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Project Finance




11 March, 2010

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So You Want to be a Mining Magnate Project Finance for Mineral Development Projects

Author: Jamie Morien

Submitted in partial fulfilment of the requirements for the degree of Master of Construction Law (MConLaw)

The University of Melbourne 2010

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Jamie Morien 246202


A B Purpose Mineral Development Projects 1 The Mining Cycle 2 Risks 3 Financing Mining a Corporate Financing b Project Financing

4 4 4 5 6 6 7


A B Exploration and Deposit Discovery Economic Evaluation 1 Scoping Study 2 Pre-Feasibility Study 3 Feasibility Study a Project Finance Submission b Risk Aspects of Project Financing i Completion Risk ii iii iv 4 Resource Risk Operating Risk Market Risk

10 11 14 15 15 16 17 18 20 22 22 23 25 25 26 26 26 27 30 31

The Commercial Aspects of Project Financing a The Sponsor b Offtake Contracts and Long Term Purchase Contracts c Contractors and Suppliers i Licenses and Permits ii iii iv v Host Government EPC/ EPCM Contractors Insurers Operations Contracts



Figure 1 Risk Reward Diagram Figure 2 Recommended Phases of a Mining Project Figure 3 United Nations Classification of Resources Figure 4 Debt-to-Total Capitalisation Ratios: Project Companies vs. Corporations Figure 5 The structure of project finance 11 12 21 24 24

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Jamie Morien 246202

barrick. you move it into development. and where the loan is non-recourse to the company‘s balance sheet.INTRODUCTION I INTRODUCTION A Purpose Taking a mining project from a prospect to a fully operational mine facility producing a saleable product is an enormous task consuming significant human and financial resources.aspx (9 January 2010) 4 of 32 Jamie Morien 246202 . It also examines the key risks of the mining enterprise that impact on project financing deals and evaluates the types of commercial arrangements that exist in such an enterprise. The use of project finance provides both a mechanism to offload risk. If the project survives the hurdles of the exploration pipeline. Barbara Lynch. human resources and money.1 According to the world‘s largest gold miner: ‗there‘s more to mining than extracting gold from rock. Entering into the industry is an unlikely prospect given the significant financial requirements and the high likelihood of failure. sustained investments of skill. ‗Basics of Mining‘ Barrick Gold Corporation http://intranet. requiring large. If it survives those new hurdles. Mining itself is a highly risky venture and ranks near the top of what constitutes risky projects. you must find (or acquire) a promising mineral deposit. Staying in the industry requires the mining companies to diversify their risks and leverage their investments. Financing the mining enterprise requires sources in addition to the banks. Project finance is not available prior to the completion of the feasibility study (which is also known commonly as a bankable feasibility study) and as such start-up costs for exploration and the economic evaluation of the prospect is necessary. commitment. First. as the banking sector is unwilling to take equity risk in such ventures. B 1 The Mining Cycle Mineral Development Projects Mineral development projects belong to a category of project called extraction projects. ‗Mega-projects as Displacements‘ (2003) 175 International Social Science Journal 15. it allows the miner to leverage in to the project with as little as 30% of the post-feasibility study costs. you commission a mine – which you then operate. This paper describes the concept of project finance and when and how it is available. It‘s a long cycle. and finally close. This paper describes a process by which a sponsor develops such a mineral extraction (mining) project.‘2 1 2 Paul Gellert.

7 This venturing out includes moving into more geographically difficult areas as well as more politically risky regions of the world. Extraction (mining) of the ore from the ground.INTRODUCTION The entire process is called the ‗mining cycle‘ and extends through six distinct stages:3 1. with the possible exception of shuttle and defence projects are the highest cost. Ore processing and refining.6 Resource bodies are generally becoming more marginal and as such mining companies have been forced to increase the scale of developments to benefit from economies of scale and access resource bodies in more difficult locations. mining is a risky endeavor. Stephen Grey. The greatest uncertainty is in the early stages of a project so the ‗decisions of greatest impact can be made during pre-feasibility and feasibility stages of a project. Final rehabilitation of the mine site. Economic evaluation of the viability of exploiting the discovery.pdf> on 5 November 1_SustMining-Aust-aReport-Master. The scope of this paper is to evaluate the risks. In fact ‗mining and resource development projects.‘4 In fact moving through to execution of a project without properly completing the early studies is a recipe for disaster as discussed in section IIB of this paper. 6. J G Perry. Monash University and Mineral Policy Institute. ‗Lifting Management to the Next Needed Level‘ (2000) December Mining Finance Yearbook 55. Regardless of which stage the project is in. ‗Risk Management for Resource Companies‘ 6. Robert Maskell. 4 5 6 7 5 of 32 Jamie Morien 246202 . 5. most complex and risky ventures undertaken in today‘s world‘. As the size and complexity of projects increase so do the number and magnitude of risks.mpi. 6 The Mining Chronicle July (2007). 4. Dale Cooper. 2. ‗The Sustainability of Mining in Australia: Key Production Trends and Their Environmental Implications for the Future‘ (2007) Department of Civil Engineering. 3. 6. ‗Risk Management and Mining – Developments and Trends‘ 2. P A 2 Risks Typically as a project progresses throughout the various stages of the mining cycle the level of risk reduces as the level of certainty increases. Neil Cusworth. Available online: <http://www.5 One risk expert posits that ‗mining can probably claim the greatest familiarity with risk‘. Exploration and deposit discovery. Very large projects are characterised by ‗long temporal horizons and require large. 2 The Mining Chronicle February (2001). Engineering Construction Risks. Construction of facilities to process the ore. irreversible 3 Gavin M Mudd. A Guide to Project Risk Analysis and Assessment – Implications for Project Clients and Project Managers (1992) SERC Project Report. commercial issues and financing strategies up to the point of the full authorization of project funds which occurs subsequent to the economic evaluation (stage 2) and prior to execution (stage 3). Stephen Grey.

‗Financing for Mining Companies: The Miner‘s Perspective‘ AMPLA Yearbook. 213.8 This makes the financing of the larger projects more difficult as the outside tenor (i. ‗Project Finance – Does it Exist in the Mining Industry: CRA‘s Experience‘ 568.g. debt financing. Such financing which is ‗on credit or full recourse to the sponsor. ‗Strategizing for Anticipated Risks and Turbulence in Large-Scale Engineering Projects‘ (2001) 19 International Journal of Project Management 445. above n 12.e.‘11 In any event many options dry up in times of economic crisis except for the truly excellent project opportunities. 2007. 42. ‗Is Mining in a Financing Crisis?‘ Project Finance. Wightman. Kyle Wightman. 568. 446. 211. above n 9. Roger Miller.‘14 The balance sheet and the income statement of the borrowers will be studied extensively by the lenders in a corporate financing. 212. profit and loss statements. Halupka. are also involved. These options include ‗bank financing. Different costs and risks are involved in these different methods of raising funds. Willie Tan. Kudnig.‘10 There are numerous options available to mining companies for raising funds to meet capital requirements.‘ 12 The financial model which the lender will use to base the credit assessment on will contain ‗forecast production levels. May 2009 Martin Kudnig. whether it is directly borrowed or guaranteed by that sponsor. ‗Principles of Project and Infrastructure Finance‘.INTRODUCTION commitments with large potential downside loss but limited upside gain‘. loan life) for mining project loans is around 12 years and in recent years has been reduced to as little as six to eight years. a Corporate Financing A mining company may seek funds for development of a prospect using its balance sheet as security for the loan. 9 10 11 12 13 14 15 6 of 32 Jamie Morien 246202 . for both the mining company and its lenders.‘13 Often lenders will rely on an assessment of the mining companies historical results ‗rather than an assessment of the project or a detailed assessment of the future activities and prospects. share issues and notes issues in both domestic and overseas capital markets. is a corporate financing. 372. With the exception of precious metals such as gold (which is considered a hedge against economic uncertainty) ‗[t]he plummet in commodities pricing has left some of the majors struggling with debt repayments and many juniors are either having to mothball projects or go out of business simply because they cannot raise cash. such as borrower reporting obligations and covenants. 31 Dec 2005). 568. above n 11. ‗The balance sheet provides a picture (‗snapshot‘) of the financial posture of the firm at a particular data (e.‘15 The 8 Serghei Floricel.9 3 Financing Mining Mining was hard hit by the global economic crisis. forecast cash flows and balance sheets. Different terms and conditions.

