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High Grading; The Implications Of Turning Ore To Waste

Friday August 16, 2013 14:55

We recently covered problems the industry faces with regards to the veracity of technical reports. Specifically we see number mistakes and fatal flaws built into NI-43-101 reports and sundry economic studies that ignore the realty of geology and mining. Folks, it is downright scary what passes for “Industry Standards”, NI-43-101 compliance, and, as the numerous industry write-downs demonstrate, mining companies’ internal studies.

With this in mine, Chris Wilson of Exploration Alliance provides a very enlightening look at what happens to a real life ore deposit when a company high grades it (changes the mine plan to extract the highest grade material) in order to increase short term profitability, or even just stay in business. Spoiler alert: about a third of the ounces go bye-bye. Also, we have added a strip ratio glossary to the Geo-Insights tab of our Exploration Insights website that is worth studying in detail here.

This is important information because as (if) metal prices (gold, in particular) decrease it is becoming apparent that the majority of mining companies cannot make money on their mines without severe cost cutting and/or increasing the mined grade. We believe this high grading probably offers the most efficient option to decrease costs, but feel the long term implication for the miners and their mines is that significant current reserves and resources will be rendered uneconomic (barring an increase in metal prices). Meaning, once again, miners will become increasingly desperate for new, high margin deposits.

Chris references the results of a BMO Capital Markets study that estimates the average “all-in costs” for the major miners is around $1,750 per ounce. This BMO cost metric is intended to reflect everything a company spends and, therefore, the bottom line profits. It is one step beyond the various cost metrics being employed by the gold mining industry that we covered in Exploration Insights March 25 (a study we can pass on to anyone interested), the essence of which is summarized below:

  • Cash Cost: The cost of production at the mine site, not including head office costs, interest expense, capitalized development, or stripping, off-site costs (like smelting or refining costs), taxes, or depreciation.
  • Total Cash Costs: Cash Costs plus off-site costs, head office costs, and sometimes interest.
  • Total Costs: Total Cash Costs plus depreciation, interest, and reported taxes (not necessarily paid).
  • All-in Cash Costs: Cash Costs plus exploration expense, head office costs, and sustaining capital.

Gold Price, Increased Operational Costs, and Reduced Profits - Some Implications for Open Pit Mining
by Chris Wilson—Exploration Alliance

The major gold miners are facing a multitude of challenges that have contributed to poor economic performance over the last few years.  Some of these challenges, such as the battle to retain profits as sovereign governments demand an increasingly large piece of the pie, are outside the control of company management.  Other issues such as large CAPEX overruns, poorly timed acquisitions, stalled and shelved projects, and substantial cost escalation, have also contributed to the inability of the major miners to turn record metal prices into corresponding profits and shareholder value.

A detailed review of over 35 major and middle tier gold miners by BMO Capital Markets Global Mining Research noted that the average all-in costs (which consist of the all-in sustaining costs plus tax and development) for gold production in 2012 were approximately $1,750/oz gold and are predicted to be around $1,700/oz gold in 2013, causing BMO to conclude that less than 5% of companies have current all-in cash costs below spot price.  Even if you take the more conservative industry standard, all-in production costs of between $1120 and $1308/oz Au, it is clear that many companies are producing at or near a loss.

The inability to control operational costs in part reflects a collective corporate mindset of increasing reserves by adopting lower cut-off grades (sustained by runaway gold prices) rather than concentrating on deposit quality and operational margins.  This approach has clearly not worked.  In fact, BMO notes that decreasing ore grades is now the largest factor (36% of cash costs) contributing to cash cost escalation, followed by labour (24%) and strip ratio (9%). Moreover, BMO notes that whilst cuts in discretionary expenditure (G&A, exploration), deferral or abandonment of new projects and expansionary capital, and short term deferral of sustaining capital (maintenance and pre-stripping of waste) will all help reduce all-in cash costs, they conclude that “mine plan revisions are required to significantly change head grades and thus restructure operating costs.”

What happens when a deposit is high graded?

The stagnation of the gold price through 2012 and its precipitous fall in 2013 has had a major negative impact on an already strained industry.  Shelved and stalled projects coupled by slashed exploration budgets will impact negatively on a company’s ability to replace the ounces it mines.  Lower gold prices will also force miners to recalculate reserves and resources, using more sustainable gold prices and thus higher cut-off grades, which will also result in a further reduction of reserves and resources.  To improve margins, companies may look to high grade accessible parts of their deposits; which, as we demonstrate below provides a short term economic benefit but will make it more difficult to mine the remaining parts of the ore body. Ultimately we feel this will result in un-mined ounces and further downgrade of reserves and resources--not good if your long term survival depends on more, not less, gold.

