Unbuilt mines with planned expansions

It is a red flag when a development-stage mining company makes plans for a mine with expansion stages.  Why?  There is one mine size that maximizes the net present value (NPV) of the deposit.  Usually this size results in a mine life of 6-15 years.  A bigger mine exploits the resource faster, making the future revenues happen earlier.  Because there is a time value to money, mining faster increases the present value of the future cash flows.  A larger mine also enjoys economies of scale that lower operating costs.  Of course, all of this has to be balanced against the capital costs of a bigger mine.  Underground mines tend to have higher capital costs so they tend to be designed with longer lives.  Open pit mines tend to have low capital costs so they tend to be designed with short lives.

If the estimated mine life is over 20 years, then there is probably something fishy going on.  Usually, it would make more sense to build a bigger mine with a shorter life.

In my opinion, the reason why mining companies talk about expansions is to mislead.  Internally, the mine engineers have done a feasibility study that doesn’t incorporate silly assumptions behind the inflated feasibility study that is released to the public.  They’ve probably figured out the correct size of the mine that would maximize the NPV.  This becomes the base case for the mine.  However, mining companies often release inflated reserve numbers to its investors.  They might say that the mine life for the base case is 30 years when it should really be 15.  In the make-believe world of 30 years of reserves, a larger expanded mine would have a higher NPV.  In the feasibility study, the engineer can pencil in an “expansion” stage that results in a higher NPV number.  The expansion plan likely doesn’t make any economic sense at all.  But it will be part of the lies that the mining company tells its investors.

Mine life

I think that unbuilt mines that are projected to have a mine life of over 20 years are probably a lie.  However, this skepticism shouldn’t necessarily apply to currently producing mines.

In practice, some mines really do keep producing for over 20 years.  This is usually due to either or both of the following factors:

  1. Commodity prices rise.  Ore that is marginally uneconomic suddenly becomes economic.
  2. More ore is discovered.

The reason why a mine might discover more ore is because it may not make economic sense to explore the property in its entirety.  Drilling very long/deep exploration holes has a higher cost per foot than short holes.  The drilling will also slowly curve off target the deeper the hole is.  After an underground mine is built, there will be shafts that go underground.  These shafts reduce the length of exploration holes needed to test the areas below the known deposit.  This reduces the cost of exploration and makes marginal exploration viable.

Historically, there have been a few mines that have produced for several decades.

Things that happen in the real world

  1. Almost all junior miners lie to investors.
  2. If the expected life of an unbuilt mine is over 20 years, the mine life is probably a lie.
  3. If the mine isn’t built and the company is talking about optional expansion stages, then the expansion stages are probably bogus.
  4. The expansion stage might get built anyways… because some management teams are crazy (e.g. Bloom Lake / the Cliffs management team before Gary Halverson).  If you’re the CEO and you surround yourself with yes men, then I guess you can justify anything.
  5. The base case of a mine might be a lie.

Links

Reading round-up: books on mining – “Introductory Mine Engineering” is the easiest university textbook to read to understand the mine engineering behind all of this.

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4 thoughts on “Unbuilt mines with planned expansions

  1. Pingback: The not so pretty side of Altius Minerals | Glenn Chan's Random Notes on Investing

  2. Pingback: Mine economics explained | Glenn Chan's Random Notes on Investing

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