liabilities. ‗Approval does not even depend on the value of the assets sponsors are willing to make available to financiers as collateral.J. Finnerty. Nevitt.‘19 Financing which does rely upon the economics of a prospect are project finance deals. so that lenders will be satisfied with the credit risk.‘17 As such competitors can collaborate to bring projects to fruition or they can seek other ways of taking a project off the companies balance sheet. but attendant with their reward is the assumption by the banks of considerable risk. ‗An Overview of Project Finance—2001 Update‘ (2002) Harvard Business School Case #202-105. Additional benefits of structuring a project finance deal include: 16 17 18 19 20 21 22 Ibid. London. Special Publications. 129. the riskier it generally is for a single firm to finance it on its own balance sheet. Project Financing (2nd Ed.16 b Project Financing For a multitude of reasons discussed within this paper. ‗The larger a project. it is basically a function of the project‘s ability to repay the debt contracted and remunerate capital invested at a rate consistent with the degree of risk inherent in the venture concerned. 129. J. 7(2000. 7th ed. 1994. Instead.K. Benjamin C.‘21 ‗This form of finance can be attractive for the banks in that interest margins can be three to four times higher than for corporate borrowing. the sponsor or an interested third party. v. 2. Stefano Gatti. Esty. Fabozzi.. Project finance is defined as ‗[a] financing of a particular economic unit in which a lender is satisfied to look initially to the cash flows and earnings of that economic unit as the source of funds from which a loan will be repaid and to the assets of the economic unit as collateral for the loan‘20 Project financing does not rely upon the soundness and creditworthiness of the parties proposing the business idea to launch the project. ‗Project Financing‘. 79. Banks however are not equity risk-takers. Ibid.23 This is due to the various benefits of the approach.18 Therein lies the rub. O‘Leary. and net worth (assets minus liabilities) also called shareholders‘ equity..‘22 The value of project finance investment has grown from less than $10 billion per year in the late 1980s to almost $220 billion in 2001.2007). ‗The key to a successful project financing is structuring the financing of a project with as little recourse as possible to the sponsor. ‗Mining Project Finance and the Assessment of Ore Reserves‘. Lenders want to feel secure that they are going to be repaid either by the project. Ibid. 23 7 of 32 Jamie Morien 246202 . F. sponsors pursue ‗off-balance sheet‘ loans to finance their mining project. while at the same time providing sufficient credit support through guarantees or undertakings of the sponsor or third party. which is positive if assets exceed liabilities and negative otherwise.) 3.INTRODUCTION balance sheet has three key elements: assets. Geological Society. P. 31. John D. Project Finance in Theory and Practice (2008).

Finance for the Minerals Industry (1985) 549.30  Risk reduction:31 o o o o o o Project financing reduces risk for the project sponsor. Wightman. 530. above n 18. Ibid.INTRODUCTION  Gearing . Reduced political risk. 568.The use of debt facilitates risk diversity allowing the companies to undertake multiple projects thereby minimizing harm in the event of project failure. 24 25 26 27 28 29 30 31 Nevitt. Repayment deferrals. 4. Therefore the universe of potential lenders for a project finance deal may include financial institutions that are not interested in participating in a conventional corporate loan facility.25  Protection of company assets .27  Preservation of sponsor‘s borrowing capacity because the borrower has not had to rely on using any of the companies assets as collateral. Esty. Limits cross default. Finance for the Minerals Industry (1985) Society of Mining Engineers. ‗Mining Finance‘. Herbert D Drechsler.For example BP typically uses project finance whenever a proposed investment exceeds approximately 5% of the companies total assets. 568. above n 12. ‗Lender recourse limited. 373. Project Finance Supports and Structuring. above n 12. Wightman. See C Richard Tinsley. the project sponsor retains control of the project. above n 9. In many instances the only other source of funding would be an equity issue (leading to share dilution) or the sale of an interest in the project to another party.Project financing can sometimes be used to improve the return on the capital invested in a project by leveraging the investment to a greater extent than would be possible in a straight commercial financing of the project.29  The sponsor retains control of the project: Within the constraints imposed under a typical project finance deal.28  A source of finance: Project lending is attractive to banks seeking higher returns than may be available from corporate lending.26  Preserves or maximises the value of the mining companies common shares by not requiring the company to issue additional shares which would dilute the value of the common shares. 27. Strong negotiating position if difficulties arise. ‗The Economic Motivations for Using Project Finance‘ (2001) Harvard Business School. 551 Benjamin C.24  Risk diversity . Halupka. 8 of 32 Jamie Morien 246202 .

To avoid being considered as a cash obligation which would dilute interest coverage ratios. o A project financing may enjoy better credit terms and interest costs in situations in which a sponsor‘s credit is weak. For some other credit impact objective:32 o o To avoid being shown on the face of the balance sheet. 6 –7 9 of 32 Jamie Morien 246202 . above n 18. above n 18. 4 – 5. Extends bank lending limits.  For any one of these side benefits:33 o Credit sources may be available to the project which would not be available to the sponsor. o o To avoid an open-end first mortgage. Nevitt. o The project may enable a public utility sponsor to achieve certain objectives regarding its rate base. o To limit direct liability to the construction period and start up and avoid a liability for the remaining life of the project. Legal requirements applicable to certain investing institutions may be met by the project but not by the sponsor. o o Regulatory problems affecting the sponsor may be avoided. For regulatory purposes. o Guarantees may be available to the project which would not be available to the sponsor. and o To keep the project off-balance sheet during construction and/ or until the project generates revenues. costs may be clearly segregated as a result of a project financing. o To avoid being within the scope of restrictive covenants in an indenture or loan agreement which precludes direct debt financing or leases for the project.INTRODUCTION o o o  Third party audit. o o Higher leverage of debt to equity may be achieved. 32 33 Nevitt. and Longer term maturities. and affect the sponsor‘s credit standing with the rating services. To avoid being shown as debt on the face of the balance sheet so as not to impact financial ratios.

