Mine Finance
INNOVATIVE FINANCE TECHNIQUES
GENERAL CHARACTERISTICS OF GOLD LOANS
A gold loan is based on the dual role of gold as a commodity and currency. In a gold loan, the
mining company needs finance for the development of its project that will produce gold. The
bullion lender has gold and is willing to lend it to the borrower in return for a commitment to
repay the gold, including interest, from future production.
In practice, the borrower needs cash to pay the various construction costs involved in the
project development. Therefore, the bullion lender normally undertakes to sell the gold on
instruction from the borrower and convert the sales proceeds into the currency required.
The transaction is denominated in gold, interest is incurred in gold, and all accounts and
statements relate to gold. The unit of account used customarily is a troy ounce of gold
bullion of a specified quality/fineness.
EXAMPLE
A typical example of an Australian mining company using a gold loan to finance a new mine
is given as follows.
New project capital expenditure A$20 millions
5 year mine life
Company borrows 40,000 ounces of gold (equal to A$20 millions at $500 per ounce)
An interest rate with charges of 2.5 % is levied on the loan.
Repayments start 12 to 18 months after drawdown of the loan and consist of 8,000
ounces each year for 5 years (plus interest of 1,000 ounces repaid in year one)
The trend to gold loans has been facilitated by:
(1) The low nominal costs of gold loans,
(2) The hedging provided by borrowing in gold for gold projects and
(3) The innovation and aggression of financial institutions in refining the gold loan
concept and marketing it.
GENERAL CHARACTERISTICS OF FORWARD SALES
In simple term, a forward sale is the arrangement of a price for the future of gold based on its
current spot price plus a premium (or contango). Forward sale locks in a contango over the
spot price at the time of a sale and implies a judgment that the price of gold will not rise over
the period faster than the relevant interest rate.
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The reasons the gold mining companies use forward sales are as follows.
To lock in a gold price to insure against future downside gold price movements,
To try to obtain a higher average sale price than the average market price and
To try to establish with certainty a higher future sales revenue upon which the capital
costs of a new project can be based.
Types of forward sales
The aim of forward sales is to fix the gold price for mine production for up to 4 to 5 years.
The various types of forward sales are, fixed forwards, deferred forwards (spot deferred),
level price forwards (flat forwards) and fee based forwards.
(a) Fixed forwards
Fixed forwards are forwards written for a fixed delivery date with the contango also being
fixed at the time of entering into the transaction. In these kinds of forwards, the amount,
delivery date and forward price are all fixed. The calculation of the forward price is as listed
below.
The forward price = spot price x (1 + contango)n
Where n is the number of periods (months or years).
An example is given to demonstrate the calculation of the forward price. The general
information is listed as follows.
The amount 8,000 ounces
The starting spot price A$500 per ounce
The interest rate 12.5 %
The charges 2.5 %
Therefore, the contango rate = 12.5 % interest rate - 2.5 % charge = 10 %.
Forward price at the delivery date:
Year 1 A$500 x (1 + 0.1)1 = A$550 per ounce
Year 2 A$500 x (1 + 0.1)2 = A$605 per ounce
Year 3 A$500 x (1 + 0.1)3 = A$666 per ounce
Fixed forward sale has less flexibility in terms of delivery times but the fixing of the
contango at the time of the transaction can usually be favourable in times of falling interest
rates.
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(b) Deferred forwards (Spot deferred)
In deferred forwards, the amount and the spot price are fixed. This is a variation of fixed
forwards and is in essence a spot sale with the settlement deferred. Before settlement, the
interest is accrued on the basis of a variable interest rate, often advised weekly.
The delivery date is open to election by the gold producers. The settlement price is a function
of the starting spot price and interest rates which float over the duration of the transaction.
The forward price = spot price x (1 + floating interest rates)n
Where n is the number of the periods (months or years)
Deferred forwards have the advantage of flexibility in terms of delivery compared with fixed
forwards. However, because of the floating interest rate, it may expose the gold producers to
the vagaries of movements in interest rates.
(c) Level price forwards (Flat forwards)
Level price forwards are fixed forwards with a string of forward contracts at one level price.
The discounted contango is effectively spread evenly over the period of the forward sale. The
gold producers in this will receive a greater revenue for early deliveries and a lower revenue for
later deliveries. The average of several prices is calculated using the fixed forward method.
EXAMPLE An example of level price forwards is given in Table 1. The average price of a
level price forward for year 1-3 is A$607.00 per ounce.
