From start to finish, it can take up to a decade to develop a producing mine from scratch. Along the way, a huge amount of investment is necessary (with no immediate return) due to the capital-intensive nature of the natural resource industry. Understandably, the vast majority of potential mines are not able to progress through the entire "Life Cycle" for varying reasons.
This piece will discuss the multi-year process necessary to turn an undiscovered mineral body into a producing mine. You'll see below a fantastic illustration of this Life Cycle provided by geologist Brent Cook. The scope of this piece will mainly be focused on the actual process (as illustrated by the colorful bottom bar of the chart), but there will also be mentions throughout the piece regarding relative value and risk (as illustrated by the red line).
The majority of the Partnership's 17 holdings are somewhere in this Life Cycle, currently trying to progress to the next stage (with the exception being the Alternative Resource Holdings). While this piece is relevant to junior miners worldwide, please understand that mentions of a "NI 43-101" study or resource estimate applies specifically to Canadian-listed companies. Quality Australian and pink sheet listed junior miners adhere to similar, though less regulated, studies.
As a second point, please note that a company doesn't necessarily need to start at square #1 in order to bring a potential mine to production. In some cases (more specifically, if partial exploration and/or development has already been conducted on the property in question), the "Concept Phase" and/or "Exploration Phase" can be completely skipped - saving both time and money. And then there are of course brownfield projects, which will be discussed in further depth at the end of this piece.
Companies in the concept phase can be considered early stage mining "start ups". Team size at this point will likely be between 2-5 people, with the predominate skill sets being exploration geology and mine engineering. The company's treasury will likely be in the hundreds of thousands of dollars (or low millions if the team has had a serious past success from this stage).
In the concept phase, the company is responsible for developing an exploration thesis and strategic plan of action. These theses will generally emphasize: (1) a particular geological location, (2) a particular commodity, or (3) a particular exploration method. Once the company is confident in their direction, the final step in this phase is to stake prospective mineral licenses where one hopes to find an economic mineral deposit.
Once mineral licenses have been secured, it's on to the exploration phase (also known as the "pre-discovery phase"). This stage generally last 12-36 months for successful companies. There are two steps in the exploration phase: (1) grassroots exploration and (2) exploration drilling.
The main emphasis of grassroots exploration is to determine (in the least expensive manner possible) which areas of a mineral license are most likely host a deposit. Keep in mind that mineral licenses are often huge, and the vast majority of every license will ultimately be untouched by drilling. There are a whole host of grassroots techniques that are used to identify the promising areas of a license. I've included a fairly comprehensive list below with brief definitions for each technique:
· Visual - The exploration geologist walks and/or flies over the mineral license scouting for promising outcrops, unique coloring, and other geological anomalies.
· Surface Samples - Rock samples are collected at surface over a large geographical area and sent to the lab for assays.
· Groundwater Samples - Water is sampled at surface and tested for elements associated with mineral deposits.
· Seismic Refraction Surveys- A seismic reading that provides information on the distribution and thicknesses of subsurface layers of rock. Refraction surveys are used for "near-horizontal" geological formations at depths less than ~100 feet.
· Seismic Reflection Surveys- A seismic reading that provides information on the distribution and thicknesses of subsurface layers of rock. Reflection surveys are used for either "dipping" geological formations or targets such as cavities or tunnels at depths greater than ~50 feet.
· DC Resistivity Surveys- A technique used to assess the "electrical potential in the ground". The actual survey is quite simple - apply an electrical direct current (DC) between two electrodes implanted in the ground and measure the difference of potential between two additional electrodes that do not carry current. These surveys are used for anomalously thick or wet soils, most of which can be classified as "clay".
· IP Surveys - Induced polarization is an electromagnetic method that uses electrodes with time-varying currents and voltages to map geological formations. The IP method can probe to subsurface depths of thousands of meters and can be used to detect metallic sulfides, graphite, and clay.
· Magnetic Surveys - Magnetic surveys can be useful in defining magnetic anomalies that represent an undiscovered ore body or gauging the actual minerals associated with a known ore deposit. There are two main types of magnetic surveys: airborne surveys and ground surveys. Airborne surveys (in which a plane flies over the ground at an altitude of 100M while taking magnetic measurements every 10M) are advantageous in that you can cover a huge amount of ground. However, aeromag surveys can't get readings deeper than 200M below the earth's surface. This is where ground magnetic surveys come in - once a specific prospect has been identified, a much more focused ground survey can be undertaken. While it is over a significantly smaller surface area, ground magnetic surveys can provide up to 25x the detail/depth.
