This article was written by Snowden’s Global manager, Tarrant Elkington.
I am not sure if you knew that the concepts of present value optimisation have been around for almost 100 years. In this post, we take inspiration from one of the pioneers to look for future improvement opportunities.
I admit this blog title might have had more impact in three years’ time, however my eagerness to share is irresistible.
Everyone understands the principle of Present Value. A dollar today is worth more than that same dollar is in a year’s time. At its simplest, we can invest a dollar today and grow its value or watch it lose value as its purchasing power lessens over time.
Its mechanics are likewise simple. Take your expected cash flows over time and divide each by a factor, based on the Discount Rate (r), for a number of time periods (exponent n), relative to today (or some other reference date).
Present Value = Future Value / (1 + r)n
Naturally, if you want to know more on the theory or calculation, Google works!
Present Value calculations are certainly not unique to mining. They are used in business to calculate the value of an asset, opportunity or business, and tests if investments today are worth the expected returns of tomorrow and beyond.
Let’s not get into a debate about how discount rates are calculated. While I appreciate the theory, it’s still a dark art for me. Why is it always ~10% and why does it suddenly decrease for a marginal project? Coincidence – I don’t think so, but then I digress.
Instead let us focus on the use of Present Value, not just as a valuation method, but as a true driver of mine plan optimisation and strategy. Recall my quote from an earlier post.
“Tell me how you will measure me, and I will tell you how I will behave” – Eliyahu M. Goldratt
Clearly, Present Value and its cousin, Net Present Value, are extremely important in comparing investment decisions. More interestingly, however, are the internal decisions which this metric drives and how it can instantly change your operating profile.
Consider being offered a bonus by your boss based on some performance metric – perhaps sales? How differently would you behave? Suddenly there’s real incentive to change your behaviour and it’s the same with mine plan optimisation.
Present value likewise drives certain behaviours and discounting urges on our strategic decision-making. Thus, discount rate effectively measures our corporate impatience and forces us to act in certain ways. The more impatient we are (the higher the Discount Rate), the more we focus on short-term cash flow. In reality, the discount rate is actually a strategic calibration tool.
In preparing this blog, I was looking through my PhD literature survey and came across this gem from 1922 from an engineer named Edwin S. Berry. Its title is “Present Value in its relation to ore reserves, plant capacity, and grade of ore”. Clearly well ahead of its time, this paper contains some of the most underappreciated secrets of mine value optimisation. I still see seasoned mining professionals grappling with or even denying some of these same concepts. So rather than explain these riddles in my words, I thought I would simply dissect some of Berry’s prophetic insights and examine their relevance in 2019 (all quotations are sourced verbatim from Berry’s paper).
Larger reserves are not always better!
“The consideration of the present value of a mine is of great importance when planning for the operation of a property, particularly so in the case of mines that have large reserves.”
Astutely, the author acknowledges that all things being equal, Present Value opportunities in mine planning are superior for larger (longer life) projects. Discounting means that cash flows received after year 15 are often worth little in terms of Present Value. Hence, mining projects need to extract utmost value in their earliest years. For long-lived projects, options such as high-grading, plant expansion and throughput optimisation (even at the expense of recovery losses) should add significant value. For a five-year project, all urgency recedes.
“Of two properties having the same grade of ore and the same operating conditions, the one having the greater ore reserves is not always the one having the greater value, for the reason that plant capacity enters into the calculations…. It can be seen that to double ore reserves from, say, 104,000,000 to 208,000,000 tons without adding to the plant, and thus doubling the life, would add only about $11,000,000 or 15%, to the present value”.
This statement might be useful to junior explorers who already have long life projects and choose to continue exploring rather than investing in developing the resources available. However, once you have 20 years of resources, the focus should be on optimising (and de-risking) exploitation, not adding more resources.
High-grading, and resistance to high-grading, is not a new thing
“In studying the subject of ore reserves and their present value, one point which stands out as being very important, and which is not always given consideration commensurate with its importance, is the question as to whether or not the ore reserves can be divided into two or more sections or large blocks of different grades, and if so, whether or not the higher-grade portion or portions can be mined separately. Nearly always only the average grade of the total ore reserves is considered although it might make a huge difference in the value of the property to the owners or shareholders if arrangements were made to mine the higher grade portion first, so as to pay them back their capital investment as quickly as possible.”
There’s that famous saying that “Grade is King”. This has been supplemented in recent years within the “Money Mining” movement to include recovery, throughput and cost. Clearly, Berry’s observations are still relevant. To optimise your mine, Present Value demands you mine best material as early as possible. Some professionals rebel against this simple concept, often in pursuit of grade consistency.
“When the size of the plant of a property, for various reasons, is fixed or limited, the sending to the plant of ore of lower grade than is absolutely necessary is a waste of plant capacity, and plant capacity costs money”.
To those who have read Ken Lane’s work, this statement certainly rings true. I‘m impressed that Berry recognised that high grading was best suited to constrained plant scenarios, acknowledging that it’s wasteful to send marginally economic ore through an expensive process plant, at the expense of much higher value ore.