Table 1 Level price forwards - an example
Period Interest Rate Fixed Forward
Selling Price
12 months 10 % A$ 550/oz
24 months 10 % A$ 605/oz
36 months 10 % A$ 666/oz
Level Price Forwards
Average Selling Price = A$(550 + 605 + 666)/3
= A$ 607/oz. (for Year 1 to 3)
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In year 1, it is much higher than for a fixed forward arrangement. However, the forward prices
of both types of forwards in the second year are about the same. In year 3, the fixed forward has
a higher selling price than the level price forward.
As mentioned above, it has the advantage of producing a higher price earlier but this is off set by
a lower price in later years. Higher up-front revenues are very important particularly for some
Australian gold producers if repayments of debt financing are being made.
(d) Fee based forwards
Fee based forwards are fixed forwards with a variation. The duration of the forward is
normally more than one year. The spot price, the amount, delivery date and interest rate are
all fixed.
The gold producers are charged a floating borrowing cost, normally on a six month basis and
the accumulated fee is deducted from the grossed up forward price.
OTHER INNOVATIVE FINANCIAL TECHNIQUES
There are other alternatives to facilitate the financial strength of a mining project by reducing
the amount of up-front capital expenditure needed.
Equity Participation By Suppliers
Equity participation by suppliers is basically one variation of joint venture arrangements -
suppliers provide material or services to the project in exchange for equity shares. The
project is financed by capital advances and operating advances from the suppliers. Capital
expenditures and operating expenses are shared in proportion to the ownership.
The gold producers have the benefits and economies of a large facility and an assured source
of supply. The only disadvantage is that the gold producer lacks absolute control over the
project's operating facilities.
The Fly In Fly Out Arrangements
In the FIFO arrangements, employees are drawn from a home base (large, coastal or
established mining town) and flown to the mine site for intensive work periods (i.e. 2 in 1 out
with 12 hrs shift). Town vs FIFO operation has SAME END COST - FIFO changes front
end capital expenditure to an ongoing operating cost - more equitably distributed over the
mine life. As a result, mines that could not previously afford to start up due to the high up-
front infrastructure costs, now may be possible. FIFO provides flexibility and control over
opening and closing the operation at short notice depending upon commodity prices and other
economically unfavourable circumstances.
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Leasing
Leasing is a modern form of off-balance sheet financing that offers a high degree of tax
efficiency. The concept of leveraged leasing involving the lessee (the user of the asset - normally
the mining company), the lessor (the owner of the asset) and a lender such as a bank provides an
efficient method for a corporate entity to utilise assets through tax deductible regular leasing
payments. Advantages of leasing over borrowing include
Lease charges written off for taxation purposes,
Offers an added line of credit
Gives added leverage to return on investment,
Reduces risk to owners if project is unsuccessful and
Owners of short life projects do not have to dispose of partly utilised
equipment.
Disadvantages include
Total cost of leasing make be greater than total cost of buying particularly for
long life projects and
The operation does not own the facility or equipment at the end of the lease.
Cannot use as a fixed asset as security against future financing.
Contractor Mining and Equipment Leasing
Without the high costs of hiring, training and settling in of workers and the up-front capital costs
of equipment purchasing, contractor mining and equipment leasing arrangements have reduced
the capital costs needed for starting up. There are also substantial tax benefits in the use of leased
equipment. The disadvantage of the system is higher ongoing operating costs.
CASE STUDIES
Basic Data of the Case Study The company selected for case study was a small scale mining
company with a major gold project financed by a gold loan facility. The detailed financial
and operational information on the project is as follows.
Mineable Ore Reserves 2.0 to 2.5mt @3.14g/t Au.
Recoverable Gold About 200,000 ounces
Proposed Throughput 600,000 tpa
Recovery 93 percent
Annual Production 56,300 ounces
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Operating Costs $27.80 per tonne or $296 per ounce
These costs are made up of : $/t
Mining 15.51
Milling 9.29
Grade Control 1.00
Transport of Ore 2.00
Total 27.80
Capital Costs Total - $12.5 millions, made up of : $
CIP plant transport and installation,
additional ball mill, water supply,
tooling, dam, power, road etc 7.5 m
First payment to owners, end of year 0 2.5 m
Second payment, end of year 1 2.5 m
Total 12.5 m
The estimated profit and cash flow of the project with gold loan financing is shown in Table
2.
The details of the gold loan facility used in the project are as follows.
The Amount of the gold loan 18,996 ounces
The Price A$473.78 per ounce
Funds Availability A$9,000,000 (less charges)
The Term 3 years
Interest Rate and Charges 2.5 percent per year
Repayments 6332 ounces per year (year 1-3)
Cash Loan Case
Another alternative for the company to finance the project would have been to arrange a cash
loan of A$9 million to cover the costs of the construction, development and commissioning
of the project. The term would have been for 3 years and the interest rate would have been
14.5 percent.