· NMR Surveys - Nuclear Magnetic Resonance is the only geophysical tool that provides information on the pore fluid found in some geological formations. NMR is helpful in determining the pore fluid's type, saturation, viscosity, and permeability. NMR surveys are used for environmental and groundwater research, as well as oil and gas exploration.
· GPR Surveys- Ground penetrating radar (NYSEMKT:GPR) uses electromagnetic wave propagation to identify contrasts in electrical/magnetic properties in the ground. GPR has the highest resolution in subsurface imaging of any geophysical method. Depth of Investigation varies from less than a meter to over 5,400 meters (in the case of ice sheets), depending on the ground's material properties.
· Geophysical Well Logging - Well logging is the practice of making a detailed record (a well log) of geological formations that have been penetrated by a borehole. The log may be based either on visual inspection of samples brought to the surface (geological logs) or on physical measurements made by instruments lowered into the hole (geophysical logs). Well logging is performed in boreholes drilled for mineral, groundwater, oil/gas, and geothermal exploration.
· Gravity Surveys - The gravity method is a relatively cheap, non-invasive, non-destructive remote sensing method that has been a favored exploration technique for decades. Gravity surveys are simply a measurement of the gravitational field at a series of different locations over an area of interest. The objective is to associate variations with differences in the distribution of densities (and hence rock types). This survey is used in the following fields: base metal exploration, oil and gas exploration, hydrogeology, and hydrothermal exploration.
· Remote Sensing - Remote sensing is the process of acquiring, processing, and interpreting images/data (acquired from aircraft and satellites) that record the interaction between matter and electromagnetic energy. There are two types of sensors used for mineral exploration: (1) optical sensors that measure the spectral data of sunlight reflected from the earth's surface and (2) synthetic aperture radar sensors that transmit microwaves and receive back scatter waves from the Earth's surface.
The 2nd step in the exploration phase is exploration drilling. This occurs once an appropriate amount of grassroots exploration has defined drill targets. At this point, it may be necessary to secure a drilling permit from the relevant jurisdiction.
An exploration drilling campaign typically takes 2-5 months from its initiation to the final assay results. The first step is to mobilize drill rigs (typically contracted in the case of junior explorers) at the defined drilling targets. In extreme cases, this seemingly simple step can take 4 plus weeks for projects that lack infrastructure and/or are in remote locations. Next the actual drilling takes place, typically lasting between 2-8 weeks depending on the amount of holes/drilling locations. Next, in a company owned "core shed", the drill core is logged and then "split" (where the cylindrical core is cut into halves or quarters). Next, split core is sent to an independent laboratory for analysis. Standard reference materials are sent along with the core to ensure proper QA/QC is conducted with respect to the laboratory analyses. This step can take up to two months, depending on the project's proximity to the laboratory and the complexities associated with the mineral(s) being tested for. Once the final assay results are received, the company drafts a press release (sometimes including a refined or reinterpreted model of the deposit in question) and releases the drill results to the market.
There are plenty of questions that need to be considered in assessing drill results. Was this RC, percussion, or diamond drilling? What are the widths? Are these intercepts at surface or extremely deep? Will the rock types that were intercepted be amenable to economic processing or not? The list goes on. However, if you have to remember anything about assessing a drill hole, there are two items that stand above the rest: the grade and the intercept length. Both the grade and the intercept length matter equally. There have been a myriad of drill results with extremely impressive grades, but with intercepts too short to matter. Likewise, there have been countless results with impressive 100m plus intercepts with grades that are far too low to be economic.
When mineralization is intercepted, the press release will typically state something along the lines of "20m of 1.05% copper". Both the grade "1.05% copper" and the intercept length "20m" are of equal importance. In the case of this hypothetical example, a grade of 1.05% copper is very impressive, as the average copper grade mined worldwide is roughly 0.45% copper. However, the 20m-intercept length is not particularly impressive (in terms of copper, only something above 100m would really raise eyebrows). While at first analyzing drill results seems somewhat arbitrary (for instance, in contrast to the above example, even a 1-2m intercept of nickel sulphides grading 2%+ is extremely meaningful), with context and experience it becomes easier to pick out truly exceptional results.
