Mining companies face many operational risks in respect of their exploration and development activities which impact their cashflow and overall profitability.
Retail investors should be mindful of these risks and carry out appropriate due diligence to ensure they understand how their investment could be affected. This article aims to examine some of the more relevant operational risks that mining companies are up against.
1. Exploration Rights
Exploration rights in the form of licences, consents, permit or regulatory approvals are entered into by a mining company for a fixed period of time and are subject to specific conditions around drilling and agreed surface (or sub surface) work programmes.
These rights require the licence holder to demonstrate that it is meeting its contractual obligations to prove up the resource (or otherwise). Failure to adhere to these performance conditions within the specified timeframe is considered a breach of obligations.
This failure can result in penalties being imposed on the holder or even suspension of activities until the issue is addressed; in the worst-case scenario it could lead to termination of the licence agreement.
A company’s ongoing operational existence can be dependent upon the grant or renewal of the licences etc needed; so any failure to secure renewal will impact on the company’s ability to continue in operation and will have adverse financial implications.
2. Errors in calculating mineral resources and mineral reserves
Estimating the volume of mineral resources and mineral reserves contained in a mine is a complex process with many uncertainties inherent in the process.
Calculations are arrived at through a combination of statistical analysis allied with the quality of available data which itself is contingent on the judgement and interpretation of the data supplied by mining engineers and geologists.
The data in turn is derived from many inter-connected elements: the results of the actual drilling programme; metallurgical testing; production capacity; evaluation of mine plans and exploration activities – all of which will impact on the estimated resources.
Once the mineral resources have been estimated, there is no guarantee that on commencement of production the actual proportion of resources converted into reserves will be recovered at the volume, grade and rates estimated.
Also, production estimates are dependent on, among other things, the accuracy of mineral resource and reserve estimates, or the accuracy of assumptions regarding mineral grades and recovery rates.
Obviously, failure to hit production estimates will negatively impact future cashflows and profitability (unless there is an offsetting increase in the underlying price of the commodity).
Retail investors should be aware that there is no guarantee that just because the mineral resource exists and has been quantified that the resource can be economically extracted. In addition, mineral resources need to be converted into reserves and the company also needs to demonstrate that these reserves are commercially mineable.
3. Political and regulatory regime
Changes to the current political and regulatory environment in the country in which the company operates may have a negative effect on its business operations. Changes in governments may result in different policies being adopted that could impact on the investment appeal of that country.
For example, ownership rights of natural resources by overseas organisations can be amended or withdrawn; tax incentives or other grant initiatives can be scaled back; royalty rates increased; and more onerous environmental or employment legislation can be introduced. All of these changes can result in unexpected additional compliance costs.
Any of these issues can impact a mining company’s ability to undertake mineral exploration and development activities and this in turn could adversely affect the economic outcome of a project and a company’s share price.
4. Access to equipment, labour and energy
Retail investors should be mindful that the inability of a mining company to secure the capital equipment, personnel or energy supply needed to manage a project or the high costs incurred to obtain these resources can lead to delays or operational constraints.
Many mining companies are based in remote, inhospitable locations with very little infrastructure. This presents an additional challenge of getting the capital equipment needed as well as attracting experienced employees to manage the project and securing a reliable power supply.
For example, the capital equipment needed for mining activities is highly specialised and may not be easily available at times and locations where it is needed. Or the company may be unable to attract the senior management and key consultant skills needed to operate the project.
In addition, the location of the mine in a remote area with an insecure energy supply can lead to power outages and fluctuations. This could result in higher energy costs or lead to losses in production, both of which could adversely affect the profitability of the project.
5. Production
Getting the mineral resource out of the ground and into production brings a new range of operational risks. Mining companies are exposed to a number of unexpected events that may adversely affect their business.
These include: environmental hazards, including discharge of metals, pollutants or hazardous chemicals; industrial accidents; labour disputes; relocation of the local population; mechanical breakdowns; unanticipated ground and water conditions; safety-related stoppages; seismic activity; and inclement weather conditions, such as floods.
Investing in mining companies
Exploring for mineral resources is highly speculative and involves a high degree of risk. It often ends in failure. In addition to the operational risks outlined here, there are also financial risks and business risks associated with investing in mining companies. To learn more about these risks, please follow the links.