C. above n 9. ‗The South African Code for the Reporting of Exploration Results. and/ or o Construction financing costs may not be reflected in the sponsor‘s financial statements until such time as the project begins producing revenue. surveying. C. o A more favourable labour contract or climate may be possible by separating the operation from other activities of the sponsor. Melbourne. Effective Mining Project Management Systems. as ‗the commercial 34 35 Halupka. The South African Mineral Resource Committee (SAMREC) Working Group Under the Joint Auspices of the Southern African Institute of Mining and Metallurgy and the Geological Society of South Africa.‘36 The uncertainty in this early phase is the greatest and therefore so is the level of risk.MINING PROJECT DEVELOPMENT o Investment protection in foreign projects may be improved by joining as joint venturers with international parties. Shillabeer. October 2006. David Noort. 374. The disadvantages of project financing include:34       Complexity Additional time and effort to implement and administer Additional lending margins and fees applying to this incremental financing The provision of security over project assets to lenders Additional legal expenses and possibly financial advisory fees A reduction in the level of confidentiality applying to the proposed project II MINING PROJECT DEVELOPMENT A Exploration and Deposit Discovery The discovery of a mineable deposit follows a program of mapping.37 The final viability of the enterprise turns entirely on this analysis. ‗Mineral resource/reserve problems are the most likely technical problem to account for failure of mining projects‘. J. Adams. 2007 Edition. drilling and core sampling whereby the deposit is classified into mineral resources (inferred. Mineral Resources and Mineral Reserves (The SAMREC Code)‘. and Gypton. ‗Highlighting Project Risk Following Completion of the Feasibility Study‘. paper presented to the International Mine Management Conference. thus lessening the sovereign risk. indicated and measured) and mineral reserves (probable or proved). defined and reported according to the relevant code of practice before each relevant phase of the project. 36 37 10 of 32 Jamie Morien 246202 .35 ‗Mineral resources should be audited. in Proceedings Mining Risk Management (2003) 101-109 (The Australasian Institute of Mining and Metallurgy: Melbourne).

39 40 41 42 43 11 of 32 Jamie Morien 246202 . and Control (2002) 306. mining projects are as a rule to risky for lenders. prior to the feasibility. D. within their respective ranges of variation. 376. Mineral Processing Plant Design. Very few exploration companies actually find commercial deposits. 371. ‗In the early exploration and reserve development phases. Sydney NSW 9-12 September 2003.‘39 Project finance is not an option in the early stages of the mining cycle but the potential for massive windfalls are what attract junior equity who ‗occupy the high end of the risk-reward curve‘40 as illustrated in Figure 1 below. John Scott.‘41 Figure 1 Risk Reward Diagram 42 B Economic Evaluation For a large project requiring significant financing. A bankable study must be ‗of sufficient technical and financial accuracy to meet bank requirements for assessment of the project for financing 38 Peter L McCarthy. Halbe. Halupka. exploration and development companies generate no cash to fund operations or service debt. above n 9. Also. ‗an independent study certified by a recognized engineering firm will be mandatory for the study to be regarded as ―bankable‖ (emphasis in original). 371. operating costs or metallurgical recoveries. above n 9. Barratt (eds). ‗Managing Technical Risk for Mine Feasibility Studies‘ Mining Risk Management Conference.pdf> Halupka. and funding is restricted to equity sources. Ibid. ‗Guidelines to Feasibility Studies‘ in A.MINING PROJECT DEVELOPMENT outcome is more sensitive to head grade variations than to capital Mular. Brian Johnston. Practice. Project financing deals in general won‘t be available until the viability of the enterprise has been proven within specified limits of accuracy following completion of the second stage of the mining cycle. D.‘43 The economic evaluation is itself a multi-staged process that eventuates in a study document widely known as a ‗bankable feasibility study‘. Janne Duncan The Global Economic Crisis – Worldwide Impact on Mining Companies <http://www.‘38 ‗Exploration and development are very risky and highly speculative undertakings. They are almost entirely dependent on risk equity which is very hard to find in the current environment.

See Daley A. R. Figure 2 Recommended Phases of a Mining Project 49 44 45 46 47 McCarthy. Michael R McCarthy.MINING PROJECT DEVELOPMENT purposes.‘45 Some writers‘ recommends sponsors and engineers avoid using the term ‗bankable‘ at all. Noort and Adams.‘48 Detailed evaluation is most intense however during the second phase of the mining cycle where a series of studies are conducted culminating in the final definitive feasibility study. ‗Essential Elements and Risks in Bankable Feasibility Studies for Mining Transactions‘ (2001) Parsons Behle & Latimer 6. 7. 48 49 12 of 32 Jamie Morien 246202 . above n 36.46 Additionally the term is founded on obtaining non-recourse project financing but is used broadly in the mineral development industry for all feasibility studies. 281.‘44 The validity of the term itself is disputed and may tend the uninitiated to falsely believe that the study itself will have some kind of bankable value. 5. ‗The use of the term ‗bankable‘ in replacement of definitive feasibility study is ambiguous and best not used as it implies that there is a underlying attractiveness to the investment which does not necessarily reflect the accuracy of the study. above n 38. The Impact on Miners and Financiers‘ (1990) AusIMM. above n 36. Figure 2 below illustrates the phases of economic evaluation and shows how each study will go through multiple iterations until a single selected go-forward strategy is agreed.47 Economic evaluation ‗accompanies all phases of the mining cycle and provides the basis and justification for continued investment of money for the proposed development. ‗‗Is it Bankable?‘ Ore Reserve Estimates. Craig Johnson. Noort and Adams. Scott and Johnston. and as such can be confusing and essentially misleading. above n 43.

‘50 Strictly following the process of successively more detailed studies focused on more specific options ensures that due consideration has been made on whether the project should be investigated further. 13 of 32 Jamie Morien 246202 . The discussion around the use of EPC lump sum turnkey contractors in a later section of this paper points out how claims are the key outcome if scope is not adequately defined at authorization. BHP Billiton Estimating Guideline PMG-PC-110. Evaluations by the author of some 25 recent mining megaprojects (valued at >USD1B) demonstrated that less than 30% was the highest level of engineering achieved prior to authorization and many of those projects were BHP Billiton‘s who follow the AACEI standard.MINING PROJECT DEVELOPMENT Typically three formal studies are conducted with different objectives and successively more accurate outcomes. and that due processes are followed in determining and fine-tuning the project scope. that project viability has been investigated in detail and confirmed prior to carrying out additional design and estimating and committing significant funds. For this reason financiers should be careful to establish. The type and quality of cost estimates have also been standardized in the industry with the level of contingency (margin for error) reducing from one study to the next in line with the increasing level of technical and economic knowledge. ‗Skipping the prefeasibility or scoping study phase can lead to costly delays in the definitive feasibility study. which can be measured in various ways before selecting an implementation approach. that all of the alternatives are investigated before a particular direction is taken. through the use of their engineer. It should be stated that the industry accepted standard below by the AACE International identifies engineering to be up to 70% complete by the time that the feasibility study is complete is probably highly optimistic in mining projects. It is important to move through the process and not skip any steps. Table 1: Percentage Engineering and Estimate Classification Investment Process Phase Identification Study Phase (Concept) Selection Study Phase (Pre-feasibility) Front-end Loading Conceptual Class 4 Equipment Factor 1% to 5% Preliminary Class 3 Semi-Detailed 10% to 30% Basic Class 2 Detailed 30% to 70% Definition Study Phase (Feasibility) Execution Phase (Implementation) EPC Detailed Class 1 Definitive 70% to 100% Project Phase Engineering Estimate Classification Estimate Type BHP Billiton51 50 51 Ibid. the true status of engineering. The level of engineering complete. which fundamentally reflects the level of scope detail drives the level of certainty in the final costs and schedule. timeframes and cost estimates.