The initial goal of exploration drilling is to advance the understanding of your license's geology (beyond what might have been gleaned from grassroots exploration). Even if the first few drill holes are "duds" (which means that they do not intercept significant mineralization), valuable information is provided that may help a exploration geologist refine or even reinterpret his understanding of what's going on below the ground.
However, if the company hopes to advance to later stages of the mine cycle, they must eventually hit a "discovery hole" before their treasury runs out. In a discovery hole, there are such high grades of a certain mineral over an impressive distance that the trained observer has no doubt that a sizable mineral deposit is present. While there is no cut and dry formula to determine whether a drill result constitutes a "discovery hole", the results are generally so abnormal (in both grade and width) that it is obvious with a little context. A few examples of discovery holes I've witnessed since the Partnership's inception include:
266m grading 1.07% copper and 0.28 g/t gold (Reservoir Minerals OTCPK:RVRLF)
8.5 meters grading 1.07% U308 (Fission Uranium OTCQX:FCUUF)
324m grading 1.07% copper and 1.16 g/t gold (Cornerstone Capital OTCPK:CTNXF)
103m grading 2.2% copper and 9 g/t gold (Mariana Resources OTC:MRLDF)
If/when a legitimate discovery hole is hit, the focus shifts from scouring the license for prospects to defining the deposit you have found. By the end of this phase (which generally lasts 12-24 months), you want to have a rough idea about the grade, size, depth, and rock type of the new discovery. Only then can you begin to assess whether you have found a mine that is economic at current metal prices.
There are two main steps to this phase: step out drilling and an NI 43-101 resource estimate.
Step out drill programs have a fixed starting point (usually the discovery hole) from which they intend to expand the mineralization zone. The duration of step out programs depends on both the commodity and the type of deposit you are looking at. For instance, some deposits (such as a continuous coal seem) may take a mere 6 holes to complete step out drilling. On the flip side of things, gold or base metal deposits may take up to 10x more drilling.
Ultimately, the length of the step out program is a question of spacing between the drill holes vs. the # of holes drilled. Once you have drilled and defined the edges of the mineralization, you look at statistics to tell you how close the holes need to be for a resource estimate (step #2 of the discovery phase). For instance, the spacing in large porphyry copper deposits is typically around 1000 feet of spacing for an inferred resource and 300 feet for a measured resource. (Exact definitions of "inferred" and "measured" resources will follow shortly.) For a high grade gold or uranium deposit, you need to be more detailed in your drilling- 50 feet spacing for an inferred resource and all the way down to 12.5 feet spacing for measured.
Once the step out program has been completed, the company (alongside a third-party consultant) is able to prepare a NI 43-101 resource estimate. These estimates provide visibility on the size and grade of the prospective mineral deposit. Mineral Resources are sub-divided, in order of increasing geological confidence, into the following three categories:
Inferred Resources - the part of a mineral resource for which tonnage, grade and mineral content can be estimated with a low level of confidence. It is inferred from geological evidence and assumed but not verified geological/or grade continuity. It is based on information gathered through appropriate techniques from locations such as outcrops, trenches, pits, workings and drill holes which may be of limited or uncertain quality and reliability.
Indicated Resources - mineral occurrences that have been sampled (from locations such as outcrops, trenches, pits and drill holes) to a point where an estimate has been made, at a reasonable level of confidence, of their contained metal, grade, tonnage, shape, densities, physical characteristics.
Measured Resources - resources that have undergone enough further sampling that a 'competent person' (defined by the norms of the relevant mining code; usually a geologist) has declared them to be an acceptable estimate, at a high degree of confidence, of the grade, tonnage, shape, densities, physical characteristics and mineral content of the mineral occurrence.
While a resource estimate provides further clarity on the size and grade of the deposit, it does not provide investors with much visibility regarding the economics. This changes in the feasibility stage - where up to 3 studies on the project's economics may be released (each with a decreasing margin of error). Even for successful stories, the feasibility phase is generally a 3-5 year slog. And it's important to remember that the vast majority of companies that begin this phase do not make it all the way through.
Before discussing the 3 studies, it is important to note that drilling occurs throughout the feasibility phase, including three possible types:
step out drilling if there is potential to increase the size of the deposit after the first resource estimate,
infill drilling to continue to move more and more of the resource into the "measured" category by decreasing the spacing in between drill holes
drilling for infrastructure/geotechnical studies which studies the deposit's structure and characteristics in preparation for mining
A wide variety of internal studies are also carried out over this multi-year phase. The two most relevant (aside from the infrastructure/geotechnical studies mentioned above) are metallurgy and environmental studies.
