Background to this Series of Posts

This is the 3rd in a Series of 17 Posts that will be published on this Blog each Tuesday and Thursday from September 16 to November 11. All 17 Posts will be filed under the Blog Category ‘Valuation of Mining Companies’. For previously issued Posts in this Series click here. We hope you find this Post Series useful.

Exploration & Mine Development

Mining industries and the companies that participate in them face significant risks. These risks relate to:

1. The company’s ability to raise financing as required at reasonable and affordable rates.

2. The company’s ability to find mineralization that can be economically extracted in the contexts of:

• commodity prices both in the context of their cyclicality and the fact a mining company’s price recoveries are market dictated and entirely outside its control;

• costs incurred in planning and constructing mine and ore processing facilities;

• operating costs incurred during extraction and production; and,

• mine closure and environmental remediation costs required to be incurred at the time production ceases.

3. The fact that finding, extraction and processing of minerals is:

• subject to political and economic risks related to the country hosting the mineralization;

• at both the exploration and producer levels subject to substantive government regulation which could affect both production and cost structures;

• in the case of Small Cap Companies typically there is a dependence on company management that is not present to the same degree in larger companies;

• dependent on external infrastructure;

• capital intensive where actual capital costs incurred in constructing and maintaining mine and ore processing facilities might be quite different from those forecast during the feasibility study and final project budgeting processes. This is particularly true in periods of periods of high global growth rates, high mine development activity, and escalating direct and indirect energy costs; and,

• dependent on costs incurred during the extraction and production timeframe, which might be quite different (particularly in the context of direct and indirect energy related costs and environmental rehabilitation costs) than costs forecasted at the time of a feasibility study.

There is, of course, the possibility of commensurate high rewards in the event mineralization in commercial quantities is found and successfully brought to market, particularly in circumstances where an explorer finds commercial mineralization at the peak of the relevant commodity price cycle and sells the deposit to a producer with capacity in existing ore processing facilities in physical proximity to the deposit.

The Important Difference between Resources and Reserves

There are important differences between a mineral ‘resource’ and a mineral ‘reserve’. Mineral Resources are of less near-term importance in a value context than are Mineral Reserves. However, following further exploration and ‘proving up’ Mineral Resources may become Mineral Reserves.

Mineral Resources

A Mineral Resource is an inventory of mineralization gathered from outcrops, trenches, pits, workings, and drill holes that in the opinion of a Qualified Person (as defined in Canadian National Instrument 43-101), have reasonable prospects for economic extraction. Mineral Resources are sub-divided in order of decreasing geological confidence into Measured, Indicated and Inferred categories described as follows:

1. A Measured Mineral Resource is that part of a Mineral Resource for which quantity, grade or quality, densities, shape, and physical characteristics are so well established that they can be estimated with confidence sufficient to allow the appropriate application of technical and economic parameters to support production planning and evaluation of the economic viability of the deposit.

2. An Indicated Mineral Resource is that part of a Mineral Resource for which quantity, grade or quality, densities, shape and physical characteristics, can be estimated with a level of confidence sufficient to allow the appropriate application of technical and economic parameters to support evaluation of the economic viability of the deposit and mine planning. An Indicated Mineral Resource estimate is of sufficient quality to support a Preliminary Feasibility Study that can serve as the basis for major development decisions.

3. An Inferred Mineral Resource is that part of a Mineral Resource for which quantity and grade or quality can be estimated on the basis of geological evidence and limited sampling and reasonably assumed, but not verified, geological and grade continuity.

Mineral Reserves

Mineral Reserves, supported by at least a Preliminary Feasibility Study, are those parts of Mineral Resources that, in the opinion of a Qualified Person, result in an estimated tonnage and grade that is the basis of an economically viable project after accounting for all mining factors including all relevant processing, metallurgical, economic, marketing, legal, environment, socio-economic and government factors. Mineral Reserves are sub-divided in order of decreasing confidence into Proven and Probable Mineral Reserves described as follows:

1. A Proven Mineral Reserve is the economically mineable part of a Measured Mineral Resource demonstrated by at least a Preliminary Feasibility Study.