‘58 The type of estimate used for this phase of the cycle is known as a Class 4 ‗equipment factored estimate‘. D.MINING PROJECT DEVELOPMENT Investment Process Phase Identification Study Phase (Concept) 5% 53 Selection Study Phase (Pre-feasibility) 10 % to 15% 10% to 40% 10% to 15% 5% to 15% 5% to 10% Definition Study Phase (Feasibility) 30% to 40% 30% to 70% 10% to 25% 20% to 35% 15% to 30% Execution Phase (Implementation) 80% 50% to 100% 40% to 60% 95% to 100% > 65% Anglo America52 AACE International Cusworth (2005) Huxley (2002)55 Hickson (2002) 56 54 1% to 15% 1% to 2% 1% to 5% 0% to 2% 1 Scoping Study A primary concern of this study is an evaluation of the resource body. Working Party #79 Report: A Guide For Reporting Exploration Information. AACE International Recommended Practice No. ‗Capital Investment Systems: Making the Right Investment Decisions‘ (Paper presented at the Project Management Australia Conference. ‗Success Strategies for Building New Mining Projects‘ in A. D. 2 September 2005). grade. 2255. Robin J Hickson. K. Neil <http://www.anglotechnical. Society of Mining Engineers. Halbe. Sinnott. The resource is defined as ‗[a] concentration of naturally occurring solid. Resources and Reserves. Barratt (eds). ‗[l]ocation.DOC> on 23 July Geological Survey Circular.59 The factorial method of cost estimation for process plants is attributed to Lang (1948). or gaseous material in or on the Earth's crust in such form and amount that economic extraction of a commodity from the concentration is currently or potentially feasible. AACE International above n 53. quality. To reflect varying degrees of geological certainty."57 The Society of Mining Engineers qualifies this language saying. ‗Estimate Classes: An Explanation‘ (2002) June. Practice. Principles of a Resource/Reserve Classification for Minerals. Chemical Engineering Design. Construction Economist. resources can be subdivided into measured.enthalpy.10 for solid process plant Delivered equipment cost X 3. 60 The Lang Factor is a formula that posits that the fixed capital cost of the project is given as a function of the total purchase cost of equipment by the following equation: 3. John Metcalfe Coulson. 831 (1980). United States Bureau of Mines & United States Geological liquid.pdf> at 9 June 2008. 12. and quantity are known or estimated from specific geological evidence. R. and inferred. Anthony L Huxley.70 for fluid process plants = Total estimated plant costs 52 Anglo America. John Francis Richardson 53 54 55 56 57 58 59 60 14 of 32 Jamie Morien 246202 . Mineral Processing Plant Design. Mular. Brisbane Australia. ‗ATDP_ES_000098 Estimate Classes‘ <http://www. 379 (1991). and Control (2002) 2250.60 for solid-fluid plants 4. 17R-97 Cost Estimate Classification System TCM Framework.

metallurgical. above n 35. Scott and Johnston. legal.pit has been established and an effective method of mineral processing has been determined. operating. which are considered in sufficient detail to demonstrate at the time of reporting that extraction is reasonably justified (economically mineable) and the factors reasonably serve as the basis for a final decision by a proponent or financial institution to proceed with. economic factors and the evaluation of other relevant factors that are sufficient for a Competent Person. the development of the project. 308. mineral resources and mineral reserves (SAMREC) defines two types of studies: pre-feasibility and feasibility. engineering. To attract a joint venture investor or a buyer for the entire project. Justify a major ongoing exploration program following a successful initial exploration effort. social. above n 35. SAMREC provides the following definition of a pre-feasibility study: A comprehensive study of the viability of a range of options for a mineral project that has advanced to a stage at which the preferred mining method in the case of underground mining or the pit configuration in the case of an open. 2. above n 43. to determine if all or part of the Mineral Resource may be classified as a Mineral Reserve. 15 of 32 Jamie Morien 246202 .MINING PROJECT DEVELOPMENT 2 Pre-Feasibility Study The South African code for the reporting of exploration results.61 A pre-feasibility study is an intermediate study and is considered essential for three reasons:62 1. governmental. mining. Provide the basis for proceeding to a final feasibility study. ‗The South African Code for the Reporting of Exploration Results‘. The overall confidence of the study should be stated.63 61 62 63 ‗The South African Code for the Reporting of Exploration Results‘. SAMREC provides the following definition of a feasibility study: A comprehensive design and costing study of the selected option for the development of a mineral project in which appropriate assessments have been made of realistically assumed geological. or finance. or to provide the basis for raising additional risk capital by way of a major underwriting. It includes a financial analysis based on realistic assumptions of technical. A Prefeasibility Study is at a lower confidence level than a Feasibility Study. The primary objective of the feasibility study is to optimise the single selected go-forward investment alternative. economic. 3. operational and all other modifying factors. engineering. environmental. marketing. acting reasonably. 3 Feasibility Study If the pre-feasibility study establishes the viability of the project within specified limits of accuracy (confidence levels) then a feasibility study will be pursued.

Dale Cooper. both qualitatively and quantitatively. here the focus is on cash movements. (This contrasts with economic appraisal.2 March (2007) BHP Billiton. thus generating recommendations for risk management and control strategies. to determine whether it is financially feasible. a Project Finance Submission Once the decision has been made to pursue a mineral development project following a so-called ―positive‖ feasibility study.  Environmental appraisal: This process examines the potential environmental impacts of the project and identifies measures for mitigating adverse effects. ‗Managing Risk in Large Projects and Complex Procurements‘ 312. to finalise the scope.) Outputs from a financial feasibility study may include recommended financing structures and debt to equity ratios.  Financial feasibility: This process examines the financing of the project and its cash flows. The appraisal process also involves sensitivity testing. McCarthy. and to clearly define the project execution plan.  Risk analysis: This process identifies major areas of uncertainty and risk. which may use elements of risk analysis in its conduct and interpretation. 11. Johnson. or as part of the financial feasibility analysis. cost and schedule and other KPI‘s. Geoffrey Raymond.64 Key parts of the feasibility study are:65  Economic appraisal: This process identifies options and assesses their benefits and costs.66 The project finance submission will be made following completion of the feasibility study once it is determined that the project is viable and prior to committing to the execution phase. Quantitative risk analysis may be conducted as a key part of the economic appraisal. to determine the options with the highest net present values or the highest benefit-cost ratios. a separate decision will be made to determine the manner in which the project will be financed. highlights key sensitivities and considers allocation of risk amongst the stakeholders. Phil Walker. It also involves consideration of responses to risk. The feasibility study document itself is submitted containing ‗all the technical/ economic information and auditing necessary for a banker (and the banker‘s independent engineer) to 64 65 ‗Standard for a Definition Phase Study (Feasibility)‘ Version 2. where non-monetary factors are important. to establish the risk profile and the uncertainties associated with this risk profile.MINING PROJECT DEVELOPMENT During the feasibility study the selected alternative for the investment opportunity is rigorously evaluated in order to optimise the total life cycle costing and net present value (NPV) for the investment. above n 47. 66 16 of 32 Jamie Morien 246202 . Stephen Grey. 4.

‗Project financing can sometimes be used to improve the return on the capital invested in a project by leveraging the investment to a greater extent than would be possible in a straight commercial financing of the project. 69 17 of 32 Jamie Morien 246202 .MINING PROJECT DEVELOPMENT determine that the project risks are acceptable and that the project is indeed viable on a stand-alone (emphasis in original) project financing basis. Financial Planning and Analysis Techniques of Mining Firms: A Note on Canadian Practice Nevitt.‘67 The actual project finance submission will typically contain the following breakdown68                    Cover/Title Sheet Index/Table of Contents Sheet Model Administration Sheet Inputs and Outputs Summary Sheet Financial Modeling Assumptions Sheet (Inputs Sheet) Income (Profit & Loss) Statement Balance Sheet Cash Flow Sheet Expenditure Sheet Operations & Maintenance Costs (O & M) Sheet Funding Drawdown (Debt & Equity Drawdown) Sheet Working Capital Sheet Project Output Sheet (Power and/or Steam output generated etc) Revenue Sheet (Power and/or Steam Revenue Sales etc) Tax Sheet Depreciation Sheet Ratios Sheet Sensitivity Calculations Sheet Benefits Calculation Sheets (where relevant) b Risk Aspects of Project Financing The various risks inherent in each of the stages of the mining cycle are of primary concern to lenders. The Dynamics of Relative Attractiveness—A Case Study in Mineral Exploration and Development. lenders take a much more conservative approach. above n 18. above n 43. consequently.‘69 ‗When banks lend capital on a long-term basis they do so in return for a relatively modest and fixed returns. Whereas equity partners seek to leverage their investment and are willing to take significant (calculated) risks with the intention of making significant returns on their investment. lenders willingly accept 67 68 Scott and Johnston. 306. 5.

