one of the key risks is realistic expectations for project delivery. Often, we have folks who are not intimately involved in the details of how the project is going to move through to execution and then actually to startup and ramp-up. We need to explain things to C-suite individuals who are competent and knowledgeable in their own role, but maybe not in operating their plant. And tie that back to what Tim said about the cash curve spend, and then ultimately to production — realizing that connections need to be made there. So, it’s trying to set them up for success and still live within investor expectations. I’m less worried about cost in the end. I’m more worried about schedule. Schedule is really hard to make up, and it’s extremely expensive to accelerate. Silver: That goes both ways. I agree there are C-suite people out there who do not really care what the engineering study is. They just need to get the mine up and running because they told the investors they are going to. But I also think the engineering companies are getting bullied. So, they are doing dumb things. I mean, we had a project I looked at that was set as a feasibility study (FS) and it was barely a PEA. And when I asked the engineering company, “Why’d you call that a feasibility?” They said, “Because that’s what the client wanted.” I also think the engineers are getting sloppy. They are using a lot of benchmarking for costing as opposed to doing proper costing. What that leads to is massive overruns. I do not think there’s anybody on this call who thinks you should build a mine based on a PEA. Gilligan: A very bad idea! Silver: And it gets done all the time. Rauch: A lot of companies out there have gotten away from proper estimating. And not just the little guys. At the end of the day, on the owner side, if you are not getting somebody who’s doing a true quantities estimate — a bottom-up estimate — then you don’t even have a chance at the right question. And the big assumptions do not get flagged, especially at the PEA level, as you said. It’s too easy, early on, to say “That’s an inconsequential detail. We’re not going to worry about that.” But eventually somebody’s got to worry about it. Silver: Yeah, and that’s what we pay the engineering firms to do. It’s their job to worry about it, not mine. Arnold: What we as an industry are not doing is giving financers any comfort level about how long it’s going to take to permit a mine. And that’s the problem. You can have a great feasibility study, and you can have all of the numbers put together, but if you can’t say with any confidence that you are going to have this mine ready to construct by a certain day, then that’s scaring off investors. And there’s a good reason for it. It’s getting better; it really is. But when you ask the question “What do we not do so well?” that has to be in the mix. Doug mentioned somebody publishing what is essentially a PEA and calling it an FS. NI 43-101 is intended to prevent things like that, and worse — like, salting your mine. But is there a fast enough feedback loop? If you have a bad engineer out there, and they are just doing whatever the owner tells them to do, are we calling that out, too? Silver: Let’s look at Canada, for instance. The Ontario Securities Commission is understaffed and overworked. And I deal with them regularly because I do not think PEAs should be giving internal rates of return (IRRs) with three decimal places. It’s just stupid. So, we talk a lot. And they basically told me, “Doug, we spot-check. We can’t look at every report. If you see a report that is egregious, let us know, and we’ll move it to the top of the heap.” But it’s not a thorough regulatory review. And that’s something the industry needs to do. But then you get into the problem of, “I won’t talk about your project if you won’t talk about mine.” And people won’t step up and say, “This engineering report is a piece of crap.” You can usually fix one thing by throwing capital at it. But when you get three or four things that are just flat wrong, you start wondering. These aren’t the small engineering firms. Major, internationally renowned mining firms are using this cookie-cutter approach to banging these studies out. I saw a study that had a company’s name in it that was not the company we were looking at. The engineering firm took an old study, changed the date on it, and resold it. I mean, that’s the stuff that we need to self-police. Gilligan: I think there’s an awful lot of value looking at how many digits there are after any given decimal point in a report. It tells you immediately if the people writing the report understood what they were talking about. When you see gold assays, for example, to three decimal places, that tells you something about the other side. Silver: Your capital estimate accuracy is +/− 100 percent and your IRR goes out three decimal places? Gilligan: Yeah, and capital numbers quoted to the nearest $100,000 on a $500 million estimate. What? Silver: If we want to make this industry better, we have got some macro issues, which I raised earlier, but with the issues we’re talking about here, we need a way of enforcing things. I think engineering companies that do shoddy work should be financially penalized and recognized as doing shoddy work. That’s just my view. Arnold: The whole purpose of the NI 43-101 came from the Bre-X scandal, and what they focused on was geology, not engineering. I’m the last person in the world to say that we need more scrutiny or rules, but let’s be honest, there’s some shoddy engineering going on out there, and there’s some really shoddy due diligence being done by engineering companies as well. I don’t know how many engineering companies have had their wrist slapped as often as you can for poor geology, but engineering is just as important. Silver: I always assumed the next Bre-X would be an engineering company. Are we saying that the average financer can’t tell the difference between a PEA and an FS? Or that they need to just hire better people to do the diligence on the reports in the first place? I mean, you talked about self-policing; who’s the self, with all these players? Silver: Well, I think you got it backward. We are very good at doing due diligence. I can go through pretty much any engineering report in 20 minutes and tell you where the flaw is. The problem is, if I identify a flaw, how do I deal with that when making an investment decision? When you have