In the Glossary of Open Pit Mining terms (appended below) we explain the concept of strip ratio, and how higher gold prices should allow an operation to sustain larger strip ratio and thus access deeper parts of the ore body.  Conversely, a decrease in the gold price (as has recently happened) will impact on the economics of pushing an open pit deeper, such that the deeper parts of the ore body become uneconomic. 

At current lower gold prices the company is faced with three options:

  • Continue to operate at a loss.
  • Suspend operations (not always possible).
  • Modify the mine plan to target high grade ore blocks that can be accessed easily from the existing pit (high grading).

As we explained in the first edition of Glossary of Open Pit Mining terms (EI June 30, 2013), successful mining requires development of an optimised mine schedule that provides the most rapid payback of capital whilst allowing all the economically viable portions of the ore body to be mined through the life of the mine.  In contrast, high grading is the process of mining the highest grade zones of the ore body to provide short term economic benefit, on the assumption that the remaining areas of the ore body will be mined as the gold price increases.  In reality, the remaining ore often becomes marginally economic or uneconomic, resulting in loss of ounces to the reserve base. 

Remember:  Ore makes money and waste removal costs money.  If material classified as ore is mined and processed at a loss, then it is waste. 

The graphic below shows two mining scenarios for an existing open pit:  in scenario “A” the company completes the life-of-mine mine plan and exploits the entire economic ore body as planned; in scenario “B” the company elects to high grade the ore body (as shown by the blue pit outline) leaving the remaining ore body for a later date.  The long section shown is from a greenstone-hosted gold system and is real data.


(Fig. 1: Comparison of two open pit mining scenarios illustrating the effect of high grading a deposit. Take note of the resultant cost data and strip ratio)

Using a cost of $5/tonne to remove waste, $1300 Au, a recovery of 85%, and assuming no dilution, the following is noted:

Screen Shot 2013-08-10 at 3
(Table 1: Changes in ore deposit when deposit is high graded)

In conclusion, high grading a deposit will result in reduced per ounce costs and improved economics; therefore, if companies cannot reduce costs they will be forced to selectively mine the high grade parts of their ore bodies.  This is especially true of the lower grade and more complex ore bodies where margins are most sensitive to gold price.  However, it is far from certain that the “ore” left will be economic, and high grading will almost certainly result in a downgrade of the remaining reserves barring an increase in metal prices. The affect to the ultimate NPV of a deposit varies, and in some instances high grading may ultimately have no real negative affect.

Reading last week’s Exploration Insights, in which Brent discussed technical studies and how the same deposit can move from a significantly positive NPV to negative NPV as the input parameters are tightened into feasibility, what we should conclude from the above discussion is that high gold prices allowed unrealistically low cut-off grades to be used to classify waste as ore.  A somewhat sweeping statement but, taken in a generalized context, it underlines the need to better define reserves using more realistic cut-off grades based on realistic cost assumptions and sustainable long term gold prices.

Editor’s side note, and thanks to subscriber BD:

The following table documents the gold price some of the larger mining companies are using to calculate reserves and resources as of Dec 31, 2012.

Company

Reserves ($/oz Au)

Resources

Agnico-Eagle

$1,490 (3 year average ending Dec 31, 2012)

 

Anglogold Ashanti

$1,300

 

Barrick

$1,500 (long-term average)

 

Couer-d-Alene

$1,650 (gold treated as by-product)

 

Eldorado

$1,250

 

Goldcorp

$1,350

$1,500

Harmony

$1,400

 

Iamgold

$1,400, subject to deposit

 

Kinross

$1,200

 

Newmont

$1,400

 

Randgold

$1,500

 

New Gold

$1,300 to $1,350

$1,400


(Table 2: Gold price used to calculate reserves for major miners. See any potential issues here?)

To reiterate, when we factor in the effects of shelved and stalled projects, reduced or cancelled exploration programs, downward re-calculation of reserves and resources using lower gold prices and higher cut-off grades, and the likelihood that high grading will ultimately result in lost ounces, then it is clear that the long term thesis of Exploration Insights is more valid than ever: that the major gold miners are not replacing the ounces mined and that ultimately they will be forced to buy future resources and reserves.  The logical follow-on, as and when the industry starts to return to health, is that any genuine discovery, especially the higher margin ones in politically stable jurisdictions, will be extremely valuable.

In future contributions we will try to explain the difference between a high margin ore body and the majority of discoveries that are either fatally flawed or are too low grade (marginal) to ever make the cut.  Understanding the difference between the two and being able to pick those differences in press releases, is a fundamental first step in identifying discoveries that will one day fit the criteria of the resource hungry major and middle tier producers.

That’s the way we see it.

Exploration Insights
By Brent Cook and Chris Wilson

www.explorationinsights.com
www.explorationalliance.com

Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Metals Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Metals Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in precious metal products, commodities, securities or other financial instruments. Kitco Metals Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.
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