‘74 Of course the worst-case scenario is that the project will not be completed at all and this then is the key risk of concern to the lenders. 2 Australian Mining and Petroleum Law Journal. Karen Brown. above n 12. ‗Standardised Risk Allocation For PPPs: Will it Impact on Transition Costs and Efficiency?‘ (2006) 17(2) Journal of Banking and Finance Law and Practice 92. i Completion Risk Obviously the most critical risk on a project is that the project itself will not be completed on time. above n 25. ‗Project Financing in the Energy Industry and its Impact on Completion Risk‘ (2001) 20. but avoid taking what they perceive as ‗equity risk‘‘. Law and Practice of International Finance (1980). Paul Tobin. 52. ‗Financing Resources Projects‘ (1988) 62 Australian Law Journal 937 Scott and Johnston. See Scott McConnel. Robert J. 42. Wightman. 551. 213. ‗Completion risk is generally allocated to the project sponsors (or project company) in the project financing of resource and infrastructure projects.‘75. The lender‘s Independent Engineer (IE) will always play a role in the monitoring of the completion test and the singing off of 70 71 72 73 74 75 Halupka. 76 77 78 79 80 18 of 32 Jamie Morien 246202 . to budget or within the performance requirements established in the project charter. 371.‘72 ‗The assessment of the various elements of risk in a project and the sharing of that risk between sponsors and lenders is the most critical feature (of project financing)‘73 A detailed discussion of four of the key types of risk and how they are assessed and allocated is of great relevance to the topic of mineral development project finance and is provided herewith.80 A completion test will be required by the lenders who will specify particular criteria to be met. 485.‘71 ‗The technique of project financing evolved around the concept of risk and particularly the idea of shifting it. 14-2. Philip Wood.76 ‗Banks don‘t accept completion risk‘.70 Even so project loans do contain some level of equity risk ‗in the sense that they rely on the project for their pay-out and not on the general credit of the borrower. above n 9. 568. the primary objective is to assess the risk that the mine will not be completed on time and within budget. A lender will consider a project to be incomplete if it is not performing to the required throughput levels for production and as such revenues are not at the level anticipated. 52. See Tinsley.77 Completion risk is often defined in broad terms that equate to definitions of risk itself78 such as ‗exposure to possible economic loss or gain arising from involvement in the construction process. 148. Kudnig. ‗In assessing the development risks of a particular project. ‗Risk Identification and Allocation: Saving Money by Improving Contracts and Contracting Practices‘ (1995) 40 International Construction Law Review. 96. 308. and Richard Ladbury. ‗The Allocation of Construction Risks on a Mega-BOT: The Taiwan High Speed Rail Project‘ (2008) The International Construction law Journal 484. above n 43. Nora Scheinkestel. above n 11.‘ 79 Completion for the lender may also be defined in a different way that it is by other project participants. 152. ‗Project Finance – The Lender‘s Perspective‘.MINING PROJECT DEVELOPMENT ‗borrowers‘ risk‘. Smith.

68. 308. There are differing stages of completion. treatment plant and infrastructure. the documentation should cover as a minimum requirement. as per Ladbury: The tests for completion are often contentious and the subject of protracted negotiation.86 It is fully expected that there will be deviations from the assumptions of the feasibility study that are realised during construction. above n 9.MINING PROJECT DEVELOPMENT test components. above n 72. above n 9. Ladbury.84 A successful completion test will result in two key outcomes. above n 43. 19 of 32 Jamie Morien 246202 . for example. that the project is capable of or actually has produced a specified level of production for a specified period at a specified cost. Where recourse for the lender is fully limited to the project this of course has limited value. Ladbury. documentation should address ―performance completion‖ which may require. Halupka. Scott and Johnston. Scheinkestel.82 The completion test will include such items as the following:83          Minimum current reserve estimate Achievement of operating stability Achievement of design production Achievement of design capacity Achievement of design recovery Specified operating cost Specified product quality Cash flow coverage of debt service Debt ceiling (debt/ equity ratio) Lenders may also require some kind of completion and recompletion covenants and a breach of such a covenant may give rise to an action for damages. 938. 378. Typically these will be marginal to the successful outcome of the project 81 82 83 84 85 86 Halupka. above n 76. There may also be sales tests or cover ratio tests to be satisfied. firstly the transfer of risk as the sponsor‘s covenant will fall away. and secondly the debt obligations transfer from the sponsor to the project on a stand-alone basis.81 The breadth of attitudes towards what is completion requires clear definition of the term for each particular project. however this requirement is not usually essential. First. 938. ―physical completion‖ of the mine.85 Following construction completion it is also likely that the lender will require a covenant around ownership and project management responsibilities (ensuring that the sponsor remains the contracted party). Second. 378. above n 76.

quality or mineralogy specified in the earlier studies.. D. Ward. ‗Mining Project Standards Must Rise to a New. Consistent Level‘ Engineering and Mining Journal. For example a study of 35 Australian gold mines in the 1980‘s found that 68% failed to deliver the planned head grade. O‘Leary. Tina Wang.7 Billion Investment Not Worth A Nickel‘ reports how BHP Billiton persisted through commissioning and into operations burning another $1. 116. Macquarie University. April 1999.90 Project financiers recognize that ‗ore reserves hold potentially the greatest risk for project finance lenders where there is no recourse to the parent entity beyond the project‘91 In fact ‗Mineral resource/reserve problems are the most likely technical problem to account for failure of mining projects. Shillabeer and Gypton. Conference Mt Isa.B. 4. August 2001. resource and 87 Peter Klinger.95 A more recent study found that 17% of a sample of 105 projects failed to meet Billion Investment Not Worth A Nickel‘.forbes. There are projects however that experience such exorbitant increases so as to make the entire enterprise uneconomic. Australian Journal of Mining. ‗$1b Over Budget and a Year Late. 134. AIG Journal Paper 2001-7. Their Ravensthorpe Nickel Project was approved in March 2004 for a $1. 88 89 90 91 92 93 94 95 20 of 32 Jamie Morien 246202 . From Resource to Reality: A Critical Review of the Achievements of New Australian Gold Mining Projects During the Period January 1983 to September 1987.MINING PROJECT DEVELOPMENT and will be provided for from a contingency fund. above n 37. December 2008.. Shareholders filed a class action against the company. Amos Q. the world‘s largest diversified mining company has too many such examples in its historical pipeline. Sometimes companies persist with the project to their own <http://www.html> at January Steve Fiscor. Burmeister B.thewest.1.2 Billion.5 Billion.94 and in the 1990‘s a study demonstrated that of nine Australian underground base metal mines only 50% achieved design throughput by Year 3 and 25% never achieved it at all.87 Last year a Forbes article provocatively entitled ‗BHP's $3. BHP Billiton for example. Nickel Mine Finally Open‘. J.‘92 The sensitivity due to ore grade can be two to three times that of the sensitivity due to capital costs. and Breaden P.89 ii Resource Risk Resource risk is the risk that the minerals and other resources will not meet the quantity.aspx?MenuID=32&ContentID=74725> at 8 June 2008. 116. In 2007 the Galore Creek project in Canada suffered a cost blow-out during construction from $2. 1988. 14-2. Qld. mass redundancies and a plummeting share price. The JORC Code – A Banker‘s View.93 Studies have shown that resource risk has had significant outcomes on projects for decades. above n 22. P. above n 71. Wood. The West Australian (Perth) <http://www.88 The fallout of the BHP Billiton loss was some major writedowns.1 Billion investment only to be completed over a year late and for a reported $2. ‗BHP's $3.2 billion to $5 billion. ‗Start-up Performance of New Base Metal Projects‘ in Adding Value to the Carpentaria Mineral Province.