a shoddy engineering report, you go back to the mining table where they have the cost and it doesn’t agree with what’s in the summary up front. That creates a credibility issue, which then leads us to speculate more about whether this project is good or not. So, we know what we’re doing and we can go through these fast enough. But when we find a really dumb error, it blows up the value of the entire report. And, you know, a company doing a DFS might have spent $5 million or $10 million on this report. Can each of you tell me one or two other ways we can improve? Gilligan: For me, one of the drivers is this obsession with maximizing net present value (NPV). That forces the owners to make dumb decisions to try and take their NPV from 2.7 to 2.8 in the belief that that’s actually better. It might be a higher number, but the decision they made to get there was not the right decision for the project. We don’t always think: “I don’t need to get to 80 percent IRR if 50 percent IRR is good enough to move the project along.” So perhaps one of the fixes is to stop obsessing about discounted cash-flow analysis. Silver: How dare you! [Laughter] Actually, we need to have a conclusion about all the engineering and math to tell us whether it’s worthwhile or not. NPV was designed for comparing investments. It was not designed to be a valuation method. And this is another mistake. I will be the first one to tell folks, “You bring me a 15 percent IRR on a PEA, I’m not even going to bother reading the report. Because by the time you get this thing built, you’ll be a ward of the bank. You bring me a project with 100 percent IRR, it’s going to raise a big red flag also, because that’s just goofy. You either missed something or there’s existing infrastructure at the site that allows you to get that kind of return.” And then we dig in and try to figure it out. High IRRs raise as many red flags as really low ones. Arnold: I’ll jump in here, being the guy who was getting beat up by the CEOs for the last 20 years. It’s not just IRR and NPV, but it’s capital and it’s mine life and it’s ounces per year and stuff like that. What I’ve said many times is, the markets are schizophrenic. One year, all I have to do is get a mine that can produce 250,000 ounces a year, and if it only lasts seven years, that’s fine. Then you put out your prefeasibility study (PFS) or PEA or FS and the market craps all over it. So, there’s a lot of pressure to get over all these different hurdles, and I think that’s just as much of a problem. We need to be making sure we are doing good engineering. And if the IRR and whatever are within the realistic realm, then it’s a go or a no-go. The mine’s going to be what it is. And the best thing in the world we could do is find out that the project is not economical before we spend another $150 million on it. Rauch: Having played a little bit on both sides, I can tell you that when I was trying to represent a financial portfolio and say, “Hey, we should make investments here, here and here,” it was totally the game of trying to sniff out the B.S. But when I was on the project development side, it was about, “How do we limit our risk and make sure that this thing gets done? How do we keep the game going, keep developing and ultimately produce something?” Because guess what? Nobody’s getting rich on one project. We have to build a bunch of projects in order to have a career.In the end, when I reflect on the balance between those two things, “finance Tom” should remind “project Tom” that sins covered up in PEAs or PFSs always come back to bite you in the end. The engineers need to have the resilience and backbone to be able to say, “Guys, we understand what you’re saying, but in order to actually answer that — or in order to say that this is truly a feasibility study and this activity is done — we need to finish the work.” And that might be inconvenient for cost or schedule, but too many people are allowing themselves to be optimistic rather than technically focused. So, think about stuff that’s left out. I write a PEA. I write you a capital estimate, and I write you a basis of estimate. Is anybody reading the basis of the estimate? If I’m writing a PEA, I’m going to say, “Half the equipment was quoted, the other half is out of a book, and we made an allowance for the water treatment plant.” Because it’s at a PEA level, I’m making a bunch of assumptions, and everyone should know that. I’ve stated them. So, is that getting glossed over because someone’s just reading the executive summary? Silver: My engineer would be reading that. I would be reading the executive summary. [Laughs] But you have people to read the rest of it for you. Silver: I got peeps. But this comes to a bigger point, that financers either outsource due diligence work to engineering firms or have their own staff. But if they have their own staff, it’s very limited in size. And you inherently are building in probability of error simply because you’re using very few people. When I was working for a big private-equity firm, we would outsource due diligence to an engineering firm, and we’d have 12 or 15 people on it because each person had their expertise and their job was to read that stuff. I think a lot of times, though, as you’re saying, people gloss over stuff because it’s buried in the document where you have to really search for it. And again, my favorite one is the capital estimate accuracy. I’ve just been through 500 engineering reports in the last three months and a surprising number of them don’t have it in there. You actually don’t know what their plus or minus is. It’s not in the report. And that to me is beyond unacceptable. One of the things we often see is the owner looks at the estimate and says, “Get rid of that contingency. We don’t need that.” Because it’s an easy thing to whack at, right? It’s not tied to anything. Whereas they can’t say, “Well, get rid of the railroad or power supply,” because there are clear consequences there. Silver: Every press release that puts out economic conclusions has a section on capital and will always say “including X dollars of contingency,” as though you don’t need it. And they don’t do that with any of the other numbers in capital — just contingency. Like it’s fluff that’s been glued on there to, you know, cover the engineer’s butt. I’ve never seen a mine that didn’t use its contingency. Arnold: Absolutely. You’ve got contingency. You’ve got no spares. That’s