Higher grades usually trump higher mining rates and costs
“When it is possible, sometimes even at a considerably higher mining cost, to mine first and separately a higher grade portion of an orebody, it is nearly always advisable to do this”
Sometimes I will hear people that like the grade profile but not the mining rate/cost of an optimised mine plan. “I want the high grades and feed tonnes, but at a lower mining rate”. Unfortunately, “you can’t have your cake and eat it too”. For a given open pit design, you simply need to mine more to uncover higher grade ore.
If you are lucky the high grade is on the top of the orebody and can be accessed without higher mining rates, but this is often the exception to the rule. So, take the holistic view. Does the increase in revenue I get from higher grade feed compensate (and then some) for a higher mining rate? The extent of this trade-off is complex and entirely project specific. If mining cost is a very small fraction of your overall project cost, then you will often mine significantly more to unlock higher grade/margin material for processing.
Please, don’t go looking at mining rates for cost savings. A properly optimised mine plan will not mine additional tonnes for no additional benefit.
Beneficiation can unlock a lot of value, even at the expense of recovery
In some cases, sorting of the ore, either underground or on the surface, may increase materially the present value of a property, especially when waste or extremely low-grade material can be sorted out and thrown away… If sorting could be done without adding greatly to the operating costs, the output of a mill or smelter might be increased very considerably, which would mean a saving in plant capacity and a probable increase in annual profits, in spite of higher costs per ton”.
Here, Berry has identified the concept of throughput management. If you can cheaply upgrade your material ahead of an expensive mill or smelter, then you can significantly optimise revenue flow. While this might come at a cost of lower overall revenue with beneficiation loss, for large projects, the impact on Present Value can be immense. I have personally been involved in projects where beneficiation has increased present value by over 50%. When considering capital, gains can be even higher.
In a world where grades are getting lower, sorting and beneficiation is becoming more and more important. The ability to beneficiate will mean the difference between project getting developed, or not. Innovative solutions, often leveraging new technology and automation capabilities, are being developed at a rapid pace. Research organisations, such as CRC ORE, have been established to promote innovation in this space.
“In general, the consideration of the present value of a mine is of great importance when planning for the operation of a property, particularly in the case of large mines, but the mere calculation of present value based on estimated ore reserves, profit per ton and plant capacity may lead to grave errors, unless careful and intelligent judgement is used in connection with each calculation”.
How is it these insights so concisely articulated so long ago, are still not fully accepted and practiced in our extractive industries? There are three possible explanations: 1) Local optimisation 2) Rejecting Present Value as a measure, and 3) Blindly applying rules of thumb without understanding their impact.
Gerald Whittle highlighted this in his excellent 2009 article titled “Misguided objectives that destroy value”:
“When undertaking optimisation studies for mining and mineral processing operations, it is not unusual to observe behaviours that reduce or limit the economic value of the business. These can occur due to the acceptance of certain simple sub-objectives, which appear to be consistent with creating value or increasing viability, but which, with more insight, can be shown to be counterproductive”. – Gerald Whittle, 2009
It is in our professional nature to find the best possible solution. Sometimes the different objectives of various disciplines; “local optimisations”, such as maximising reserves, minimising mining costs or maximising recovery, seem sensible in isolation, but act against a holistic Present Value optimisation.
And occasionally people just do not believe in Present Value as the correct metric. Bringing cash flows forward, impact on the latter part of the project (when cash flows are lower) and may produce emotional responses in those involved in the project directly. For those that do not “believe” in Present Value as a driver, I would simply ask: “What else”?
Have you ever tried running a schedule optimisation without discounting (i.e. a zero discount rate)? Go ahead – make my day! Pretty much every answer will be the same since the value is projected to be the same today as in 10 or 100 years (assuming constant inputs). If that was true, we may as well just defer, defer, defer… Or not… It simply does not matter. I do acknowledge that sometimes the best net present value solution is not the best, due to other factors, such as risk profile and ability to source funding (this will be the subject of my next post). However, in these cases, the concept of Present Value should still be used to drive strategy.
Lastly, sometimes people just don’t know any better and apply rules of thumb blindly without consideration of the impact. A classic is Ken Lane’s cut-off grade equation. He made provision in his formula for the inclusion of opportunity cost, which would encourage elevated cut-off grades to be applied for large, plant-limited projects. However, this addition was the most complex and often omitted from simple marginal cut-off grade derivatives, since it often requires use of software.
Addressing these three issues, through awareness, could lead to some of the biggest improvements in the value and profitability of mining operations and projects around the world. At Snowden, I’ve seen significant improvement in this space in the last 10 years, but there’s still a long way to go. We can’t correct the missed opportunities of the past but we can act on them going forward, and act we must.
Thanks to Edwin S. Berry for starting the discussion.
Look out for future posts where I will delve into the world of strategic mine planning and optimisation, apply some of these topics, provide some tools and tricks and identify some of the big unsolved problems you might never have thought of. Please provide feedback, ask questions, and share your own experiences.
Berry, E. (1922). Present Value in Its Relation to Ore Reserves, Plant Capacity, and Grade of Ore. Mining and Metallurgy, June 1922, 11-16.
Lane, K. (1964). Choosing the Optimum Cutoff Grade. Quarterly for the Colorado School of Mines, 59 (4), 811-829.
Whittle, G (2009). Misguided Objectives that Destroy Value. Orebody modelling and Strategic Mine Planning Conference, Perth, 97-101.