defined and reported according to the relevant code of practise (sic) before (emphasis in the original) each relevant phase of the project.‘99 One issue is widely agreed and that is that ‗[m]ineral resources should be audited. 7. Schanz.MINING PROJECT DEVELOPMENT reserve estimations. Noort and Adams. 116. above n 38. whereas a South American copper producer defines a block confidence ± 25% at the 95% confidence level on an individual clock basis to qualify in the same category. J. J. 7. above n 89. which offer a set of guidelines for mining studies. Fiscor. The United Nations Classification of Resources is illustrated as follows: Figure 3 United Nations Classification of Resources 97 A roundtable by one of the larger mining consultancies agreed overwhelmingly that levels of accuracy for feasibility studies overall should not be defined in terms of estimate accuracy but rather in terms of detailed lists of prescribed investigations with the estimate accuracy implied by completing the specified studies. above n 36.‘100 In general project financiers have been willing to accept resource risk where they ‗have had the opportunity to call in independent experts to assess the relevant data forming the basis for the 96 97 McCarthy. O‘Leary.96 The best response is to adhere to the specifics of the standards described earlier in this paper. 98 99 100 21 of 32 Jamie Morien 246202 . 313. Modifying the resource base because of geological reinterpretation or information obtained during the course of a study phase is often the cause of rework and delays. above n 22 133.98 The issue that faces the financiers is that the classification systems can differ significantly in terminology and interpretation. For example a ‗North American gold producer that defines ‗proved‘ ore as ‗a block estimated on the basis of at least one sample no more than 75m from the block centre‘. ‗The United Nations Endeavour to Standardise Mineral Resource Classification‘ (1980) 4 Natural Resources Forum 307.

1. 377. above n 9. thereby leaving a 50% ―reserve tail‖ as a cushion against deviations from the plan. above n 71.‘101 As another form of risk mitigation lenders will typically require a ―reserve tail‖ which is ‗an amount of economically recoverable ore reserves which remain unexploited at the scheduled maturity date. advisers and consultants have a good ―track record‖.106 ‗Where the producers. If there are take or pay agreements it is vital that the project is ready to delivery product from inception date of the off-take agreement or it will face 101 102 103 104 Ladbury. 83. above n 76. 14-2.‘105 Generally the lenders are willing to accept operating risk. or at least that there won‘t be unacceptable risks of volatility in that market.108 The best treatment for this type of risk is to establish offtake agreements which are a form of hedging. 55. Wood. Off take agreements govern the sale of the product of the project. Financiers will not lend the funds and boards will not approve the project if there are no customers locked in to take the product. The impact of the offtake agreement is on practical completion. Bremen and Lawrence. within reason.‘103 iii Operating Risk Operating risk includes ‗new technology risk. Halupka. For process plant projects these agreements are crucial to the development proceeding. the expertise of the operator and the exposure of the project to a hostile physical environment.‘ 102 A standard rule of thumb in project lending is to ‗restrict the loan life to a maximum two-thirds of the project life on the basis of proven and provable ore reserves. 83. Scheinkestel. Wood. above n 76. management and labor issues. above n 71. ‗Taking it to the Bank – Making Your Mining Project Bankable‘ (2005) September Engineering and Mining Journal 80. 937. Adrian Lawrence. Ladbury. above n 72. 938.MINING PROJECT DEVELOPMENT estimates…[the] degree of risk may be reflected in the security taken and the relevant margins. vulnerability of the project to breakdown. lenders usually accept technology risk‘107 iv Market Risk Market risk is the risk of whether there will be a market for the product. the availability of a competent labour force. 14-2. James Bremen. above n 104. post-construction.‘104 Operating risk also includes ‗the availability of raw materials for the project.1. and environmental and governmental interference issues. 105 106 107 108 22 of 32 Jamie Morien 246202 .

The market for the product is thus tied to the limited market of refiners who have a facility of the proper configuration to treat the concentrate. The smelting and refining process can be resource intense so it is more cost effective to export the concentrate to an existing smelter and refinery in Indonesia rather than construct a similar facility in Australia. above n 9. 233. When the global financial crisis caused the purchaser to put their facilities on care and maintenance they chose to pay rather than take physical delivery of the acid. ‗Project financing deals typically require that at least 80% of production during the loan life be secured under long term purchase and sale conracts with approved smelting/ refining companies. The entire process plant had to be shut down as there was nowhere for the acid to be stored as it was produced during the process. The network of contracts (first and foremost. silver and zinc. Scheinkestel. Stephen Webb. above n 21. 110 111 112 113 23 of 32 Jamie Morien 246202 . It may even have to buy product on the open market to meet its obligations. and 2. EPC Contracts – Process Plants (2005) Review.mallesons. In fact the quantum of paperwork involved is tremendous as exemplified by the CSR Limited‘s Delhi transaction in 1982 which according to the lenders involved more paperwork than the rescheduling of the entire Polish sovereign debt outstanding at the time.MINING PROJECT DEVELOPMENT penalties.109 In mining projects the product produced is often not in its finished Nicholas Tsirogiannis.‘110 Lenders may prefer sales contracts to be established based on a take-or-pay form of contract whereby there is an unconditional obligation to pay for the product irrespective of whether the product is actually delivered. For example a mine in Australia might produce copper concentrate with dilutions of gold. above n 76.111 In my own experience such a take-or-pay arrangement was put in place for the sale of acid which was produced as a by-product of a mineral processing process. Halupka. Gatti. This can be a costly exercise if those markets are thinly traded or demand for these products is high. 375. the credit agreement) that regulate the relationship between the different players in the project. 939. 4 The Commercial Aspects of Project Financing A number of contractual arrangements exist in a project financing arrangement that define the commercial and financial relationships between the various parties to the project.113 109 Damian McNair.112 The legal considerations of a project financing deal revolve around two groups of concepts: 1. above n 72. Ladbury. 53. A risk that wasn‘t properly identified prior to establishing the take-or-pay contract was what to do in the event of such a scenario where the wider market for acid faltered. at http://www.cfm?id=481 at 25 November 2008. The project company and its economic/ legal function.

relying heavily on debt leverage (typically 50% or more) for its capital needs. Esty. above n 23. How the project company is structured is determined by ‗the financial. legal. accounting and taxation constraints and objectives of each of the sponsors‘. 37. Corporations 116 Figure 5 below demonstrates a typical structuring for a project finance deal.115 Figure 4 Debt-to-Total Capitalisation Ratios: Project Companies vs. For example there may not be an issue of bonds and the sponsors may be the only equity investors and are typically the operator of the facility. 24 of 32 Jamie Morien 246202 .114 Compared to typical public companies this highly leveraged element is significant. Figure 4 demonstrates the significant difference in the debt to total capitalisation between a sample of project companies and corporations in the United States. The structuring differs from one project to the next. ‗Project Finance‘ in Bruce et al Handbook of Australian Corporate Finance (1997) 302.MINING PROJECT DEVELOPMENT A key characteristic of a project financing is that the project company is established as a separate business and legal entity. above n 9. John Martin. or Special Purpose Vehicle (SPV). Figure 5 The structure of project finance 117 114 115 116 Halupka. 371.