Metallurgy/processing studies occur throughout the feasibility phase, with increasing degrees of accuracy. These studies focus on the economics and actual technical processes needed once ore is extracted from the ground when a mining operation hypothetically begins. Remember that a rich copper deposit in today's standards averages 1% copper. That means that once the actual ore is scooped from the ground, there needs to be processing circuits in place to separate the copper from the other 99%! This is an essential part of the equation for any mine - metallurgical difficulties have doomed thousands of potentially economic mines.
That understood, there are specific aims for these studies: (1) determining the expected "recovery" of the actual mineral from the mined ore, (2) determining the optimal processing methods in regards to OpEx, (3) determining the optimal processing methods in regards to CapEx, and (4) determining whether additional byproduct minerals can be recovered economically from the mined ore.
Permitting and Environmental studies will also be conducted throughout the feasibility phase, though with a heavier weighting towards the later stages. From a practical perspective, these studies need to be completed and approved by the government prior to the beginning of construction. . In most jurisdictions, the company needs to: (1) show how it will protect the water, air, flora, fauna, and/or any archeological structures and (2) provide a closure and remediation plan for the mine, which usually entails putting up a bond to cover closure/remediation costs.
The studies and drill programs mentioned above ultimately support the release of 3 different reports that estimate the economic value of the project in question (with increasing degrees of accuracy). One important note is that all of these studies are released in conjunction with a third party engineering consultancy. Depending on the project, it may take years and tens of millions of dollars to complete all three of the studies. Any company able to progress through all three studies should consider themselves very lucky - as the vast majority of companies will release a PEA/PFS/FS only to realize that their deposit is not worth pursuing further due to economics.
Preliminary Economic Assessment - The first and least expensive of these three studies is the PEA. A PEA generally costs between $2-5M to commission and carries a 30-35% error margin. The main focuses of the PEA are to: assign an initial economic value on the project, evaluate recoveries, and decide upon an optimal processing method. This report, which generally takes 12 months to complete, is an exciting one for junior mining investors as it's the first chance to glean initial estimates and management assumptions in the following areas: (1) pre/post tax NPV, (2) pre/post tax IRR, (3) pre/post tax payback, (4) average annual production, (5) initial capex, (6) all-in cash costs of production, (7) projected lifespan of production, (8) project's assigned discount rate, and (9) projected commodity pricing. All of the above estimates/assumptions are refined with increasing accuracy in the following reports. A critical difference between a PEA and the next two reports (PFS and FS) is that only in a PEA can you include Inferred Resources.
Pre-Feasibility Study - For companies who have been able to produce a promising PEA, the next step is to begin work on Pre-Feasibility Study. Depending on the size and technical profile of a specific project, a PFS can cost anywhere between $5-30M and take between 12-24 months to complete. The main goals of the PFS include: refining the error margin to 15-20%, producing a mineable reserve, undertaking detailed engineering studies to better estimate project costs, and defining a project "base case scenario". Employment of project specific metrics is actually what sets a PFS apart from a PEA (which is generally based on industry standards rather than being derived from detailed site-specific data).
In rare cases, the PFS can be skipped if management is so sure about the economics of a given deposit after releasing a PEA that they immediately embark on the more costly (both in time and money) Feasibility Study. Golden Arrow Resources (OTCQB:GARWF) and Kaminak Gold (OTCPK:KMKGF) are two companies currently pursuing this strategy. However, more often than not, the PFS is a necessary step to attract the funding, off-take agreements, etc that are necessary to advance mine development.
Feasibility Study - The final and most detailed of these three studies is the Feasibility Study, which is confusingly also referred to within the industry as a "Definitive Feasibility Study" or a "Bankable Feasibility Study". According to NI 43-101, a Feasibility Study is a "comprehensive study of a mineral deposit in which all geological, engineering, legal, operating, economic, social, environmental and other relevant factors are considered in sufficient detail that it could reasonably serve as the basis for a final decision by a financial institution to finance the development of the deposit for mineral production." Depending on the size and technical profile of a specific project, a PFS can cost anywhere between $5-30M and take between 12-36 months to complete. The main goals of the FS include: refining the error margin to 8-12% and provide a final economic assessment of the project before potential financing/construction.
