Agricola Consultants

FINANCING MINING PROJECTS

By Euan Worthington M.Sc., F.I.M.M; Executive Director, International Mining Group,
SBC Warburg
(Source: Mining Journal, August 1, 1997)
The mining industry is different to other industries because of two crucial factors; every
resource has a finite life and a mining company cannot decide on the location of its
mine. In these respects, the mining industry differs from farming, the only other basic
industry, which has climate as its main indefinable operating parameter.
Development of most mining operations involves heavy capital expenditure. This capital
can only be secured after a number of project risks (from ore reserve estimation through
operating parameters to product end markets) have been confirmed or controlled.
Although mining is a high-risk business, it can also lead to high rewards. This attracts a
number of speculative operators to the industry (more than adequately illustrated by BreX).
On account of this, management is the most important area of risk to be assessed in
mining projects. It is worth noting, however, that different investors can tolerate varying
levels of risk. Even a private individual will require some degree of comfort on the risks
involved with any project before making an investment.
Mining Project Risks:
Management
Political risk
Ore reserves
Production (technology)
Construction
Commodity (price and market)
Environmental impact
Without competent management, no mining project can be guaranteed to succeed.
There is a need in the mining industry for good managers at all levels of management,
from individuals with entrepreneurial skills to highly trained engineers.
Investors, whether private or corporate, require the comfort that a mining project can be
operated and managed efficiently. The larger the project, and consequently the greater
the capital cost, the more important becomes management's experience and
qualification.
The second heading on my list is 'Political Risk', which is constantly lessening and could
hopefully (but not likely) one day be unimportant. In other industries, companies have a
choice as to where they locate their operations, and indeed are often encouraged by
growing local markets as well as the availability of grants and low cost loans to locate
their operations in emerging countries. Since you cannot physically relocate orebodies,
the mining industry does not have the option of locating to the most attractive political

www.agricolaconsult.com

Page 1

Agricola Consultants
location. Major mining companies will not spend money where security of tenure can not
be guaranteed.
Twenty years ago, many banks would not have lent money to companies trying to
develop projects anywhere in Africa, South America, the CIS or China. The list has
shrunk now but banks may still have reached the limit of their exposure to any one
country, or indeed commodity.
On the subject of political risk, it should be noted that most people understand this term
to cover expropriation or imposition of excessive taxes and conditions by a government.
However, I believe it should be extended to include the difficulties that mining companies
now have in obtaining permission to develop projects in many developed countries.
Governments can interfere in many different ways. Also, it is a notable feature of the
mining industry that different size companies may accept different levels of risk.
Ore reserve definition is an area of technical risk, which is not a bankable activity but has
to be financed by equity. Risk at this stage of any project is at its highest. Once
exploration has delineated an ore reserve, lenders will require an independent audit of
those reserves to ascertain that there is sufficient proved and probable ore to sustain the
project over the life of a loan, and that adequate drilling or development has been done
to confirm these reserves.
As a rule of thumb, banks will demand a 50% reserve tail, which means that if the
proven and probable reserves indicate a mine life of 15 years, then project debt should
be repaid within 10 years. Coincidentally, 10 years seems to be a mining project finance
maximum. In the same risk category as ore reserves comes geological uncertainty, rock
stability and the area's hydrological conditions.
Next in line in the risk table is production -- selection of the mining method and
technology to be used for ore recovery. It goes without saying that banks are more
comfortable with conventional, proven technology and may not lend against a process
that has not been tested commercially. The depth and grade of the orebody will dictate
whether the mine is an open pit or an underground operation and whereas the former is
relatively straightforward (even taking into account strip ratios, pit slopes, bench heights,
rock stability, water inflow and ore sampling), it is perfectly possible to choose the
incorrect underground mining method, locate shafts in the wrong position, choose an
inadequate mining extraction rate and order the wrong size underground equipment.
Just as the depth and grade of the ore-body will determine the method of mining, the
mineralogy of the orebody will govern the ore recovery method. This can range in
complexity from no more than a washing plant or crusher for coal and industrial
minerals, to autoclaves, smelters and refineries for some complex metal ores. The
lenders will be keen to establish and confirm what realistic recovery rates can be
expected and will use conservative assumptions in their financial modelling.
Also in this area of technical risk, is the reputation and past experience of the company
constructing the mine. Project location and infrastructure are also important. No mining
projects can get along without water and in many cases they require large volumes. The
recent interruption to production at the Ok Tedi copper mine in PNG illustrates how
water can have an impact in more ways than just the processing stage (supplies could
not be shipped in and concentrates out due to low water levels in the Fly River). Less

