Venmyn Deloitte notes that “the fundamental asset that underpins the value of a mining project or mining company is its Mineral Reserves, and a thorough understanding of the Mineral Reserves should be the single most important item that drives the value and any financial performance of a mining company.”
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“The significant influence of changing commodity prices on the mine planning process, mining schedule, the resultant Life of Mine (LoM) plan and the declared Mineral Reserves is illustrated in the schematic flow chart above. Mining companies, in most cases, are commodity price takers and have little or no influence in determining the price of the commodities that they produce, except through influencing the supply dynamics. It should be further noted that commodity prices are the single most sensitive input assumption among the technical and economic assumptions required in the determination of the quantum of Mineral Reserves available and the resulting LoM and, finally, the resultant mineral asset value of the project or company.
How to determine the appropriate Commodity Prices?
The forecasting of long-term real commodity prices is one of the important economic inputs considered in annual mine planning, business budgeting and Mineral Reserves declaration processes. As part of the annual mineral reporting process of updating content each year in annual reports, the Competent Person would need to have a difficult conversation on the validity of the Mineral Reserve, especially in the current economic climate where commodity prices continue to be depressed.
One of the issues is that current industry practice involves the wide range of stakeholders that influences and/or provides inputs in the selection of modifying factors including the commodity prices used in Mineral Resources and Mineral Reserves estimation process. The Competent Person takes overall responsibility of the result.
It should be noted that neither the international mineral reporting codes such as JORC, SAMREC, NI 43-101 or PERC Codes, nor their guidelines, provide any guidance on what or how to estimate the commodity prices for this process. The Codes require that, for commodities traded on metal exchanges, reasonable forward-looking prices should be used and such prices should be based on historic full-cycle price averages and should be disclosed. However, for commodities not traded on metal exchanges, it is recognised that disclosure of a specific price may put a company at a competitive disadvantage, and may not be disclosed into the public domain.
The exception is the regulator at the New York Securities Exchange (NYSE), which has provided some guidelines on which commodity prices to utilise in these annual process. For example, one gold company quotes “the Cut-off grades have been calculated in accordance with the SEC Guidelines and approximate the historic two to three year average commodity prices”.
The figure above shows the influence of selected commodity prices on the mine planning process, mining schedule, the resultant LoM plan and the declared Mineral Reserves, if the commodity prices used increase or decrease significantly.
What is considered appropriate Commodity Price?
As a general rule, the long-term real commodity price used in the mine planning processes and Mineral Reserves estimation process should be lower than the current spot prices at any given point in time. In recent times, Venmyn Deloitte has seen companies using commodity prices well above the current spot prices, in a bid to try and limit impairment charges and in the hope that commodity prices will recover in the short-term. The idea of using a lower commodity price compared to the forecast spot price is that the company should be seen as a going concern and continue economic mining operations, even during very low commodity-price periods. This would also avoid instances where one may be required to develop a new mine plan during the financial reporting period due to a significant decrease in the commodity price or changes to any modifying factors.
Using high commodity prices in determining the Mineral Reserves might mean that the mine will be designed to make an operating loss at least in the short-medium term. Due to fluctuations in commodity prices over the last few years, some mines have closed despite companies still reporting a Mineral Reserve. This is contrary to the original intentions of the International Mineral Reporting Codes to declare Mineral Reserves determined by a mine plan that is technically achievable and economically viable, and that material modifying factors have been considered at the time of reporting. In the SAMREC code 2016 edition, the term ‘economically mineable’ implies that extraction of the Mineral Reserve has been demonstrated as viable and justifiable under a defined set of realistically assumed modifying factors. In most of these cases of mine closure, the commodity price used in the Mineral Reserve declaration would have been unreasonable or inappropriate.
What should the board be thinking about?
For the Company Director or CEO or auditors it is important to understand that a re-estimation of the Mineral Reserve with a different commodity price would take significant time, i.e. approximately three to six months depending on the complexity of the mining operations. Industry best practice recommends that appropriate sensitivity testing is done during the mining-study level and in each annual revision of the Mineral Reserve estimation on the commodity price forecast along with all modifying factors. The Company Director or CEO can then inform the market of the valid ranges and when a new Mineral Reserve estimate may be required.
Commodity price variations may trigger modifications, and reductions or increases in other areas of the mining operations, including production rates, waste stripping, operating costs, on-going capital costs and/or cut-off grades. All these, combined, can negatively affect the Mineral Reserves declared, the business plan and the financial performance of the mining company.
What about the auditor?
Current accounting standards are dependent on the resulting Mineral Reserves, as the determiner of useful mine life and, hence, the allowable time over which to depreciate and amortise mineral assets and exploration/development expenditure. This would play an important role in the determination of any impairment charges to be considered in the financial statements. Both the declared Mineral Reserves and the resulting LoM are highly dependent on the commodity price selected in the mine planning and Mineral Reserves estimation process, as illustrated in the schematic flowchart. To fully understand the diagram, the green colour shows the impact of increasing commodity prices in the planning process, and the red colour shows the impact of the current depressed commodity prices to the Mineral Reserves and to the LoM plan.
Summary
The commodity price assumptions used in the mine planning and Mineral Reserve declarations should be reviewed considering the potential influence on the LoM plan and financial statements. It is important to select an appropriate long-term real commodity price forecast so that the company does not react to short-term commodity price movements, but also to ensure that value is not destroyed by planning to mine at a loss.