the one that drives me insane. You’re not going to have any spare motors in your mill? Are you kidding me? The thing that frustrates me about contingency is, they’ll put in that line about contingency and it says they’ve got a 30 percent contingency on earthworks, which is probably right, even at a feasibility level. But they don’t tell you that they only put 5 percent contingency on everything in the mill. So you never can trust what an overall contingency is in a report any longer. It’s buried elsewhere. And on a feasibility or a PEA, that thing should be 50 percent. Rauch: Yeah, I think getting better clarity on project results. Because how many studies go out where everybody ends up thinking, “Well, it was a fine study, but the project didn’t get funded.” And if we’d built it, then we would have found out that actually the study was crap. It missed a bunch of scope. We were never going to get there. We don’t have that many data points on the final product to be able to call bluffs, but certainly we can look at trends. I think in the end, everybody individually is doing their piece of the puzzle, but somebody’s left holding the bag. Ultimately, financers have to have a lot of trust. They can only spend so much time analyzing what was done. The long nature of our projects drives that risk and it makes it hard to evaluate whether the right decisions were made at the time. Contingency is absolutely intended to be spent. It is not a slush fund. It is not nice-to-haves for operations. It is calculated based on the level of development and the gaps at the time and what the worst-case scenario should be. If somebody can’t show you a risk register that equates to contingency, I’d start asking questions and see what other gaps they have. Closing thoughts? Gilligan: I think owners need to be realistic, be conservative, and recognize that credibility is your greatest asset. Don’t rush the study stages. What you’re really trying to do is derisk the project, not simply publish a study by a target date.And to the point about engineering, I think a lot of judgment in the studies should stay in-house, in the company, and not be outsourced to engineers. So have suitable in-house people to exercise that judgment and provide input on the study. Engineers need to design for construction and operability, not just produce a technical solution. And we want the engineers to challenge the client’s assumptions. If the engineer is saying, “Okay, fine, I’ll call it an FS,” that’s not good enough. We need real-world costs and schedule discipline embedded in those studies. My last thought here is, I think financers get a better deal if they back a capable team, not just an asset. A team’s track record matters because those groups of people will be accountable for delivery. I think you’ve got to hammer everyone for transparency on fundamental assumptions. What are the assumptions for your capital estimate, schedule and permitting risk, and how do they affect the outcome? If all that happens, we might just improve the industry. Silver: Reputations are like virginity: You only lose them once. The engineering firms are supposed to be third-party experts. We should hold them to this, and they should not compromise the standards. There should be financial penalties for those who don’t adhere to generally accepted standards. Part two is, I think they ought to add a section to the NI 43-101, or to any engineering report, called “owner’s input,” where the owners provide things like tax, inflation, permitting timelines and financial metrics, which are really not the business of the engineering firms. I think if we did that, you’d have a document that would be more comprehensive. Arnold: I concur completely that engineering companies need to put studies together as if they were planning on building the projects. I like Doug’s idea of making the owners responsible for their portion of it. Even if it’s just a PEA; as we all know, it’s only going to get worse from there because there are so many unknowns. And as you do more and more engineering, honestly, it gets a little more expensive — or it should. If you’re the Qualified Person (QP) on a report or you’re a Professional Engineer (PE) and you’re putting out trash work, there’s a system to take care of that, and it should be used more often. Rauch: I really like designing projects as though you’re expecting to build them. I can tell you I learned a lot more about projects and building things when I went to work in other sectors that are building a lot more projects. It’s hurting us that we don’t get as much practice as other sectors where they’re building more. So, we do need to design a project as though we’re expecting to build it, and we need to have more discipline. And that starts with developing comprehensive and organized scopes. Make sure that all the buckets are defined, even if during the PEA or PFS, you say, “Hey, this bucket, I’m going to put this aside here. I think it’s something that we can effectively answer in later studies.” Fine, say that. Don’t leave it unidentified. Then make a detailed, logical schedule to get the project through to actual completion. And finally, develop costs based on actual quantities and labor. Have that design basis, schedule basis and estimate basis. So that way you can say, “I know where my gaps are. I know where I’m strong.” And ultimately, that should be illustrated in your risk register where you can say, “This is what I need to do to move forward.” We all need to be better stewards of the industry by doing a really excellent study. And finally, work with your partners. Know the strengths and weaknesses of your team, the owner’s team, the finance team, etc., and come together to ultimately have a team that you think can actually get the project done. Even if it stops at a feasibility study or a front-end loading 3 (FEL3), that’s your best chance of success, because the much scarier thing is, it moves forward and everybody says, “Great, let’s go build it.” And you realize that you’ve been six months behind from day one.

Roundtable discussion on mine finance

Authored by: Daniel Palo

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Get your SME Foundation VIP Access Conference Pass to MINEXCHANGE 2027

“Check the box” and help support the SME Foundation

To view the past issues of the UCA magazine you must be a member of SME/UCA.

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