It is in this sort of financing that conflicts can arise between the lenders and the nonborrowing joint venturers in relation to the joint venture agreement. above n 17. An unincorporated joint venture is the most common ownership structure for projects in Australia. Where several finance is obtained on the security of the project the borrowing venturer will almost invariably be asked to charge its individual interest and its interest in production. each of the joint venturers arranges its own finance. 124. 943.MINING PROJECT DEVELOPMENT a The Sponsor Given the sheer size of many mining projects it is often essential to involve multiple parties in the project company.122 b Offtake Contracts and Long Term Purchase Contracts The offtake contract or long terms purchase contracts are important as they assure a market exists for the project‘s output as per the discussion above. 3. above n 15. Esty.‘120 A key benefit to creating an SPV is that it ‗provides an opportunity to create a new. Each joint venturer commonly gives a charge over its individual interest in the project and any product. Scheinkestel.124 Therefore it is also important that the length of offtake agreements (and certain other agreements) is adequate: The relative lengths of the key project contracts are important for project financing. 303. the lenders to a project who are depending on the offtake. 36. and other key agreements as an important source of the credit strength of the project will not agree to a debt contract whose maturity 117 118 119 120 121 122 123 124 Tan. Ibid. asset-specific governance system to address the conflicts between ownership and control. sales contracts and proceeds in favour of the lenders. each of the joint venturers procures its finance from the same lenders. 944. Finnerty.‘121 This extends to deterring expropriation by host governments of projects. As a general rule. One commentator identifies numerous examples of project sponsor‘s having to renegotiate with purchasers as diverse as Japanese steel mills and Australian government owned utilities discover that estimates of requirements or long-term pricing may have been flawed. Ladbury. above n 76. raw materials. above n 72. Martin.‘119 In several financing. Ibid.123 Challenges arise however when the fundamentals underpinning the original deal change significantly. ‗In joint financing. operating.‘118 The joint venturers may procure lending together (joint financing) or severally (several financing). 58. above n 23. 25 of 32 Jamie Morien 246202 . any sales contracts and the proceeds thereof. and also gives a guarantee of the other joint venturers‘ debt in favour of the lenders and a charge in furtherance of that guarantee. above n 115.

125 126 Finnerty. Halupka.129 Other key licenses and permits encompass native title. 2256. Bank loans and bonds will be scheduled to mature before the concession agreements and the offtake contracts are scheduled to expire. 37. 127 128 129 130 131 26 of 32 Jamie Morien 246202 .MINING PROJECT DEVELOPMENT exceeds the length of any one of these key agreements. Barratt (eds). discriminatory legislative or regulatory changes covering tax regimes and environmental laws. licenses essential to construct and operate the plant such as water supply licenses. the length of these key project agreements constrains the maturity of project debt. D. 379. thirdly the construction (sub)contractors who are engaged by the EPC and EPCM firms and fourthly the insurers. 61. Practice. procurement and construction management .‘ 125 c Contractors and Suppliers The contractors and suppliers in the project financing structure provide materials. property and right to mine licenses. the Engineering. Ibid. ‗The Risks and Rewards Associated with Different Contractual Approaches‘ in A. Procurement and Construction Management (EPCM) contractors who provide the balance of the engineering design. political force majeure such as riots. wars. Halbe. Procurement and Construction (EPC) turnkey contractors or Engineering. ‗Construction Risk and Project Finance – Risk Allocation as Viewed by Contractors and Financiers‘ (1997) 1 The International Construction Law Review 9. D. 83.127 and proper risk identification should lead to the form of contract most suitable for the project.‘128 i Licenses and Permits The lenders will require the process technology licenses to be in place for at least the duration of the project loan. above n 104. Mineral Processing Plant Design. Mular. 379. equipment and services for the design and construction of the mine. process plant and infrastructure. Halupka. Bremen and Lawrence.130 In less mature legal jurisdictions the process can be highly uncertain and as such lenders will require that at least ‗in principle‘ agreements be in place prior to the finance submission. concession. Andrew Stephenson. and Control (2002) 2245. civil unrest. The main contracting parties involved in the design and construction of the mine process plant include the process supplier who provides the ‗high tech‘ process engineering design. above n 17.126 Contracts can be used to allocate risk.131 ii Host Government Host governments pose a special set of political risks especially in the developing world in regard to expropriation. P Jeff Gard. As the project company will usually have to repay the debt by the maturity of the debt agreement. ‗Risk Allocation in Process Engineering Projects‘ (2003) 22 Australian Resources and Energy Law Journal 49. strikes. above n 9. Peter Megens. 84. above n 9. The contracts define the terms and conditions by which the facilities will be built.

The contracting strategy. which defines in a major way the overall implementation strategy. terrorism. government participation or nationalisation. September 2005.mallesons. currency availability. John Dorter. Review. 15. Stephen Webb. ‗Management of Risks. process plant and infrastructure is of key interest to the lenders.MINING PROJECT DEVELOPMENT invasions. P J Gard. schedule and performance.132 Insurance may be an option for treating host government risks. are generally preferred by lenders. and religious turmoil need to be considered. should be developed through a detailed process of risk allocation. Cusworth.134 and the proper risk identification should lead to the form of contract most suitable for the project. 14-17 – 14-18 Megens. foreign management. Nicholas Tsirogiannis. pp.135 However for the bulk of investments (by number and probably value) in the resource sector. Externalising the governing law of and forum for the loan and  Taking out political risk insurance. Contracts can be used to allocate risk. above n 71. iii EPC/ EPCM Contractors The implementation strategy for the development of the mine. <http://www.136 For this reason contracts guaranteeing completion and performance such as Engineering. above n 54 Damian McNair.  Encouraging the involvement of international agencies as co-lenders on account of their greater diplomatic bargaining power in the event of default. In practice lenders seek to avoid political risk by:133    Externalising the security (e. 9. above n 127. Performance. Uncertainties and Opportunities on Projects: Time for a Fundamental Shift‘ 19 (2001) International Journal of Project Management 89. which include liquidated damages for late or under-performing plants. BCL Vol. 1999. Formal undertakings from the host government as to its policy on taxes. Procurement and Construction (EPC) contracts. royalties. guarantees are kept in external trust accounts).137 A construction contract is after all ‗an exchange of promises to produce a project for a price within a period. the implementation strategy is typically set to first deliver completion guarantee support to debt providers. The problem that may arise here is that the sponsor may be unable to apply innovative risk management and transfer strategies or alternative contracting strategies because of the involvement of the project financier who 132 Ali Jaafari.cfm?id=481> at 25 November 2008. 361 133 134 135 136 137 138 27 of 32 Jamie Morien 246202 . ‗EPC Contracts – Process Plants‘. and the continued availability of the concession. 92. Wood.‘138 And EPC contracts probably provide the most advantageous risk structure for certainty of price. above n 128.