2. A Probable Mineral Reserve is the economically mineable part of an Indicated Mineral Resource, and in some circumstances, a Measured Mineral Resource demonstrated by at least a Preliminary Feasibility Study.

The foregoing should be considered only a brief primer in respect of Resources, Reserves and the categorization of each. For a more detailed discussion see the Valuation E-book Valuation of Small Cap Mining Companies found under the E-Learning tab on the Main Navigation Line of www.StockResearchPortal.com, or Canadian National Instrument 43-101 which describes in detail the difference between Resources and Reserves.

Steps in Exploration and Development of a Mine

The steps in the process of exploring for and developing a commercially viable mine can be summarized as follows:

1. Financing (and as the exploration process proceeds, incremental financing if required) is secured.

2. Exploration drilling is conducted.

3. If exploration drilling results in discovery of what is believed may be a commercial ore body, resource and (typically later) reserve estimates are developed based on the size and grade of the deposit. For Canadian companies these resource and reserve estimates typically are developed pursuant to the reporting standards governed by National Instrument 43-101.

4. A pre-feasibility study is conducted to determine the theoretical economics of the deposit, give an early indication of key risks, outline further required work programs, and determine whether further investment in engineering and other studies is warranted.

5. A feasibility study (sometimes, although less appropriately, referred to as a ‘bankability study’) is conducted to determine the technical and financial viability of the project. This study includes metallurgy, evaluation and forecasts of economic ore recoverability, engineering, infrastructure and ore processing costs, production, marketability, debt and equity requirements, mine life, and reclamation (environmental) costs. This study results in a ‘develop, or walk from’ project decision.

6. Where a project is determined to be economically viable all required regulatory approvals are obtained.

7. Further financing is secured and the construction of mine and processing infrastructure and tie-in to external infrastructure is completed. Where processing is contracted to third parties that is arranged.

8. The ore body is then mined and continuously expanded by further exploration while the mine is operated through to the end of its economic life.

9. Reclamation pursuant to then prevailing environmental laws is completed at the end of the mine’s life.

The timing of the development of every commercial mine is fact specific. However, there typically is an elapsed time of, say, 5 – 9 years from the time exploration begins to first production, broken down as to ‘exploration and development of reserve estimates’ (2 – 4 years), ‘pre-feasibility and feasibility studies’ (1 - 2 years), and ‘permitting, mine development and construction’ (2 – 3 years). Over the course of that time period and during each development phase a myriad of failures, reversals, and changes to commercial risk can, and typically does, occur. It is important that as a practical matter the Board and Management of many exploration companies have no intention or strategy to do other than find commercially viable mineral deposits and then create a liquidity event by selling either those deposits or the outstanding shares of their companies to major producers.

For previously issued Posts in this Series click here.

Ian R. Campbell has for over 35 years been one of Canada’s best-recognized Business Valuation Experts – see biography on this Blog.

This Series of Posts is reproduced and supplemented in E-Books titled ‘The Valuation of Mining Companies’ and ‘Valuation Methodologies’. Those E-Books can be found under the E-Learning tab in the Main Navigation Bar of www.StockResearchPortal.com. They are reviewed and amended as market conditions change and our experience dictates. Accordingly, we recommend readers of this Blog Series periodically visit www.StockResearchPortal.com and review those E-Books.

For a comprehensive discussion of Share and Business Valuation see ‘The Valuation of Business Interests’, Ian R. Campbell and Howard E. Johnson, The Canadian Institute of Chartered Accountants, 2001, available through the websites of either Campbell Valuation Partners Limited www.cvpl.com, or The Canadian Institute of Chartered Accountants www.cica.ca.

The views expressed in this Post are those of the author. The value of shares of a given company is time and fact specific. The valuation theories, principles, methodologies, observations, comments and data inputs discussed in this Post are of a general nature, and are provided for information and general guidance only. They should not be taken to include all ‘value or price relevant factors’. Nothing in this Post is intended to, nor should be taken to, constitute economic or investment advice. See Legal Disclaimer.

© 2008, Stock Research DD Inc., all rights reserved.

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