Interestingly, the FS is an extremely important milestone in terms of financing for more than the above reasons. This is due to a legal technicality - once a junior resource company has released a FS, commercial banks are able to provide debt financing without personal liability if the investment turns into a major bust (responsibility in this case shifts to management and the associated engineering consultancy). However, if a commercial bank invests before the release of an FS, the bank and its officers take full responsibility in the case of a major bust. For this reason, the release of a Feasibility Study is generally necessary for a prospective mine to receive full construction financing, particularly if debt is involved.
These three reports are of extreme interest to any serious investor in the junior resource space, and at the very end of this piece I address how I value a development project based on its stage of development. In the meantime though, I will provide a short list of what I specifically look at in PEA/PFS/FS reports. After determining whether the management and the third party consultancy used reasonable expense assumptions and expected future commodity prices, I look for at three things to determine whether the company is working on a "quality asset":
1. NPV > initial capex
2. IRR > 25%
3. Payback < 3 years
Please note that the above metrics only apply to whether the project is a quality asset. This is only half of the equation and should be not confused with a quality investment. The judgment of investment potential for mining projects in the development stage will be discussed at the very end of this piece.
Before beginning construction, the junior miner in question must procure financing for their project's initial capex. This can be done in a number of manners - I will outline the most popular options below.
Offtake Agreement - This form of financing involves an end user of the commodity being produced by the prospective mine. (For instance, a major Chinese producer of copper wiring could theoretically enter into an offtake with a prospective copper mine.) A "proper" offtake agreement entails the following two things: a commitment by the end user to purchase all or some of the future mine's production and a commitment by the end user to fund all or some of the mine's capex. Nowadays, particular in the specialty metal space, we are seeing pseudo-offtake agreements - where an end user commits to purchasing future production but does NOT commit to funding any of the project's capex. If anything, this is more of a vote of confidence and is not as meaningful as a proper offtake agreement
Equity - A third party financing option (aka a commercial bank, hedge fund, private equity group, sovereign wealth fund, pension fund, etc) provides all or some of the project's capex in exchange for either an equity stake in the company in question or an equity stake in the project in question.
Debt - A third party financing option provides all or some of the project's capex in the form of debt. The details of debt agreements vary dramatically from company to company. Often times there are covenants attached in which creditor can gain further control and/or ownership in the case of mishaps (i.e. construction isn't completed in a timely manner or the company's working capital drops below a predetermined level). Sometimes the debt can convert to equity if certain conditions are met.
Acquisition - This popular method of financing a mine's construction is also the most easy to understand. It entails a larger mining company purchasing outright either the company who owns the prospective mine or the prospective mine itself. The larger mining outfit then uses internal capital and technical know how to ultimately construct the mine.
Joint Venture Agreement - A larger mining company provides all or some of the project's capex in exchange for partial ownership of the project and/or equity in the junior miner who owns the project. This type of agreement will often occur well before the Feasibility Study is released and, in rare cases, before the prospective mineral body has even been discovered. Though not always the case, the majority of JVs ultimately lead to an acquisition (discussed above) due to the fact that very few junior miners are in the financial position to provide a significant percentage of their project's initial capex.
Royalty Agreement - This financing option includes a third party (often described shorthand as "streaming and royalty company" - popular examples include Silver Wheaton SLW, Franco Nevada FNV, Royal Gold RGLD) who provides all or some of the project's initial capex in exchange for a certain percentage of the prospective mine's net smelter return. Net smelter return is defined as the gross revenue that occurs within a defined mining property, minus transportation and refining costs. From an investment perspective, the appeal of royalty agreements is that occasionally mines have become much bigger in size in the months or years after a royalty agreement had been signed (aka the investor gets a slice of a larger than expected pie).
Streaming Agreement - The majority of streaming agreements are also underwritten by dedicated "streaming and royalty companies". In this option, the financier agrees to fund all or some of the project's initial capex - in exchange for the right (and/or obligation) to purchase a predetermined quantity of mine production at a predetermined price (often much lower than market). While this type of agreement doesn't provide the financier the ability to profit off of further discovery, it does provide leverage to the price of the commodity in question.
