Snowden’s Tarrant Elkington notes that “identifying an approach is important when selecting robust strategies in order to understand the interplay between decision making and uncertainty. One approach to arrive at the optimum mining strategy under economic uncertainty is to focus on commodity price uncertainty. This might not be the most financially optimum strategy under expected conditions, but it will be robust in terms of reducing risk and exposure to potential fluctuations in economic conditions.
“Commodity prices are volatile and dependent on the metal supply and demand conditions. Anticipated future prices can only be estimated based on available historical data and interpreted behaviour. The assumption is made that such behaviour and patterns will prevail into the future. This is a precarious but very common foundation from which an evaluator is required to construct the business case for a mining project. The graph shows only a number of possible future outcomes for a copper price projection based on historical performance. Note how uncertainty increases dramatically with time.”
He focuses on mitigating the effect of price uncertainty by selecting robust strategies. “Many other economic variables (e.g. capital cost estimates, operating cost, exchange rates) could be included to develop an even more complete appreciation of the economic uncertainty underlying decision making.
“Mining and processing capacity selection has no obvious and generalised answer. Given the impact of these decisions on value or risk, it should be extensively analysed in order to arrive at a reliable conclusion. Very often in the industry, project evaluators and decision makers will resort to previous experience and/or rules of thumb in determining mining and processing capacity; rather than supporting these decisions with proper analysis. This could lead to inefficiencies and inaccuracies.
“Each mineral deposit is different in many aspects and therefore basing the decision for capacity sizing on previous experience could lead to a mismatch between the project and the supporting equipment and infrastructure. This could have capital cost implications which could reduce project value or lead to project failure.
“The justification of additional upfront capital expenditure requires compensation in the form of increased present value of future operating cash flows. This study considers to what extent incremental capacity expansions (mining and processing) can be justified against a full spectrum of potential price outcomes.
“The interplay between risk and return occurs due to the assumption that potential investors require greater risk to be compensated with higher returns. Low levels of risk are often associated with low potential returns, whereas high levels of risk are associated with high potential returns. The risk return trade-off often leads to higher profits only if accompanied by the possibility of higher loss. One of the difficulties in understanding the risk-return trade-off is that returns can be readily quantified, whereas risk is not as easy to express.” [email protected]