Hickson. Delay in reaching mechanical completion. above n 56. ‗On the Allocation of Risk in Construction Projects‘ 9. The key difference between the EPCM and the EPC forms of contract is that in the EPC form the contractor is a principal in relation to procurement and construction. 143 144 145 146 147 28 of 32 Jamie Morien 246202 . Lawyers Weekly.139 Also the lenders may ‗seek to allocate maximum risk to the contractor for the good of cash flow – insisting on an allocation of risk even more narrow than that which might otherwise have been negotiated between industry participants. 2.143 This is often because the scope of mineral development projects is less defined moving from the feasibility study into the detailed engineering that kicks off the execution phase once full project authorization has been received. whereas in an EPCM is merely an agent. Stephenson. ‗Conducting an Effective and Accurate Assessment of Project Risk‘ 5. are change orders to the contractor‘s benefit‘. 370. Andrew Chew. 142. Patrick Mead.144 But one must be careful in selecting an EPC contract when an EPCM may have been more suitable because if ‗limits are not precisely defined. I EEE Technical Applications Conference and Workshops Northcon95.142 The use of EPC contracts for mineral development projects however is much less common than EPCM contracts. ‘Reducing Development Time & Cost Through Effective Project Management‘ (1995) Northcon 95. for example. Mining and Public-Private Partnership (PPP) Projects‘ (2004) May/ June Australian Construction Law Newsletter. 61. 3 (1991) International Journal of Project Management. Ibid. ‗An Overview of Delivery Structures used in Major and Complex Infrastructure. above n 248. 6. and Inadequacy of insurance.‘140 At the same time ‗a project financier may be unhappy to proceed if it feels significant risks are being borne by a project participant who may not have the wherewithal nor ability to control that risk.‘ 141 The result is that projects may be implemented differently where there is project finance involved than if a sponsor with full equity had ultimate control of the strategy. 372. Such a scenario implies increased cost and schedule risk. should be aware of this and not simply follow the precedent of other similar projects which may have been influenced by the lenders in this way. 120. Delay in commissioning and ramp-up. ‗Who Goes First?‘ (2006) October 13. Project participants who are involved in selffunded projects with some of the majors. all one gets from a lump sum. above n 273. The Lump-sum EPC acts as a quasi-insurer. S Ward.MINING PROJECT DEVELOPMENT will see completion risk as one of the key drivers.145 The key risks that are assigned to the EPC contractor are:146      Defects in design and failure of the process engineering. C Chapman. 10-12. Von Branconi.147 The EPCM contractor will merely carry out the balance of the engineering design (typically 139 140 141 142 Patrick Mead. Defects in construction. 140. Process Plant. 2261 Dominick Soldano.

119.  The inability to determine which risks should be shared: risks that are outside of the control of both contractual parties may be ones best shared – for example the risk of inclement weather may be one agreed to be borne by the principle in a time sense but in a cost sense will be the contractor‘s risk. a project financier may be unhappy to proceed if it feels significant risks are being borne by a project participant who may not have the wherewithal nor ability to control that risk). Construction Industry Institute. Chew. 6.152 That being said. in order to provide balance sheet protection. above n 54. investing more resources and assuming all risks.150 Important consequences may flow from the inefficient allocation of risks:151  The bankability of the project (i. Implementation Resource 165-2. such as an insurer. manufacture and construction. cost and performance of design. 151 152 153 29 of 32 Jamie Morien 246202 . Chistoph H Loch. above n 143. 21.  The principal paying an inflated price for the project as a result of loading unnecessarily (from the principal‘s point of view) built into the tender prices as a result of the tenderers being asked to price a contingency over which they have no control. The selection of the appropriate contracting strategy is ‗far from an exact science – there is no formula into which each project‘s peculiarities and owner‘s requirements can be ‗plugged in‘ to produce the most suitable delivery structure‘. Mead. ‗Owner‘s Tool for Project Delivery and Contract Strategy Selection‘ (2003. ‗Contracting for Major Projects: Eight Business Levers for Top Management‘ (2004) International Journal of Project Management 22. 49. 2 nd ed) Project Delivery and Contract Strategy Research Team.  The ability of that party to procure the requisite and appropriate insurance or even to determine whether insurance is required with respect to a particular risk or whether that risk is better managed via that party‘s internal risk management processes.148 Typically the EPCM contractor has limited liability in respect to time.149 The owner must take a much more significant role with an EPCM contract and ‗…drive the project.MINING PROJECT DEVELOPMENT excluding the process technology) and manage the procurement and construction of the project. The contractor has little incentive to be efficient‘. Doug Jones. 1. recognizing the unique circumstances of 148 149 150 Chew. Christof von Branconi.e. a think tank in Austin Texas produces numerous tools for assisting project developers including the ‗Owner‘s Tool for Project Delivery and Contract Strategy Selection‘. the Construction Industry Institute (CII). above n 143. 8. ‗Where Are the Standard Forms Going?‘ 47 Australian Construction Law Newsletter 15. Shared risks outside of the control of each party with financially significant consequences may also be ones transferred to a third party. 120.153 CII points out that risk allocation should be done ‗in a compromising and educated manner.

‗Conventional and Nonconventional Risks Insurance for Mining Projects‘ (1995) Forty-first Annual Rocky Mountain Mineral Law Institute 472. Allens Arthur Robinson. John Baartz. Ibid. time and quality). Justin Swanson ‗Contracting to Appropriately Allocate Risk‘ CII Research Report 210-11. The factors are ranked in order of significance and the outcome is a chart demonstrating the most appropriate contracting strategy and a ranked tabulation of the project delivery and contract strategy options with default compensation approaches recommended. In situations where the EPCM contractor is not responsible for the process design. Project planning and controls capability of the contractors (cost. construction. 474 . Schedule constraints. Tony Holland. Capability of the principal (technological. 158 159 160 30 of 32 Jamie Morien 246202 . John Naughton. construction and commissioning. above n 153 1.). Hanna. August 2007 Construction Industry Institute.155 Chew (2004) points out that the following factors need to be considered in the development of the contracting strategy:156        Degree of complexity of the engineering. performance risk.MINING PROJECT DEVELOPMENT each specific project. Safety record of the contractors. Insurance may be the only risk allocation solution for the sponsor. ‗Construction and Infrastructure Projects – Risk Management through Insurance‘.159 Numerous unconventional insurances may also be available to the financier and are worth exploring that cover risks including design risk. political risk. 5th ed) 277. 473. Level of control the owner wants over the project phases of design development. 6.158 Conventional project insurances do however allow the financiers interests to be recognised in the project cover. the EPCM provides no warranty for the process itself working. project controls etc. above n 143.160 154 155 156 157 Awad S. but one option is to take out loss of profits insurance against the risk of late delivery of the project or other delay in cashflow. ‗Project and Infrastructure Financing‘ in Mellesons Stephen Jaques Australian Finance Law (2003.‘154 The CII tool involves six steps whereby the project team evaluates the project objectives and then selects six factors that are imperative to the delivery of the project. 2003 Charles Berry. shortfall of mineral deposits and force majeure. iv Insurers An important consideration is the insurers. Peter Doyle. The size and complexity of the project.475. Chew.157 It is typically difficult for finaciers to obtain insurance cover specifically protecting their exposure during the construction phase.

above n 17. They may like to see raw material contracts to ensure adequate sources of supply for the key raw materials without which production cannot take place and possibly some advancement on operating agreements that govern the day-to-day operation of the project company.MINING PROJECT DEVELOPMENT v Operations Contracts Lenders are much less concerned with the risks during operations of a plant.161 161 Finnerty. 31 of 32 Jamie Morien 246202 . 37.

The miners have to take the initial lead in this process and understand what the requirements are of financiers and address them early in the investigation and study process. Mining is risky business and the typically conservative financiers seek to protect their investment and not take an equity risk on the project. control and treat risks to ensure that uncertainty is reduced and quantified.CONCLUSION III CONCLUSION This paper has examined many of the issues that arise in a project financing undertaking for mining projects. Once an opportunity is proven however within specified tolerances the use of project finance becomes an option. The need then for the miner and financier alike is to assess. Project finance allows them to leverage their resources and pursue more or larger projects than otherwise possible. The significant up-front costs in initiating a mining project still rely on conventional funding sources including bond and share issues and investments of equity. 32 of 32 Jamie Morien 246202 . Project finance will likely continue to be the predominant form of financing for mining projects as it allows mining companies who have diminishing reserves to maintain a pipeline of new projects. The use of project finance has many benefits to the sponsor organisation that extend from the key defining element of this type of finance which is that it is ‗offbalance sheet‘ with limited or no recourse to the sponsor.