The schedule of repayments would have been A$3 million plus interest per year from year 1
to 3. The estimated profit and cash flow of the project with the alternative cash loan
financing facility is shown in Table 3.
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Table 2 Estimated profit and cash flow with gold loan financing.
Year 0 1 2 3 4
Year Ended June 1989 1990 1991 1992 1993
Throughput 100000 600000 600000 600000 400000
(tpa)
Average grade 3.14 3.14 3.14 3.14 3.14
(g/t)
Recovery (%) 93 % 93 % 93 % 93 % 93 %
Gold production 9390 56338 56338 56338 37559
(ounces)
Revenue A$500 4.69 28.17 28.17 28.17 18.78
($M) A$550 5.16 30.99 30.99 30.99 20.66
Operating costs 2.78 16.68 16.68 16.68 11.12
($M) A$296/oz
Interest & charges 478 478 317 156 0
(ounces)
Net Revenue
A$500/oz 1.68 11.49 11.49 11.49 7.66
A$550/oz 2.12 14.31 14.31 14.31 9.54
Deprec. & Amort. 0.48 3.2 3.6 3.6 2.6
($M)
Exploration ($M) 0.5 1.5 1.5 1.5 1.5
Income Tax ($M)
A$500/oz 0 0 1.25 2.49 1.39
A$550/oz 0 0 1.80 3.59 2.12
Net Profit ($M)
A$500/oz 0.70 6.79 6.39 6.39 3.56
A$550/oz 1.14 9.61 9.21 9.21 5.44
Capital Expend. ($M) 10 2.5 0 0 0
Gold Repayment 0 6332 6332 6332 0
(ounces)
Net Cash Flow
($M) A$500/oz -8.82 4.33 6.82 6.83 6.16
A$550/oz -8.38 6.83 9.32 9.33 8.04
NPV ($M)
MROR A$500/oz 9.17 MROR 7.05
@10% A$550/oz 16.39 @15% 13.34
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Table 3 Estimated profit and cash flow with cash loan financing.
Year 0 1 2 3 4
Year Ended June 1989 1990 1991 1992 1993
Throughput 100000 600000 600000 600000 400000
(tpa)
Average grade 3.14 3.14 3.14 3.14 3.14
(g/t)
Recovery (%) 93 % 93 % 93 % 93 % 93 %
Gold production 9390 56338 56338 56338 37559
(ounces)
Revenue A$500 4.69 28.17 28.17 28.17 18.78
($M) A$550 5.16 30.99 30.99 30.99 20.66
Operating costs 2.78 16.68 16.68 16.68 11.12
($M) A$296/oz
Interest & charges 1.3 1.3 0.87 0.43 0
($M)
Net Revenue
A$500/oz 0.62 10.19 10.62 11.06 7.66
A$550/oz 1.08 13.01 13.44 13.87 9.54
Deprec. & Amort. 0.48 3.2 3.6 3.6 2.6
($M)
Exploration ($M) 0.5 1.5 1.5 1.5 1.5
Income Tax ($M)
A$500/oz 0 0 1.08 2.32 1.39
A$550/oz 0 0 1.63 3.42 2.12
Net Profit ($M)
A$500/oz -0.36 5.49 5.52 5.96 3.56
A$550/oz 0.10 8.31 8.34 8.77 5.44
Capital Expend. ($M) 10 2.5 0 0 0
Loan Repayment 0 3 3 3 0
($M)
Net Cash Flow
($M) A$500/oz -9.88 3.19 6.12 6.56 6.16
A$550/oz -9.42 6.01 8.94 9.37 8.04
NPV ($M)
MROR A$500/oz 6.56 MROR 4.66
@10% A$550/oz 14.52 @15% 11.59
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Project financed by gold loan has a higher NPV than the project with cash loan and with
lower breakeven gold selling price.
Table 4 Summary of the NPV of the projects studied
Selling Price of Gold NPV
With Gold Loan With Cash Loan
MROR @ 10% $M $M
A$500/oz 9.17 6.56
A$550/oz 16.39 14.52
MROR @ 15% $M $M
A$500/oz 7.05 4.66
A$550/oz 13.34 11.59
Table 5 The breakeven gold selling price for both alternatives.
Breakeven Gold Selling Price
M.R.O.R. With Gold Loan With Cash Loan
10 % A$ 436.5/oz A$ 458.8/oz
15 % A$ 443.9/oz A$ 466.4/oz
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