www.agricolaconsult.com

Page 2

Agricola Consultants
obvious, but as important to costs, are the location of powerlines, railways, roads and
ports. If the grade and size of the orebody is good enough, all these aspects can be
accommodated in financial planning but ultimately they have a bearing on the economics
of a project. For some bulk commodities and industrial minerals, the geographical
location of the orebody relative to end markets may be critical.
Because banks are naturally cautious and the risks of developing mining projects are
very high, the lenders to a specific project will require certain completion guarantees
being met before the debt is allocated to the project rather than to the sponsor.
Completion guarantees will cover all steps of the mining, milling and recovery process
but the ultimate test will be the volume and grade of the final product compared to
expected levels at the feasibility stage.
Each commodity has its own risk profile. Be it gold or phosphate, there are aspects of
the markets, supply and demand profiles (historical, current and projected), and prices
which the lenders will look at very closely. The future is particularly important as it may
be 2-5 years from when the bank first lends money to a development project until the
first production is sold. The lenders have to be comfortable that demand for the product
will exceed supply on a world-wide industry basis not just for the specific project that
they are looking at. They will also have to look at the stages of development, and the
relative cost curves of other projects both now and into the future.
Other questions that the bankers will try to gain comfort from are:

is there a risk of new technology or substitution replacing the product to be mined

(aluminium v tin cans, copper v optic fibres, platinum v palladium);
is the market for the product truly free or is it subject to a cartel (debt financing of
commodities that do not trade freely is often impossible);
will production from the project make a significant contribution to the world market
(often the case with fertilisers);
if there is no terminal market for the product, can customers be identified?

Ultimately, bankers can gain comfort if the project is low cost compared to its
competitors. Alternatively, the bankers risk can be offset by hedging sales forward, if
there is a terminal market for the product, or by signing long-term contracts to cover
operating and financing costs for the period of the loan.
The last item on the 'project risk' list is the one that has gained most prominence in
recent years. The environmental aspects are becoming increasingly important. Not only
are the regulatory authorities, particularly in the developed world but now almost
universally, laying down strict guidelines about the environmental aspects of mining and
processing operations but so are the banks.
Mines today may be shut down not just by market conditions or technical problems but
also by the regulatory authorities for polluting the air, the water or the land. Bankers will
expect to see allowances for these controls, and eventual reclamation costs, in financial
models.

www.agricolaconsult.com

Page 3

Agricola Consultants

Sources of finance
Until 50 years ago, the equity financing route was the only way to finance mining
projects in countries where political risk was high. However, mining projects often require
huge capital sums and even the largest mining company could not over-expose its
investors to high-risk countries. Consequently, development of many major projects has
been delayed (eg, until recently, the Tenke Fungurume copper project in the Democratic
Republic of Congo, and the Udokan copper prospect and the Sukhoi Log gold deposit in
Russia). However, since 1945, the creation of multilateral development banks and
agencies, such as the World Bank, International Finance Corp. (IFC), European Bank for
Reconstruction and Developement and the African Development Bank, as well as
national import and export agencies, have filled a niche where commercial banks are not
prepared to lend.
Political Risk is the one area where insurance can be obtained for debt lending. The
investment risk insurance arm of the World Bank, the Multilateral Investment Guarantee
Agency (MIGA), or the Overseas Private Investment Corp. (OPIC) of the US, offer a
degree of political risk insurance (usually when combined with loan advances). There is
also some inbuilt insurance in loans from these multilateral development banks since the
governments of the countries where projects are located will be very keen not to upset
these important lenders.
Turning to sources of finance for mining projects, notwithstanding any nonrepayable
grants, these can be categorised under two headings -- Equity and Debt.
EQUITY:
- Private
- Listed securities
- Joint ventures
- Debtquity
DEBT:
- Commercial banks
- Project finance
- Multilateral development banks and agencies
- Equipment leasing
- Gold loans and hedging.
The traditional route for financing mining projects was by equity raised from investors or
mining finance houses. Equity funding is still a very important mechanism for the mining
industry and the only way to raise funds for grassroots exploration work. No bank will
lend money for exploration when there is no guarantee of cash flow or payback at the
end of the day. However, equity investors are prepared to gamble (particularly as many
tax authorities will offset losses on such activity against gains made elsewhere) and may
even invest in unquoted securities at this high risk stage.
In simple terms, equity financing means that investors receive a share in the company in
exchange for a cash contribution. In the case of exploration companies, the investor is
hoping that the value of his share will rise with exploration success. Investor demand for
(mining) equity is cyclical, partly in line with metal prices but also more locally through
exploration success or political events. This is illustrated by the recent Bre-X saga. The