As stated earlier, the vast majority of development projects do not even advance to the point of a Feasibility Study - and obtaining actual financing for the project's capex (often in the hundreds of millions of dollars) is an even more daunting hurdle. More often than not, it takes a combination of the above financing options to ultimately procure full funding for mine construction. Two very feasible hypotheticals follow:
A junior mining outfit strikes gold by discovering a major copper/gold porphyry deposit in Chile. The company is able to advance the project through a Prefeasibility Study - which shows robust numbers. However, due to funding restraints, the company decides to fully sell the project to a larger mining company. The larger company in turn is able to develop the prospective mine to the point of construction, but only have the working capital available to fund 50% of the project's initial capex. They then turn to a large gold streaming company who agrees to the remaining costs in exchange for all gold production from the proposed mine. Only then can construction begin.
A well-backed junior mining company acquires a major potash deposit in Ethiopia. Over 3-4 years, the company is able to advance the project through a Feasibility Study by conducting standard capital raises. Understanding that the project's capex will be too large to fund by itself, the company agrees to give a large fertilizer producer a 30% stake in the project in exchange for a commitment to fund 30% of initial capex. This announcement attracts the attention of multiple African development banks, who agree to fund 60% of the project with debt (the junior miner is then responsible to provide the remaining 10%). Only then can construction begin.
Once financing for initial capex has been obtained, construction can begin. From company to company, the mine being constructed will vary significantly in cost, size, technical difficulty, and length of construction (generally between 1-3 years). Ultimately one of three different mine types will be constructed:
Open pit - An open pit operation is the least technically difficult of these mining methods. It involves blasting layers of rock from the surface and then loading the ore onto trucks to transport to a plant for processing. Open pit mining is limited to mineral deposits that sit near the surface of the earth (a good rule of thumb is that any deposit within 200m is amenable to this method).
Due to the lower capex (and possibly operating costs) open pit mines enjoy when compared to an equally sized underground project, the company can often get away with mining a lower grade deposit then their underground counterpart and still enjoy impressive economics. This illustrates the fact that a large, low-grade, near-surface mineral deposit can be extremely valuable; given that it is near enough to the earth's surface to employ open pit methods. Conversely, the very same deposit 1000m deeper could be completely worthless as an underground mine.
Underground - An underground mining operation applies to mineral deposits that sit far enough below the earth's surface to the point where an open pit mine is no longer feasible and/or economic. These deposits have to be high enough in grade of the mineral in question in order to justify the higher development costs of an underground mine. Underground mines will generally extend to a depth between 200-1500m; however the world's deepest underground mine (the TauTona gold mine in South Africa) has reached the unfathomable depth of 4000m.
There are three general methods to construct an underground mine. Room and pillar the method of choice for more shallow underground mines. It involves excavating rooms and installing pillars that hold up the roof during mineral extraction. For deeper mines, one of two methods is used. In block caving, miners drill tunnels underneath the ore deposits and then draw the material down. In the more selective/expensive cut-and-fill method, miners work in horizontal slices underneath the surface, and the slices are then backfilled after the mining is finished.
In Situ Recovery - Conventional mining involves removing mineralized rock from the ground, breaking it up and treating it to remove the minerals being sought. In Situ Recovery, on the other hand, involves leaving the ore where it is in the ground, and recovering the minerals from it by dissolving them and pumping the pregnant solution to the surface where the minerals can be recovered. Consequently there is little surface disturbance and no tailings or waste rock generated.
The ISR technique relies on the principle of hydraulic control. Hydraulic control is a series of wells around the mine area that lowers the water table so that all solutions flow inward to the deposit (this ensures that no groundwater contamination occurs below the water table). In a nutshell, the In Situ process is as follows: the company "fences off" the area that they want to mine using hydraulic control, the company mines the "fenced off area", the company rinses the "fenced off area", and then the company removes the hydraulic fences and moves on to the next portion of the deposit that they would like to mine.
In situ operations are by far the most obscure of these three mining methods. In fact, ISR mining has only been used on uranium, copper, gold, salt, and sulfur deposits up to present day. (Interestingly, an impressive 47% of global uranium supply is mined this way; meanwhile the vast majority of copper or gold mines are open pit/underground.)
The decision on whether to employ an open pit, underground or in situ operation depends solely on the characteristics of the actual mineral deposit and its effect on economics. For the vast majority of projects, the likely mining method is known well before the PEA is even released. However, you will occasionally see major adjustments to the mining method as the project advances through the PEA, PFS, and/or FS (particularly in cases where additional drilling reveals that the actual mineral deposit is significantly different than what was anticipated in earlier models).
