This article was written by Snowden's Principal Consultant, Jeremy Peters.
Over the years, I’ve observed mine owners’ preoccupation with their contractors’ margins. When problems arise, I’ve either seen a poorly scoped contract or an owner who has neglected or simply misunderstood the importance of Latent Conditions or Conditions Precedent. Contracts benefit from improved scope preparation and role alignment and it’s essential to understand some fundamental points:
1: The Principal produces metal and the Contractor shifts rock.
Because their livelihood depends on it, Contractors are in most cases better than miners at:
- Purchasing machinery, spares and consumables at attractive rates
- Maintaining their mobile fleets
- Managing short-term mine schedules
- Running a tight(er) safety ship, often on which their reputation is based.
2: Contracts are really about “risk sharing”.
A junior miner engages a mining contractor to spread its operational risk, thereby reducing its capital investment, increasing NPV and IRR and increasing operational efficiency. The Majors also engage contractors in the earliest or most precarious years of their operations. A common strategy for a long-lived operation is to have a contractor for the first 5 years of the operation, with a buyout clause, once the mine is established. The owner will then take control of an established workforce and the equipment that goes with it.
3: Owners rarely appreciate risk loading.
A recently developed mine bought a fleet of second-hand equipment (and there's always a good reason why it's second-hand) and proudly proclaimed that it was owner-operator, thereby sidestepping contractor margins. This occurred in parallel with a poorly-defined orebody, the absence of a feasibility study and a novel processing flowsheet. This owner was preoccupied with the bottom line and failed to appreciate relative process risk.
There’s a spectrum of contract styles, defined by risk spread:
- Schedule of Rates: With a 40-year record in the Australian Mining Industry, this well understood contract type shifts the risk to the contractor. It’s ideal when the nature of the job is known but its continuity is less clear. For a well understood orebody and a predictable near- term mining schedule, it’s often ideal.
- Fixed and Variable: This requires the owner to pay the contractor's fixed costs, (including insurance which gives the Principal considerable control over the Contractor) and for production at a schedule of rates. This is often preferred where there is some uncertainty regarding the Resource, with the owner sharing more of the risk.
- Cost Plus: This is generally applied to short-term or urgent projects where out of scope work occurs (the geo identifies more mineralisation in the pit wall or there’s a ramp failure), which is done on an open book basis. In such instances, there is little or no onus on the contractor’s part to control costs.
- Alliance or Partnership: This typically includes reimbursable costs plus a performance bonus and is often used for very large projects, where the owner and contractor share capital costs. For example, BHP-Mitsubishi (BMA) coal alliance where the customer (Mitsubishi) is also (effectively) the equipment supplier, with the owner responsible for resources development and technical input. In this instance, risk and reward is shared by both parties.
A recent development is the internal Contractor. Northern Star has a management team highly skilled in contract mining. This effectively allows an internal mining arm to contract back to the parent company.
When an investor is looking in the resource sector, an appreciation of the basic types of contract goes a long way to help risk rank individual projects. Wisely sharing the technical risk benefits both parties. For this reason, I firmly believe that if the contractor is not making a commercial margin, it is ultimately the mine owner that suffers. A mine owner should always commission a shadow bid in order to understand the contractor’s business and not unreasonably pressure the contractor.
And a hint to close with– in any contract, even the best managers should anticipate around 15% of the claim to be out of scope or dayworks.
About the author
Jeremy has more than 25 years’ experience as an Engineer and Geologist, with a background in open pit and underground gold, iron ore and base metal and nickel mines.
Jeremy also has exploration and mine geology experience in Iron Ore, Gold, Base Metals, Nickel and industrial minerals in the Pilbara, Yilgarn, the NT and Far North Queensland of Australia. He has consulted internationally as a mining engineer and geologist in Papua New Guinea, the Mediterranean, Russia and North Africa.