Accurate mine project studies – essential

IM, is debating international project studies in the December 2007m issue, with contributions being lined up to keep the debate going in 2008. Dorothy Kosich, on Mineweb, yesterday noted that Haywood Securities’ Kerry Smith has suggested the suspensionof the Galore Creek copper-gold-silver project due to capex concerns may indicate broader issues regarding major greenfield mining project studies.

In an analysis published Tuesday, Haywood Securities metals analyst Kerry Smith, a professional engineer, said the decision by Teck Cominco and NovaGold to suspend the Galore Creek project “calls into question the quality of other feasibility studies. This recent development now calls into question the quality of other feasibility studies conducted by engineering firms for large projects, such as Pebble, Donlin Creek, Fruta del Norte, Cerro Casale, Fort Hills, Pascua Lama, Andacollo sulphides,” he suggested.

However, Smith blames neither Hatch Engineering, which prepared the original 2006 feasibility study for Galore Creek, nor AMEC, which reviewed the original study and found that capital costs would be significantly higher. The original $2 billion estimate has now more than doubled to US$5 billion.

“Part of the problem is the difficulty is accurately estimating the capital cost for a project of the scope of Galore Creek in a tight mining construction market where costs are rising rapidly and competition for skills is high,” Smith noted.

For instance, costs are particularly painful in developed, capitalistic, industrial nations in North America, western Europe and Australia. The competition for labour and materials is particularly acute for miners operating in these countries as permitting and project timetables grow lengthier.

As Standard and Poor’s credit analysts recently noted in an analysis of mining M&A activity, new greenfield investment is typically more risky and costly for mining, representing “quite a step-up in capital expenditure levels, partly caused by major cost increases.” Meanwhile, “the limited availability of qualified labor and equipment, plus higher cost energy and raw material inputs” are also pushing up project expenses.

In a remote area without much infrastructure, such as the Galore Creek location in British Columbia, building or obtaining the required infrastructure can be particularly costly. The cost for tailings and water diversion is now estimated to be about 40% of the overall project capex, or equal to the “previous total capital cost estimate at $2 billion,” according to Smith.

Mining project feasibility studies are typically prepared to an accuracy of +/-15% for capital expenditures. However, steel, fuel and labor costs for mining projects planned several years into the future are very difficult to forecast and estimate during the current economy in which these prices change almost weekly. Smith advises that “in reality, the only way to really accurately estimate costs is to complete detailed engineering and obtain firm quotes for construction-a process that would be extremely expensive.”

Although Teck spent six months conducting due diligence on the Galore Creek project-with the assistance of consultants,” Smith noted that “the company has suffered some loss in credibility as its due diligence was obviously not adequate for a large investment like Galore Creek.”

Teck admitted it relied heavily on the results of the original Hatch feasibility study “and should have spent more time reviewing the results in greater detail,” Smith said. Nevertheless, he added, “Teck has no doubt learned a valuable lesson from all of this, and will conduct more thorough reviews on its other development projects (Andacallo, Petaquilla, and Fort Hills) to ensure that the estimates for these projects are reasonable and accurate.”

Meanwhile, Smith claimed that “the accuracy of the estimated capital costs is likely to be better defined for smaller than for larger projects such as Galore Creek, a new greenfield development with significant infrastructure costs. For example, in August 2006, the Andacollo Hypogene [copper-gold mine] brownfield expansion had a pre-production capital cost of $336 million based on average annual production of 157 Mlb of copper and 59,2000 oz of gold. The scope of such smaller projects is much less, and we would not expect to see significant capital cost increases at Andacollo.”

Forex concerns, such as stronger Australian and Canadian currencies, are also making mining company projects more vulnerable to cost inflation.

A number of mining projects may not be commercially viable, when based on historical long-term price averages. S&P stresses that “the long-term price assumptions used by resource companies to justify their investment in growth projects is probably the most important factor in ensuring an appropriate capital return for risk.”

“There is a heightened risk that companies may over-expose themselves on themselves to the risk of lower prices, on the assumption that high prices are here to stay. We know for example that mining companies have tended to revise upward their own internal price assumptions, for investment purposes”.