While it is tempting to think otherwise, a potential mine is far from de-risked even after construction commences. (In fact, as I will explain in more detail in the last section of this piece, I only assign 50-60% of the NPV to prospective mines in the construction phase - implying that I believe up to half of them will not make it cleanly to full production.) In the recent bear market, there have been a few stark examples of how badly things can go wrong, even in this advanced stage of development:
Colossus Minerals (OTC:COLUD) is one such example. The company began construction on their Serra Pelada property in late 2011 and was sporting a market capitalization of nearly $1b in early 2013. The company began to encounter major construction issues due to flooding in mid-2013 and announced that both more time and more money will be needed before first production. These struggles resulted in stunning wealth destruction over the following months - by the end of 2013 the company's shares were worth less than $0.10. The technical reason for this decline was panicked selling due to worries that Colossus would violate debt covenants and risk default. Sure enough, while the timeline is unclear, it looks as if the entire Serra Pelada project is going to be taken over by creditors in the near future.
RB Energy (OTCPK:RBEIF) began construction on its Quebec-based Val d'Or lithium project in 2013 and had a share price of ~$0.80 in early 2014. In mid-2014, however, the company also reported that both more money and more time would be needed before reaching first commercial production. This negative news resulted in a precipitous share price decline as investors worried about the project falling into the hands of creditors. Sure enough, the company's shares are now trading at less than $0.01 (for a total decline of 99.8% over the trailing 12 months) and shareholders will likely receive no compensation for the project.
Formation Metals (FMETF) started construction on their Idaho Cobalt Project in Q3 2011 but only raised financing for half of the project's initial capex. Due to deteriorating market conditions, the company was unable to raise the full sum after over one year of effort and, in Q1 2013, essentially halted construction activities. The unique aspect here is that the company found themselves stuck on-site with tens of millions of dollars equipment/construction materials that had already been procured in anticipation of construction. While it did not result in a full loss of the actual project, a lawsuit was brought against Formation's management for their role in the fiasco.
Reaching the production phase is a massive achievement, particularly for companies that do not have other producing mines. This phase is all about cash flow. By this point, tens of millions will have been spent on exploration, development, and mine construction - with not a single cent of cash flow being generated by the potential mine! Mining is inherently an extremely capital intensive business, and only after production is reached can a company begin to recoup their massive investment of time, effort, and money. As a good rule of thumb, a quality mine will generally recoup its entire initial capex within 3 years or less.
Before the celebrations can begin, the mine must be "scaled up" to full production. This process will generally take between 1-4 quarters (and in a surprising amount of cases far longer if the company was being too optimistic with their estimates - the rise and fall of Molycorp is an extreme example that is particularly engrained into the minds of past/present rare earth participants). During the scaling up period, the company will focus on maximizing recoveries in the processing circuit, minimizing inefficiencies in the mining method, and tailoring the final product to end user specifications.
Some mine plans call for "scaled expansion" - where injections of sustaining capital are planned 1-5 years after first production to boost the mine's production (and value) further. This strategy is particularly common in bear markets when funding for initial construction financing is scarce. The benefit of this strategy is threefold: (1) the company has the opportunity to use internal cash flow to fund all or some of the necessary sustaining capital, (2) the company can wait for higher commodity prices before committing to further production, and (3) if necessary, the company has an opportunity to prove to prospective investors that the project is viable.
The production stage will generally last between 10-30 years, though some current mines have been operating over 100 years. More often than not, the ultimate life of mine will be stretched longer than original projections. The company can expect positive cash flow over this entire period (whether this cash flow satisfies market expectations is of course a different story).
Greenfield vs Brownfield
Now that we've completed our discussion of the mining cycle, it's time to clear up some loose ends. The above sections contained a key, unsaid assumption -that the mine in question is being built completely from scratch. This is called a "greenfield operation", which basically means that no mining operations of any kind had been conducted on the property before.
There is a second option called a "brownfield operation". A brownfield operation refers to projects that are located near or adjacent to an operating mine (or a mine that formerly was in production). As geologists are able to use existing data, the risk in brownfield exploration is considerably lower than in greenfield exploration. Additionally, because the facilities for mining and processing the ore have often already been built and paid for, the initial capital expenditure necessary restart production is often far lower at a brownfield project.