www.agricolaconsult.com

Page 4

Agricola Consultants
outcome is history but, behind the headlines, it is the Canadian mining market which has
suffered most with many 'legitimate' companies unable to raise equity funds for
exploration (particularly in Emerging Markets). In addition to the Bre-X scandal, the
recent collapse of the gold price firmly shut the door to raising conventional equity for
gold companies until the outlook for that metal starts to look healthier.
Even when a project has passed the feasibility test and been shown to be robust enough
to support some debt, bankers are unlikely to wear a debt:equity ratio higher than 70:30.
With the risks inherent in a mining project, that is hardly surprising. Obviously, where
banks are not satisfied that all risks have been covered, or the project is too small for
commercial banks to be interested, the project will need 100% equity financing if it is to
proceed.
Debt carries an interest rate, and has to be repaid, whereas equity investors do not
expect a dividend to be paid on the share-holdings until the mine is well into production.
In fact, investors in gold mining companies today hardly expect any dividend at all. This
means that, if you can raise equity after a higher initial cost (commissions can range
from 0.5% to 10%), it is by far the cheapest form of finance.
Mining equities
The world's quoted mining and metal shares make up a geographically diverse stock
market sector with a total market capitalisation today in excess of US$ 220 billion. As a
comparison, this would rank it as one of the ten largest stock markets in the world,
ahead of Hong Kong and Australia. However, looking the other way, this is less than
twice the size of the 3rd largest quoted US company -- US oil major Exxon (valued at
some US$ 150 billion).
The major mining equity markets are located in the English-speaking world where major
mine discoveries were made earlier this century (Australia, Canada, the US and South
Africa). However, there is now a 'New Geography' to the world mining industry, with
countries such as Chile, Peru, Ghana, Kazakstan and Indonesia gaining in importance
as mining centres.
Joint ventures, which have become an established feature of the mining industry in the
past two decades, should also be included under the heading of Equity. Here, the equity
is not being provided by an investor but comes from another mining company (or product
consumer).
The Japanese smelting and refining groups have become important joint venture
partners, notably in large copper projects where they can secure a long term source of
copper concentrate supply in exchange for equity in the project or debt financing. In
these cases, the miner also gains by having a guaranteed source of off-take for a
proportion of its end product.
In addition to some joint venture arrangements, there are instruments such as High Yield
and Going Public bonds, mezzanine finance and convertibles which bridge the gap
between equity and debt ('debtquity'). These instruments carry higher than average
interest rates and could be considered the financing mechanism of last resort. For
mining companies, instruments in this category include notes linked to metal prices.

www.agricolaconsult.com

Page 5

Agricola Consultants

Forms of debt
Debt can come in many different disguises but fundamentally involves a sum of money
being lent which bears interest at a market rate and will have to be repaid at intervals
over a certain period.
In the case of non-recourse project finance, a term which anyway is a misnomer, the
interest rate could be 2-3% higher than commercial bank debt lent to a large company.
Project financing is becoming increasingly acceptable in the mining industry, despite the
risks involved. Borrowers have to be clear that it is never totally non-recourse because
lenders will generally require a sponsor with a strong balance sheet.
Completion tests have to be fulfilled, and it could be up to a year after production has
begun before project finance debt is fully assigned to a new mining operation.
The multilateral development banks and agencies have become important sources for
mine and infrastructure financing in emerging markets. The most notable lender to
mining projects has been the International Finance Corp. (IFC), which is often seen as a
lender of last resort. It commonly takes an equity position in projects but is viewed as
fairly bureaucratic. The World Bank and African Development Bank will lend for
infrastructure associated with mining projects but not directly for mine development.
A number of countries have export credit agencies which tend to guarantee the debt of
local banks in exchange for supplying locally-made equipment (ahead of their
international competitors). Import agencies from countries without major natural
resources (eg Japan and Germany) are keen to secure mineral and metal supplies.
Equipment leasing is also a form of finance for mining operations. Of course, the cost of
mining equipment is only part, possibly less than 20%, of the development cost of a
mining project, and leasing or support from national agencies will therefore only be part
of the mining finance package. The capital cost of mine development can be reduced, of
course, by using contractors to mine the deposit but this will add to operating costs.
A specific form of mine finance was the development of gold loans some 20 years ago.
This has had a significant impact on the gold mining industry, some might say
detrimentally since it eased the financing of a number of gold mine developments and
increased the supply of gold. Bankers recognised that gold was effectively a currency,
fully convertible, traded on an open market, often held in reserves by national or
commercial banks and usually produced at the mine site in near pure form. Therefore, to
utilise these reserves, gold loans were devised whereby a bank lends gold to a gold
mining company which then sells the gold to raise funds for developing or expanding a
mine. The mining company repays the loan in bullion from its future production.
Gold loans carry a low interest rate (1.5 to 3%) and remove commodity price risk but the
mining company misses out on being able to use the gold contango and gain from any
higher prices over the repayment term. Of course, financial engineering has moved
ahead over the past decade, and there are now a number of alternatives to the standard
gold loan, which at today's depressed gold price is a very unattractive form of financing.

www.agricolaconsult.com

Page 6

Agricola Consultants
As an extension to the gold loan concept, metal price hedging (the ability to sell future
metal production today at prices which benefit from perceived interest rates) can now
stretch over five years. It is not uncommon for gold miners in the developed world today
to achieve perhaps US$ 15-30/oz above the current spot price by complex financial
engineering. This could involve forward sales, option strategies and even currency
swaps. Lenders may insist on forward sales to cover interest costs or miners may deem
it appropriate to secure prices to cover operating costs over future production. Hedging
is yet another method of mitigating one of the risks of mining projects.

www.agricolaconsult.com

Page 7