How to quickly value a project based on NPV and Stage of Development
This is the final part of this crash course. Below I will illustrate a back of the envelope method to evaluate an approximate fair value for development stage projects. In short, the method is simply a risk-adjusted estimate of future (discounted) cash flow. Please note that this applies to roughly 50% of the Partnership's overall portfolio. To further clarify, the following technique only applies to companies that are in either the feasibility phase (i.e. the company is working on either a PEA, PFS, or FS), mine financing stage, or construction phase.
It's important to understand that this technique indicates "value" (vs "quality"). As I stated earlier in this piece, a "quality" project will generally adhere to the following three financial measures:
1. NPV > initial capex
2. IRR > 25%
3. Payback < 3 years
If the above three conditions are met, there is a high likelihood that the project will be constructed and become a producing mine.
That said, just because a project is highly likely to reach production DOES NOT mean that it is a prudent investment. Think about it - as an extreme anecdote, a mine certain to reach production with an NPV of $500m at a $800m market capitalization probably isn't as attractive as a mine with a 40% chance of reaching production, an equal NPV of $500m, and a market cap of $40m (aka an expected value of $200m - significantly differing from the current market cap). This is simple expected value arithmetic and is the crux of valuing of companies in these early stages.
Remember, this is only a back of the envelope way of valuing junior mining development projects and is only significant if the market capitalization of the company in question truly diverges from the expected fair value. On top of that, it needs to be stated again that the project needs to be legitimately viable with a competent management team - i.e. no fraud, which occasionally happens in this space and realistic commodity pricing estimates - generally anything above current market prices is a red flag. With that said, the method is as follows:
A company who has recently released a PEA should most likely have a market capitalization between 5-10% of NPV. Assuming that the project is "quality", any market cap greater than 10% is likely overvalued; likewise, any market cap less than 5% is potentially undervalued.
Once a company releases a PEA, you'd expect their valuation to be between 5-10% of their expected NPV. The implicit assumption here is that historically only 1 out of every 10-20 potential mines at this stage will ultimately reach production (and realize the NPV projected in their PEA). These statistics are sobering but reasonable when you consider the $5-30m that presumably will need to be raised to advance to the next stage of development and the fact that a PEA has a whopping 30% margin of error.
A company who has recently released a PFS should most likely have a market capitalization between 15-20% of NPV. Assuming that the project is "quality", any market cap greater than 20% is likely overvalued; likewise, any market cap less than 15% is potentially undervalued.
Once a company releases a PEA, you'd expect their valuation to be between 15-20% of their projected NPV. The implicit assumption here is that historically only 1 out of every 5-7 potential mines at this stage will ultimately reach production (and realize the NPV projected in their PFS). These statistics reflect the improving odds of reaching production. That said, $5-30m will presumably need to be raised to advance to the next stage, and this particular report still has 15-20% margin of error.
A company who has recently released a FS should most likely have a market capitalization between 25-35% of NPV. Assuming that the project is "quality", any market cap greater than 35% is likely overvalued; likewise, any market cap less than 25% is potentially undervalued.
Once a company releases a FS (and HAS NOT YET RAISED CONSTRUCTION FINANCING), you'd expect their valuation to be between 25-35% of their expected NPV. The implicit assumption here is that historically 1 out of every 3-4 potential mines at this stage will ultimately reach production (and realize the NPV projected in their FS). While a FS has a respectable 8-12% margin of error, historically it is clear that companies at this stage are not a shoo-in to reach production. More specifically, in order to reach production, a company at this stage still has to accomplish three daunting tasks: (1) raising construction financing - which may very well be in the hundreds of millions if not billions of dollars, (2) complete construction on budget and in a timely manner, and (3) scale up production to expectations in a timely manner.
A company who has recently started construction should most likely have a market capitalization between 50-100% of NPV. Assuming that the project is "quality", any market cap greater than 100% is likely overvalued; likewise, any market cap less than 50% is potentially undervalued.
For a mine currently under construction, a valuation between 50-100% generally indicates fair value. Key determinants include: the amount of time until first production and whether the initial capex has been fully raised. A mine under construction that is valued at greater than the NPV projected in the Feasibility Study indicates one of two things: (1) the mine is overvalued by the market or long-term prices of the commodity in question will be significantly higher than the assumptions made in the Feasibility Study. The line between these two scenarios is often blurred. Likewise, if the mine under construction is valued at less than 50% of projected NPV, it may very well be an excellent bargain (assuming due diligence reveals no serious problems).
Disclosure: I am/we are long CTNXF, GARWF.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.